On May 23, 2019, the U.S. House of Representatives, by a vote of 417 to 3, passed legislation called Setting Every Community Up for Retirement Enhancement Act of 2019, or the SECURE Act. This legislation, if passed by the Senate and signed by the president, will cause significant changes for retirement planning, many of which are positive, but it also includes aspects that could have a big impact on estate planning.
The following are several of the more positive changes made by the SECURE Act:
- The repeal of the maximum age for traditional IRA contributions;
- The age for the beginning date for mandatory distributions will be increased from 70½ to 72;
- The five-year payout rule on inherited balances is increased to 10 years; and
- Allows for penalty-free withdrawals from retirement plans for individuals in the case of birth or adoption.
A significant, less favorable change made by the SECURE Act is the effective elimination of “stretch” IRA provisions for non-spouse beneficiaries. Currently, upon the death of an IRA account owner, certain non-spouse designated beneficiaries (individuals, groups of individuals or certain see-through trusts) are permitted to receive required minimum distributions (RMDs) over the life expectancy of the beneficiary, typically beginning the year following the year of the IRA account owner’s death. This provides a significant income tax deferral benefit by allowing investment profits to continue to be reinvested without being subject to taxation. That is, the longer the funds stay in the account, the greater the benefit due to the ability to effectively reinvest funds that would have otherwise been used to pay the taxes. Once the funds are distributed, they are included in the beneficiary’s taxable income.
For spouses, not only can they receive distributions based on their life expectancy, they may also “rollover” the inherited IRA into their own IRA, possibly delaying RMDs until the spouse reaches age 70½.
Under the SECURE Act, distributions to non-spouse beneficiaries (other than those who are disabled, chronically ill, or minor children) will be required to be taken over a period that would end 10 years following the year of the IRA account owner’s death. The existing rules described above will continue to apply for spouse beneficiaries. For minor children, the 10-year rule will apply once the child reaches majority.
This elimination of the stretch IRA provisions will have a significant impact on existing trusts that have been structured to accommodate retirement plans. That is, many such trusts allow the trustee to control distributions to the beneficiary based on the timing of RMDs, typically for the life expectancy of the beneficiary. If the SECURE Act is passed, the trustee could be required to distribute the account during the 10-year period following the IRA account owner’s death, or 10 years following the minor child beneficiary reaching the age of majority, losing the benefit of holding the funds in trust. If the trust allows for distributions to be accumulated in the trust, such distributions would be taxed at the trust’s more compressed tax bracket and potentially higher rates. Consequently, such trusts used in conjunction with retirement planning will need to be re-evaluated and alternative planning structures considered.
There appears to be bipartisan support for the House bill. The Senate has a similar bill in the works. Assuming that bill will pass in the Senate, the House and Senate bills will need to go through a reconciliation process before being sent to the president for signature.