The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law by the President on December 20, 2019 and implements major changes concerning retirement accounts such as traditional IRA, Roth IRA, 401(k) and 403(b) accounts.
The SECURE Act raises the age for beginning required minimum distributions (“RMDs”) to age 72 from age 70 ½ for individuals who turn 70 ½ after December 31, 2019. All IRAs (traditional or Roth) may now be funded at any age, provided the taxpayer is still working and earning income. Previously, only Roth IRAs could be funded after age 70 ½. Individuals who work at least 500 hours per year for three years will be able to participate in qualified retirement plans. The SECURE Act also expands penalty-free early distributions for account owners under age 59 1/2, for up to $5,000.00 within one year for the birth or adoption of a child, and allows an early distribution to be recontributed to the same plan or IRA and treated as a rollover without any time limit. Additionally, the rules are generally expanded to permit more qualified retirement plans to offer annuity payout options.
The most significant change made by the SECURE Act for estate planning purposes is the elimination of the “stretch” provisions for most non-spouse beneficiaries of retirement accounts. Prior to the passage of the SECURE Act, designated beneficiaries (generally, living human beings and certain qualifying trusts) on retirement accounts were eligible to “stretch” RMDs over their life expectancy (or in the case of a qualifying trust, over the oldest applicable trust beneficiary’s life expectancy), potentially receiving decades of income-tax free or tax-deferred compounding. For example, a child who inherited a parent’s IRA at age 40 could take out the benefits over 43.6 years based on the Treasury Regulation’s life expectancy tables.
The new standard under the SECURE Act is the “10-Year Rule.” Under the 10-Year Rule, the entire inherited retirement account must be distributed by the end of the tenth year following the death of the account owner. For someone who dies in 2020, the retirement account is required to be depleted by December 31, 2030. For the 40-year-old beneficiary referenced above, 33.6 years of possible tax deferral or “stretch” is lost due to the SECURE Act.
There are four groups of designated beneficiaries to which the 10-Year Rule does not apply, and the same rules that applied to them before the SECURE Act continue to apply to them. These beneficiaries are: (1) surviving spouse, (2) disabled or chronically ill (as defined in the tax code) persons, (3) individuals who are not more than 10 years younger than the account owner, and (4) minor children of the account owner until they reach the age of majority. It is unclear what is the age of majority for purposes of the SECURE Act. It may be as old as age 26 if the child is in a “specified course of study.” Future IRS guidance will be needed to provide clarity on this point. Once the minor attains the age of majority, the 10-year payout period will apply. Therefore, the maximum payout possible will be until the account owner’s child attains the age of 36.
Individuals who have IRAs or other retirement accounts should contact their estate planning attorney to review their current estate plans and beneficiary designations, particularly where trusts are named as retirement account beneficiaries, to determine what modifications, if any, are needed given the passage of the SECURE Act, and to discuss alternative planning strategies to help lessen the tax impact when leaving their legacy.