The so-called SECURE Act is a comprehensive reform of the federal pension laws that also contains provisions that may have a material impact on an individual’s personal tax and estate planning. The provisions of the Act that have such an impact are summarized as follows:
I. Elimination of age 70-1/2 Restriction on Deductible IRA Contributions
Before the Act, an individual who attained age 70-1/2 could no longer make deductible contributions to a traditional IRA, even if he or she still had compensation income.
Beginning in 2020, the Act eliminates this prohibition and allows those who are still working or whose spouse is still working to make deductible IRA contributions. The income limits on the deductibility of those contributions remain in effect as before the Act.
Even if post age 70-1/2 IRA contributions are not deductible, one can consider making nondeductible traditional IRA contributions and then converting the traditional IRA to a Roth IRA.
The $100,000 annual limit on so-called qualified charitable contributions from an IRA is reduced by the amount of deductible IRA contributions made after attaining age 70-1/2.
II. Increase in Age for Required Minimum Distributions
IRA owners and certain participants in employer-sponsored retirement plans (collectively, “Account Holders”) are subject to the so-called required minimum distribution rules, which require the Account Holder to take these required minimum distributions (“RMDs”) over the life or life expectancy of the Account Holder.
Before the Act, an Account Holder must begin taking RMDs no later than April 1 of the year following the year in which the Account Holder attained the age of 70-1/2 years. This date is known as the “required beginning date.”
After the Act, the “required beginning date” is increased to age 72 years, but only for those Account Holders who attain that age after December 31, 2019. Those whose “required beginning date” was 70-1/2 must continue to take RMDs as if the law had not changed. In other words, anyone born on or before June 30, 1949 will be required to begin taking RMDs no later than April 1 of the year after they attain age 70-1/2, and anyone born on or after July 1, 1949 will be required to begin taking RMDs no later than April 1st of the year after they attain age 72.
III. Changes to Beneficiary Required Minimum Distribution Rules
The most profound change in the law for many will be the elimination of the lifetime ‘stretch’ of RMDs for certain non-spouse beneficiaries. This forced acceleration of the taxation of IRAs and employer-sponsored retirement plan benefits (collectively, “Retirement Benefits”) will likely turn many estate plans on their heads because of the individual’s reliance on the long-standing ‘stretch’ rules.
Prior to the Act, the post-death RMDs pertaining to an Account Holder’s Retirement Benefits varied depending on whether the Account Holder died before, on, or after the Account Holder’s required beginning date, and whether there was a so-called “designated beneficiary” of the Account Holder’s Retirement Benefits. If an Account Holder died before his or her required beginning date, the portion of the Retirement Benefits payable to a designated beneficiary generally must begin to be distributed no later than the last day of the calendar year following the year of the Account Holder’s death, and it could be taken over the designated beneficiary’s own life expectancy. If an Account Holder died on or after his or her required beginning date, the general rule was that the portion of the Retirement Benefits payable to a designated beneficiary generally must be distributed over the Account Holder’s remaining life expectancy (as if he or she had not died). In all other cases (i.e., where there is no designated beneficiary), the entire amount of the Retirement Benefits had to be distributed by the end of the fifth calendar year following the year of the Account Holder’s death. These rules will continue to apply to the accounts of those who died on or before December 31, 2019, and the rule in the preceding sentence will continue to apply in all cases.
For anyone who dies after December 31, 2019, the Act generally requires a designated beneficiary to take a complete distribution of his or her share of the Retirement Benefits by the end of the tenth calendar year following the year of the Account Holder’s death, regardless of whether the account holder dies before, on, or after his or her required beginning date.
There are exceptions to this new 10-year rule for so-called eligible designated beneficiaries (“EDBs”). An EDB is an individual who, with respect to the Account Holder at the time of his or her death, is (a) the Account Holder’s surviving spouse, (b) a minor child (but not a grandchild) of the Account Holder, (c) a disabled or chronically ill individual (regardless of any familial relationship to the Account Holder), or (d) an individual (regardless of any familial relationship to the Account Holder) who is not more than ten years younger than the Account Holder. An EDB (other than a minor child) may take distributions over his or her own life expectancy. However, upon the death of the EDB, the balance of the Retirement Benefits must be distributed within ten years. Once a minor child attains the age of majority, the child must take the balance of the Retirement Benefits within ten years from when he or she attains the age of majority.
IV. The Trust Beneficiary Problem
Many had set up their estate plans to provide for so-called conduit trusts for children as beneficiaries of Retirement Benefits. The purpose of the conduit trusts was to regulate a child’s access to any inherited Retirement Benefits. The trustee would withdraw the annual RMD (based on the beneficiary’s own life expectancy) and then distribute it to the beneficiary as a mandatory distribution.
After the Act, the trustee will be required to collect the entire balance of the Retirement Benefits by December 31st of the tenth year following the year of the Account Holder’s death (or the death of the Account Holder’s spouse if he or she was the primary beneficiary). The problem is that the amount collected in that tenth year will be a mandatory distribution, thus thwarting the Account Holder’s intent to regulate the distribution of the Retirement Benefits consistently over the non-spouse beneficiary’s life expectancy.
As a practical matter, it might make no difference to those who feel that their children will be sufficiently responsible at the end of such ten-years-after death period. However, for those who have young children or children (regardless of age) with spendthrift tendencies, or who have any sort of addiction, this could be a matter of great importance.
Fortunately, there is a solution. It won’t prevent the accelerated taxation of the Retirement Benefits (they will be taxed at the trust level), but it will provide for the control mechanism regarding access to the Retirement Benefits. The solution is a so-called accumulation trust, which allows the trustee to collect the Retirement Benefits, pay the income tax, and then hold the after-tax benefits for distribution in accordance with the trust provisions regarding any other trust assets.
V. What to Do
You should review your beneficiary designations for any IRA or other employer-sponsored retirement plan. If you have named a trust as the primary beneficiary, or as a contingent beneficiary, then you should contact us as soon as possible so that we can review your trust agreements to determine how best to respond to the Act’s new provisions in view of your circumstances.