CLIENT ALERT: The SECURE Act Impacts Retirement & Wealth Transfer Planning

By Attorney Amanda N. Follett, Schloemer Law Firm, S.C.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) will have substantial repercussions for retirement and wealth transfer planning, especially in the area of accelerating taxation of Inherited IRAs. The SECURE Act was signed into law December 20, 2019 and became effective on January 1, 2020.

Highlight of Beneficial Provisions

Certain provisions related to retirement plans may benefit you:

Extension of Requirement Minimum Distributions (RMDs). The Act extends the age at which you are required to begin taking RMDs to age 72 (previously 70 ½). (Note, however, that this does not help anyone who has already attained the age of 70 ½ in 2019 or before, and those individuals must continue to take RMDs.)
Removal of Age Limitation for Contributions to Traditional IRAs. An individual with earned income can make contributions to a Traditional IRA regardless of age. Previously, individuals were prohibited from making contributions in the year they turned 70 ½.
Qualified Charitable Distributions from IRAs. The Act does not change the age at which an individual can begin making Qualified Charitable Distributions from an IRA, which remains at age 70 ½. This created a window where an individual can make charitable distributions starting at age 70 ½ before they are required to begin taking RMDs at age 72.
Penalty-Free Withdrawals from IRAs for Birth or Adoption. The Act allows for penalty-free withdrawals from retirement plans for qualified birth or adoption distributions.

Provisions related to Section 529 college savings plans have been expanded in two important ways:

Payment of Student Loan Debt. Up to $10,000 of 529 plan assets can be used to pay off student debt of a plan beneficiary during an individual’s lifetime.
Apprenticeship Program Expenses. Funds can now be used for approved apprenticeship program expenses.

Controversial Provision: Annuities as Retirement Plan Investments

Annuities are now an eligible investment for retirement plans. An annuity as an investment vehicle needs to be carefully scrutinized due to their complexity and fee structure.

Detrimental Provisions: Acceleration of Taxation on Inherited IRAs

To make up for lost revenue in other areas, the SECURE Act will accelerate taxation of Inherited IRAs in many cases.

Prior to enactment of the SECURE Act, proper beneficiaries and careful estate planning could defer taxes on retirement accounts over the life expectancy of the beneficiary, which was often the life expectancy of children, or even grandchildren. This tax deferral is referred to as a “Stretch”. The advantages of the tax deferral under these Stretch rules could be very large.

Under the SECURE Act, when there is a “Designated Beneficiary” that is properly named most beneficiaries are required to fully withdraw the balance—and thus recognize the income—within 10 years. More specifically, all amounts must be distributed by December 31 of the year that contains the 10^th anniversary of the date of death. If there is not a “Designated Beneficiary” properly named (for example, if the beneficiary is listed as “my estate” or a standard Revocable Living Trust). The funds must be paid out within 5 years.

There are a few very important exceptions where “Stretch” deferral remains more advantageous:

Spouses. A surviving spouse can elect to either (1) roll a deceased spouse’s IRA into their own IRA, or (2) receive an Inherited IRA with distributions stretched out based on their life expectancy
Minor children. A minor beneficiary may stretch the Inherited IRA over their life expectancy, until they reach the age of majority. Upon attaining the age of majority, the beneficiary must fully withdraw the funds from the Inherited IRA within a 10 year window; withdrawals can be made in such amounts and at such times during this 10 year window as they desire, provided that all funds have been withdrawn at the end of the 10 year window.
Disabled Persons. Certain individuals with disabilities may stretch the Inherited IRA over their life expectancy
Chronically Ill Persons. Certain individuals with chronic illness made may stretch the Inherited IRA over their life expectancy
Persons Close in Age. A person who is not more than 10 years younger than original IRA owner may stretch the Inherited IRA over their life expectancy

Retirement account beneficiaries should be reviewed with your attorney and financial planner.

In those instances in which the participant is married and has no special planning concerns regarding the availability of the IRA for the surviving spouse, it is customary that the surviving spouse is designated the primary beneficiary. The surviving spouse would then have options to take advantage of “Stretch” rules to defer taxes. If this is a second marriage or there are other concerns, these should be reviewed and addressed.

In a customary situation, children are named as the contingent beneficiary. Children would qualify as “Designated Beneficiaries”. Accordingly, they would have 10 years to withdraw the funds. All funds must be withdrawn during the 10 year window at times and in such amounts as the Designated Beneficiary selects. If they are minors, they could stretch distributions over their life expectancy, until they reach the age of majority. Upon attaining the age of majority, they would be required to withdraw the funds within a 10 year window.

If a parent wishes to have funds a retirement account held in trust, they will need to consider the trust provisions carefully. In the past, Retirement Trusts were often used to allow for stretch designations on accounts while maintaining funds in trust. “Conduit Provisions” in these trusts allowed for the Inherited IRA payments to be stretched over the lifetime of the trust’s beneficiary (i.e. for the lifetime of the child), by requiring that all retirement account distributions to the trust be further distributed outright to the beneficiary. Under the SECURE ACT, these Retirement Trust may be less advantageous than they were under prior law. Using a “conduit” trust as beneficiary for IRAs will no longer make sense in most instances, since it would mean that the entire tax deferred retirement account will necessarily be distributed to beneficiaries of the trust by the end of a 10-year period, or within 10 years of attaining the age of majority in the case of a minor, which would rapidly deplete the trust assets. Rather, if an individual desires to maintain assets in trust for a beneficiary, the trust would need to be drafted to avoid the requirement for distribution of funds. While this may not be the most tax-advantageous approach (income taxed to a trust being subject to compressed income tax rates), it may be helpful in fulfilling other planning objectives, such as protecting funds in trust when there are concerns with the beneficiary’s spending or other life choices.

If you are interested in charitable giving, naming a charity as a beneficiary on a retirement account is now more advantageous than ever. More specifically, charities are income tax exempt, and they will receive the distribution income tax free. Accordingly, if you intend to leave any part of your estate to charities, you should strongly consider doing so through your retirement accounts to minimize or eliminate taxes for your children, or other beneficiaries.

Next Steps

No matter what your goals are, it is imperative to review your beneficiary designations to minimize taxes and unintended consequences in light of the SECURE Act. It is now more important than ever to carefully consider your primary goals in estate planning, whether it be tax deferral or elimination, wealth building, asset protection, or trusts to protect beneficiaries or contingent beneficiaries.

If you have any questions about this article, please contact the author Amanda N. Follett at [email protected] or 262-334-3471 or one of our Estate Planning Attorneys.

Originally published: January 13, 2020.