HOW THE SECURE ACT AFFECTS YOUR RETIREMENT ACCOUNT

by Thomas D. Begley, Jr., Esquire, CELA

The SECURE Act passed by Congress and signed by President Trump became effective on January 1, 2020.  It applies to individuals who die after December 31, 2019.  The law applies to Qualified Retirement Plans and IRAs.  It is designed to raise approximately $16 billion for the Treasury and to prevent retirement plan accounts from being used as wealth transfer vehicles.  The tax will be paid primarily by your children.

Under the old law, an individual inheriting an IRA could take the Required Minimum Distribution (RMD) over the lifetime of the beneficiary.  If a 44-year old child inherited his parent’s IRA, the child could withdraw from the IRA over the child’s remaining life expectancy in accordance with the tables, which would be 39 years.  Under the new law, the 10-year mandatory withdrawal will result in significantly higher taxes for beneficiaries, usually children, inheriting IRAs, because they will be required to take minimum distributions while they are still working and the income from the RMD will be added to their employment income and other investment income and it is likely to place them in a much higher tax bracket.  Just as important is that the time over which your child must take RMDs is reduced, thereby decreasing the time for the tax-free build-up.

For example, if a parent dies leaving $500,000 in an IRA and an adult child age 44 is named as beneficiary, under the old law the income on the account would accumulate tax free and the money would grow until the child reaches age 83.  Let’s assume a 6% growth rate in the account.  The total to be distributed over the child’s lifetime would be $2,102,689.05.  Under the new law, the distributions must be made over a period of 10 years, not 39 years, and the amount distributed would be reduced to $659,039.75.  The difference is $1,443,649 that would not inure to your child’s advantage.  In addition, if your child is still working, some of that retirement plan money will be withdrawn during your child’s lifetime and will be taxed on top of your child’s earned income in higher tax brackets.

There are certain exceptions to the 10-year mandatory RMD for individuals classified as Eligible Designated Beneficiaries (EDBs).  These include:

• A spouse who inherits an IRA from a deceased spouse may continue to receive benefits over the life expectancies of the surviving spouse.
• Disabled beneficiaries. A disabled beneficiary of a retirement plan may continue to receive benefits over the life expectancy of the disabled individual.
• Chronically-ill individuals. Chronically-ill individuals may continue to receive benefits over the life expectancy of the chronically-ill individual.
• Individuals less than 10 years younger than the Participant. Individuals less than 10 years younger than the Participant may continue to receive benefits over the life expectancy of such individual.  Typically, these would be siblings of the Participant.
• Minor children. Minor children of the Plan Participant may receive inherited benefits over their life expectancies, but only until they reach age 18.  Thereafter, benefits must be paid out no later than 10 years after the child’s 18th birthday.  Stepchildren and grandchildren do not qualify for this purpose.

There are a number of strategies available including the following:

• Name Eligible Designated Beneficiary. Name an EDB as beneficiary of the retirement account.

• Life Insurance. The Plan Participant could use RMD or could withdraw additional monies from the retirement account to replace all or part of the lost growth.

• Roth Conversion. There are situations where it may make sense for the retired parent to withdraw money from her retirement plan at the parent’s lower income tax rates and convert to a Roth IRA.

• Multiple Beneficiaries. If there are multiple beneficiaries of a retirement account, the tax on the RMD will be spread over several tax returns.
• If a charity is named as beneficiary of the retirement account the charity pays no income tax, so the money is distributed income tax-free to the charity.

If the retirement account is being left to a Trust under a Will or a Living Trust, then retirement account provisions should be considered.  An analysis should be made as to whether Conduit Trust or Accumulation Trust language is appropriate.  Opinions among experts vary considerably.  From an income tax standpoint, there is an advantage to a Conduit Trust in that the monies are withdrawn from the retirement account and distributed immediately to the beneficiary and income taxes are paid at individual tax rates.  In an Accumulation Trust, monies are withdrawn from the retirement account and can be accumulated in trust.  The disadvantage to a Conduit Trust, from a tax standpoint, is that trust tax brackets are much lower than individual income tax brackets, so the actual income tax may be higher.  The advantage to the Accumulation Trust is that it offers greater protection.

 

Beneficiary                                                     Type of Trust Provision

Spouse                                                            Conduit Trust, except an Accumulation Trust may be considered in second marriage situations.

Disabled                                                          Accumulation Trust

Chronically Ill                                                 Accumulation Trust

Less Than 10 Years                                        Conduit Trust

Minor                                                              Conduit Trust with special Language when the Beneficiary achieves majority.

 

Non-Eligible Designated Beneficiary:

Usual                                                               Conduit Trust

Problem Child                                                 Accumulation Trust

It is suggested that individuals wanting to protect significant retirement assets seek the advice of an Estate Planning Attorney, a CPA and/or a Financial Advisor.

• Estate Planning Attorney. A competent Estate Planning Attorney familiar with the SECURE Act should be engaged to discuss the alternatives and draft or revise necessary documents and beneficiary designation forms.
• A Certified Public Accountant may be helpful to assist with illustrations and advice as to appropriate strategies.
• Financial Advisor. A Financial Advisor may be helpful to assist with illustrations and advice as to appropriate strategies.