The SECURE Act, which was signed into law on December 20, 2019, will greatly affect estate planning for many of our clients. Before the SECURE Act, owners of tax-favored retirement plans (IRAs, 401ks, etc.) were able to leave their retirement assets to a designated beneficiary who could then keep the plan in its tax-deferred status over his or her life-expectancy. This was termed “stretching” in that the funds could be stretched over a lifetime. For most beneficiaries, the new act now limits the payout period of the retirement assets to 10 years from the death of the original owner.
After SECURE, the period of payout, whether life expectancy or 10-years, will depend solely on whether the beneficiary is an “Eligible Designated Beneficiary” (EDB) or not. The new act specifies EDBs who are exempt from the 10-year payout rule and are still eligible to stretch the inherited retirement funds over their lifespan. EDBs include the spouse of the decedent, individuals who are less than 10 years younger than the deceased, a disabled or chronically ill beneficiary, and minor children. However, a minor child must switch to a 10-year payout once reaching the age of majority. In addition, minor children only applies to the children of the decedent, not grandchildren. Any successor beneficiary of the EDB will always be subject to a payout over a maximum of 10 years.
The typical estate plan leaves retirement assets to the children or grandchildren of the owner who, unless disabled or chronically ill, must now take these funds over a 10-year period. Often, the child or grandchild is in his or her peak earning years and already subject to a high tax rate. Although there are no required minimum distributions during the 10-year payout, the entire balance in the plan must be distributed by the end of the 10th year following death. The limited payout period which will often coincide with the beneficiaries’ highest taxable years will probably result in a scenario far different from the original intent of the plan owner.
Prior to passage of the SECURE Act, a useful tool in estate planning was the trusteed IRA whereby the plan owner left the retirement assets to a see-through or conduit trust providing a stretch payout over the life of the heirs. The trust could dictate the payout of distributions in order to protect the assets from being squandered by an imprudent beneficiary, potential creditors, or a divorcing spouse of the beneficiary. With passage of SECURE, if the beneficiary is a non-EDB, the shortened payout period and resulting taxes will likely undermine the objective of the plan holder at the time the trust was drafted.
Another estate planning strategy is the use of an accumulation trust as the beneficiary. Although the accumulation trust would be subject to the high trust tax rates in year 10, the remaining plan assets could be kept in the trust and distributed under the trust terms thereby preserving the residual plan assets from a spendthrift beneficiary.
Although the SECURE act applies to individuals who die after 2019, it also affects pre-2020 inherited plans for successor beneficiaries of the original beneficiary of the decedent. Although the original beneficiary of an individual who died prior to 2020 ¬(pre-SECURE Act) can still take the retirement funds over his or her lifetime, once that beneficiary dies, any successor beneficiary will be forced to take the funds within a 10-year period.
In a nutshell, all pre-2020 estate plans which were set up to transfer retirement assets should be examined to determine how the new law will affect the original objectives of the estate plan. In addition, SECURE is so new that many areas within the new law are undefined and subject to interpretation at this time.
The SECURE act is far too complex to discuss most of its scope in this article. Schedule a meeting with our office to discuss the new law’s effect on your estate.
By Cheryl DeVoe, CPA
- This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.