The Setting Every Community Up for Retirement Enhancement Act of 2019 (really, you can’t make this stuff up), better known as the SECURE Act, was signed into law on December 20th as part of the year-end appropriations bill. The SECURE Act touches many topics, including employer retirement plans, 529 Plans, and other tax matters. Here, we concentrate on one aspect of the SECURE Act that affects many individuals: the impact of the law on IRAs.
The major takeaway is that if you have a large IRA that you had hoped to leave to your heirs, you should review your beneficiary designations and evaluate other strategies, especially if you have designated a trust to receive these assets.
First some good news.
The SECURE Act, recognizing that people are now living longer, increases the age at which you must start taking Required Minimum Distributions, or RMDs, from an IRA. The age changed to 72, up from the current age of 70½. This new rule applies to anyone who had not yet turned age 70½ by December 31, 2019. Those who had previously turned 70½ must continue to take RMDs.
As before, you will have until April 1 of the year after you turn age 72 to take your first distribution, keeping in mind tax rates and Medicare premium surcharges when deciding which year to take your initial RMD in. Existing life expectancy tables are still utilized to determine the amount of the annual RMD. Although, unrelated to the SECURE Act, the IRS proposed new life expectancy tables last November that would reduce annual RMDs by as much as 10% or more compared to the current tables. The new tables, if they are adopted, would apply starting in 2021.
Now the bad news.
Prior law permitted that, if you inherited an IRA from someone other than a spouse, you could stretch out the RMDs over your life expectancy, called the “stretch” IRA. If you were relatively young when this happened, the economic benefit of the stretch could be very significant. However, the SECURE Act kills the stretch IRA, simply because Congress wanted to eliminate the IRA as an estate planning vehicle and needed to raise revenue to offset the revenue cost of some of the other provisions of the Act.
Now, with some exceptions, if you inherit an IRA from someone other than your spouse, you will be required to fully distribute the IRA and pay the income taxes within 10 years after the owner’s death. Annual distributions will no longer be required, although periodic distributions may still make sense to manage tax rates. The new rules apply to inherited IRAs if the owner dies after December 31, 2019, so existing inherited IRAs are not affected. The new rules do not apply to spouses who continue to have the same special options as under prior law. Also, some beneficiaries, such as minor children, disabled or chronically ill individuals or anyone not more than 10 years younger than the IRA owner, can continue to use the old stretch rules under some circumstances.
Many wealthy individuals have used trusts as the beneficiary of their large IRAs to exercise some control after death, while still maintaining the tax efficiency of the stretch rules. The SECURE Act now requires that all IRAs inherited by trusts be fully distributed within 10 years after the owner’s death. This change dramatically affects IRA trust planning, to say the least. Depending how the trust is drafted, both control over the assets and income tax efficiency could be lost. Moreover, certain types of trust commonly used as IRA beneficiary will now only work in very limited circumstances.
The bottom line is this: If you have designated a trust to be your IRA beneficiary (even as a contingent beneficiary), your estate plan should be reviewed soon to see if a trust should continue to be used, and if so, whether the trust should be modified to reflect this new realty. In fact, anyone with a large IRA needs to examine strategies to mitigate the tax effect of these rules. Solutions could include changing beneficiaries, Roth conversions, charitable giving, insurance replacement strategies or even taking larger than required distributions during life.
As always, Ancora is happy to answer any questions you may have. Please reach out to your relationship manager or the Retirement Plans team contact for more information.