The Setting Every Community Up for Retirement Enhancement Act of 2019 (the ‘SECURE Act’ for short) came into effect in January 2020.
This act puts in place a number of changes that impact both IRA account holders and their beneficiaries. Intrigued? Confused? A little scared? Read on.
Benefits For IRA Account Holders
The SECURE Act includes some benefits for IRA account holders, including delaying required minimum distributions and allowing for contributions to IRA accounts for working adults regardless of age. Some of the key benefits included in the SECURE Act are:
- Required minimum distributions (RMDs) now must begin at age 72 instead of 70 ½
- Contributions to IRA accounts can continue as long as an adult is working, instead of being prohibited after age 70 ½
- New parents can withdraw up to $5,000 per parent without penalty for each child born or adopted
- 529 funds can be used to pay down up to $10,000 in student loans
These and a host of other changes may actually help create a more SECURE retirement for older working adults. You can read about these in detail here.
The Downside For IRA Account Beneficiaries
While the SECURE Act allows older working adults to accumulate more in their IRA accounts and delay their distributions, it simultaneously penalizes non-spouse beneficiaries by eliminating the ‘stretch’ option and requiring a maximum 10 year payout time frame of IRA benefits.
What was the ‘stretch’ option?
Before the SECURE Act, non-spouse beneficiaries were allowed to take distributions from an inherited IRA over the non-spouse beneficiary’s lifetime, based on a rather complicated calculation of life expectancy based on IRS rules and mortality tables. Without getting into the detailed mathematics involved, if your daughter was the beneficiary of your IRA, under the old laws, she would have been able to spread out distributions from the inherited IRA over the course of her expected life expectancy.
Why was the ‘stretch’ important?
Distributions from an IRA (either to the IRA account holder as RMDs or to a beneficiary from an inherited IRA) are treated as ordinary income on the distributee’s income taxes. In most cases, the IRA account holder would name their spouse as the primary beneficiary and the children as the secondary beneficiaries.
The ‘stretch’ provision allowed the children to take distributions from the inherited IRA over their lifetimes and minimize the tax impact. Depending on the size of the inherited IRA, the non-spouse beneficiary’s distributions could kick them into a higher tax bracket, increasing their total tax liability significantly.
Why did they take away the ‘stretch’?
The most common explanation for why the stretch provision was taken away by the SECURE Act is that because additional contributions are being allowed that are shielded from taxes, the lost revenue must be made up somehow and the 10 year complete distribution requirement would increase tax revenue upon distribution. In effect, non-spouse beneficiaries will be making up the lost tax revenue from additional contributions allowed for older working adults.
What can be done to protect my children from the tax burden as a result of the SECURE Act?
If you want to protect your children from the potential increased tax burden as a result of the 10 year distribution rule or even if you simply don’t feel like your children can handle large sums of money over such a relatively short period of time, there is a solution for you and your family.
An IRA trust can help you to spread out distributions over a longer period of time while giving the trustee of the IRA trust the flexibility to structure distributions to avoid negative tax consequences.
The IRA Trust
Yes, we are combining the concepts of IRAs and trusts. We know you have been told many times to keep your living trusts and your IRAs firmly separated. This is because IRA accounts are governed by IRS regulations and the IRS requires that IRAs be passed onto individuals and not entities. However, the elimination of the ‘stretch’ provision in the SECURE Act is a good reason to consider an IRA trust to handle your IRA accounts for your non-spouse beneficiaries.
What is an IRA Trust?
An IRA trust is a special type of revocable trust containing specific language that complies with IRS regulations that allows the IRA trust to hold IRA account proceeds for longer than allowed by standard IRS regulations and laws. The IRA trust is named as the beneficiary of your IRA account instead of your children or other non-spouse beneficiaries. Until the passage of the SECURE Act, there was very little need for most families to use an IRA trust due to the ‘stretch’ provisions. Now, without the ‘stretch’ provisions, an accumulation IRA trust may be the solution for IRA account holders with large balances.
How does the IRA trust work?
An accumulation IRA trust allows the trustee the discretion to pay out or retain RMDs within the trust depending on each beneficiary’s needs. This type of IRA trust can also protect the IRA assets from creditors. This type of trust is complex and ideally requires coordination between your attorney and your tax professional. The accumulation IRA trust is named as the beneficiary of your IRA accounts.
Who is impacted by this new law?
The good news is that if you already inherited an IRA before 2020, the new 10 year maximum distribution rule doesn’t apply to you. You can continue to take distributions from your pre-2020 inherited IRA over the course of your life expectancy. Ah, the good old days.
If you inherited an IRA in 2020, you’re subject to the new 10 year maximum distribution rule. No more ‘stretch’ for you! And unfortunately, if you’ve already inherited an IRA this year/in 2020, it’s too late to set up an IRA trust. The IRA trust needs to be established by the IRA account holder during their lifetime.
What do you need to do now?
IRA trusts are complex. They require very specific language in order to comply with IRS regulations for these types of revocable trusts and must be handled in the context of the larger tax implications for your beneficiaries.
If you have large amounts accumulated in your IRA account, you should consider utilizing an IRA trust to help your non-spouse beneficiaries best prepare to receive their share of your IRA account. It is not advisable to do these yourself or use a standard form. Please see an experienced estate planning attorney and speak with your tax professional as well.