In the final days of 2019, with little warning, Congress and the President enacted significant changes to how the federal tax code affects retirement assets such as your 401(k), 403(b), and IRAs - all of which went into effect on January 1, 2020. Known as the “SECURE Act,” these changes may affect you during your lifetime, but also affect how those retirement assets may be distributed to your beneficiaries after your death.
Effective January 1, 2020:
Changes Affecting You During Life:
One component of the SECURE Act that will affect many people during their lives is a change in the age at which a person must begin taking distributions from a qualified plan or IRA. Under the law prior to the SECURE Act, most people (with the exception of some who are not yet retired) were required to begin taking distributions from their qualified plans or traditional (non-Roth) IRAs by April 1 of the year following the one in which they reached age 70.5 years. Under the SECURE Act, the age is increased to 72 years for those who were not yet required to take distributions under the old law. In addition, the SECURE Act removes the age cap for funding traditional (non-Roth) IRAs, meaning that individuals over age 70.5 years are now eligible to make contributions to a traditional IRA.
In addition, individuals younger than 59.5 years who welcome the birth or adoption of a child may withdraw up to $5,000 within one year of the birth or adoption without incurring a 10% penalty. Although there is no requirement that the withdrawal be repaid or re-contributed, it may be repaid or re-contributed at any future time and to any retirement account.
These changes involve additional detail and nuance beyond the brief summary provided above and may present an opportunity for some to take further advantage of the tax-deferred savings offered by qualified plans and traditional IRAs. In some instances, they may even present additional opportunities for funding a Roth IRA. Your accountant or financial advisor is likely in the best position to advise you as to whether and how you might benefit from the new law’s age changes and/or the birth or adoption exception. We encourage you to reach out to them to discuss your retirement strategy in light of the SECURE Act. Of course, you are welcome to contact us as well, and we will be glad to assist you in understanding how the SECURE Act applies to your circumstances, in coordination with your other trusted financial professionals as appropriate.
Changes Affecting You (and Your Beneficiaries) After Death:
Perhaps the most significant changes brought about by the SECURE Act, at least in terms of estate planning, relate to how your qualified plan or IRA is distributed and taxed after your death to avoid penalties. If we helped you plan for your retirement plan and IRA beneficiaries, you may recall that we discussed the possibility of “stretching out” your retirement assets after death. Under the law prior to January 1 of this year, it was possible to stretch the distribution of inherited qualified plans and IRA assets over the life expectancy of a beneficiary, if that beneficiary met the requirements of a “designated beneficiary” under the law. This lifetime stretch-out offered potential advantages in terms of income tax-deferred growth of the retirement assets during the beneficiary’s life, the cumulative amount of income tax paid on distributions from the retirement account, and protection of the retirement assets from the beneficiary’s creditors, or even from a beneficiary who might not have the ability to handle significant amounts of money at one time. The law also permitted these advantages for retirement assets left in trust, as long as the trust was structured to meet certain requirements.
The SECURE Act has changed these rules, so that most designated beneficiaries will be required to receive the full amount of an inherited qualified plan or IRA within ten years of the death of the person who funded the plan or IRA. As a result, all of the assets will be taxed within those ten years instead of what could have previously been many decades. Certain designated beneficiaries, including your surviving spouse, your minor children (but not grandchildren), and beneficiaries who are disabled or chronically ill, are still permitted to take distributions over their expected lifetimes (though children who are minors at the time of inheritance must now take the full distribution within ten years after reaching the legal age of adulthood). However, if the retirement assets are left to those beneficiaries in trust, they may not qualify for the lifetime distribution, depending on the terms of the trust.
The good news is that the SECURE Act does not change the method of designating a beneficiary or beneficiaries to receive inherited retirement assets. If you have existing beneficiary designations in place, those designations are still valid. What the SECURE Act does, however, is introduce a host of new considerations that we must take into account in structuring your estate plan to maximize the benefit of the retirement assets and best protect your beneficiaries. As a result, even though your existing beneficiary designations are still valid, they may result in drastically different results than what you desire.
Unfortunately, Congress gave us very little warning that these changes were on the horizon. Accordingly, estate plans that, through the end of 2019, offered a sound approach to planning for retirement assets, may no longer provide a good solution. For example, some of our clients may have current plans in place that, at death, leave their retirement assets to a trust known as a “conduit trust.” Any retirement assets paid to a conduit trust will pass immediately from the trustee to the beneficiary. Under the old law, that may have been a good solution in some situations, because the distributions would be stretched over the expected lifetime of the trust beneficiary. However, under the SECURE Act, that same conduit trust may now require distribution of the retirement assets to the beneficiary within ten years of the death of the plan participant or plan owner or when the minor child reaches adulthood. Depending on the circumstances, other planning techniques may better serve the goals those plans are meant to achieve, given the new rules.
If you have assets in a qualified plan or IRA, we recommend that we review your estate plan as soon as possible to ensure that it disposes of those assets in the best possible manner, taking into account the SECURE Act changes. We welcome the chance to discuss these changes with you, answer any questions you may have, and make recommendations specifically for you. Please contact your Smith Haughey estate planning attorney to arrange a meeting or phone conference at your convenience, so that we can help you find the best planning solutions to meet your needs and those of your family.
Note: The contents of this alert are for informational purposes only and are not intended to constitute legal advice or form an attorney-client relationship. For information and advice particular to your situation, please contact our estate planning attorneys to arrange a meeting.