SECURE Act - New IRA Rules May Require Changes to Your Estate Plan

If you have an IRA account, it is important that you be aware of some important changes in the tax laws that became effective January 1, 2020. The “Setting Every Community Up for Retirement Enhancement Act” (“SECURE Act”) made changes to the IRA rules that are so significant that you may need to review your estate plan to make sure your wishes are carried out. It may be necessary for you to revise your IRA beneficiary designation forms and in some cases, revise your wills and trusts if the wills or trusts contain provisions intended to receive IRA distributions.

The following is a brief discussion of some of the more important changes to the IRA rules under the SECURE Act and some planning opportunities:

Death of Stretch IRA’s. One of the most important changes is the death of the so-called “stretch IRA” for most beneficiaries. The new rules apply to IRA accounts of individuals who die on or after January 1, 2020. Under the new rules, the beneficiary will be required to withdraw all assets from the IRA within ten years of the date of death of the IRA owner. No withdrawals are required during the ten year period (there is no RMD) but the entire balance in the IRA account must be withdrawn no later than the end of the ten year period.

Under the prior rules, many IRA beneficiaries could take distributions over his or her life expectancy. This was known as a ‘stretch IRA” and it was a planning strategy that allowed the beneficiary to defer payment of taxes on amounts in the IRA account. The strategy was especially beneficial when the beneficiary was much younger than the IRA owner, such as an owner’s grandchild. The RMDs were calculated on the life expectancy of the grandchild or other young beneficiary, thereby achieving significant tax savings.

Under the Secure Act, the stretch IRA is not available for most IRA beneficiaries. Only an “eligible designated beneficiary” will be allowed to take distributions over the beneficiary’s life expectancy. Others will have to take distributions of the entire account balance within ten years of the date of death of the IRA owner.

Under the SECURE Act, an “eligible designated beneficiary” is an individual who is:

• A Surviving Spouse of the deceased IRA owner;
• A beneficiary who is no more than ten years younger than the deceased IRA owner; and
• Chronically ill or disabled persons.

A minor child is also considered an “eligible designated beneficiary” until the child reaches age 18. At that time, the ten year rule will apply and distributions will have to be made no later than ten years following the date the child attained age 18.

Planning Strategies

It is important that IRA owners review their IRA designation of beneficiaries and their estate planning documents to make sure that the SECURE Act does not adversely affect how their estates are distributed upon their death. Although the stretch IRA has been eliminated for most beneficiaries, there are still some planning opportunities. For example:

• Change the designation of beneficiary for the IRA. In the past, IRA owners would usually name a spouse as primary IRA beneficiary and their children or trust as secondary beneficiary. The IRA owner may want to consider making the spouse a 50% beneficiary and children or a trust a 50% beneficiary. The children or trust would take smaller distributions from the IRA upon the death of first parent and then take the remaining balance of the IRA upon the death of the second parent. This would enable the IRA owners to stretch the timing of the distributions up to twice as long.
• Designate a CRT as beneficiary of the IRA. Upon the death of the grantor, the IRA would be paid to a charitable remainder trust (“CRT”) and no current income taxes would be payable. A CRT is a tax-exempt trust that pays income to a beneficiary for a stated period of time and then donates the remainder of the trust to a designated charity. Payments would be made to the beneficiary in accordance with the terms of the CRT, which generally requires at least a 5% payout. This would accomplish a deferral similar to that of the stretch IRA. If a CRT is used, consideration should be given to the use of life insurance to replace the assets going to charity at the end of the CRT.
• Review trust provisions of estate plan. Often when providing for a younger beneficiary, an IRA owner would use a “see-through” or “conduit trust,” which restricts the amounts payable under the trust to the amount of the RMD. This controls the amounts being paid to the beneficiary, thereby preventing the beneficiary from withdrawing, spending, or otherwise squandering the assets of the IRA; however, some conduit trusts only permit distributions of RMD. No other distributions are permitted. Under the SECURE Act, this could be a problem because the new law does not require RMDs. As a result, no payments could be made to a beneficiary. The new law merely requires that all amounts in the trusts be distributed lump sum to the beneficiary at the end of the ten year period. The IRA owner should revise the trust provisions to permit distributions other than the RMD distributions. In the alternative, the IRA owner may want to consider using an accumulation trust instead of a conduit trust. An accumulation trust can accumulate IRA distributions inside the trust and make distributions to trust beneficiaries in accordance with the wishes of the person creating the trust. This provides some creditor protection for the beneficiary and can be used to control the amount of money the beneficiary receives; however, the accumulation trust often pays taxes at a higher rate than what the beneficiary of the trust would pay.
• Review estate plan distribution strategy. Often individuals have an estate plan distribution strategy that distributes a portion of their estate outright to children and grandchildren providing them with current funds and the individuals use a stretch IRA to provide future funds for the children and grandchildren. Since the stretch IRA is no longer available, the individuals might want to use their IRA for current distributions to children and grandchildren and leave the remainder of their estate in a trust to be paid out over a number of years (much like the stretch IRA). Consideration should also be given to the use of life insurance products to provide a long-term income stream to children and grandchildren.

Increased the Age for Starting RMD from age 70 ½ to age 72. People who were born on or after July 1, 1949, can delay the start of their required distribution (“RMD”) from their IRAs until the April 1st following the year in which they attain age 72. If you were born prior to July 1, 1949, your distributions do not come under the new rule and you must continue to take your RMDs in beginning at age 70 ½ in accordance with the old rules.

Elimination of the Age Cap on IRA Contributions . Under previous law, you could not make IRA contributions past age 70 ½; however, you could make Roth IRA contributions. Since there are income limitations, some could not make contributions to either type of IRA. Under the SECURE Act, there are no age limits for both types of IRAs.

Distributions Permitted for Payment of Birth and Adoption Costs. The SECURE Act permits you to withdraw up to $5,000, without penalty, to pay for expenses for the birth or adoption of a child. This distribution must be made within one year following the birth of the child or the date the adoption is finalized. Under prior law, such distribution would have been subject to a 10% early distribution penalty.

Reduction in IRA Qualified Charitable Distributions. After reaching age 70 ½, you are permitted to make qualified charitable distributions (“QCD”) to a qualified charity in an amount up to $100,000 per year directly from your IRA account. For 2020 and later tax years, this $100,000 annual QCD limit will be reduced by the aggregate amount of your deductible IRA contributions made after you reach age 70 ½.