Does The Secure Act Affect Your Estate Planning?
For more than 30 years, those with significant IRAs or other qualified retirement accounts used trusts to create what is commonly known as a “Stretch IRA”. Doing so allowed the IRA owner to force the stretch out of the IRA to the beneficiaries over the remainder of the beneficiaries’ lifetimes.
The SECURE Act has changed all of that and likely your estate plan. The purpose of this article is to review the potential impact of the Secure Act on your planning.
Gone are the opportunities to stretch the IRA, which instead have been replaced with a maximum 10-year post-death payout. So now the 45-year-old son or daughter who inherits mom’s IRA is required to withdraw the entire account balance within 10 years following mom’s death instead of taking distributions over the 38.8-year life expectancy that would have otherwise applied prior to the Secure Act.
The full name for the SECURE Act is “Setting Every Community Up for Retirement Enhancement Act.” How long did it take Congress to come up with that acronym?
The new SECURE Act became law at the very end of 2019. While many of the same definitions still exist in the new law, the way beneficiary distributions are treated has significantly changed, with a few exceptions.
The government wanted to make sure that the inherited retirement account funds were pulled out of those accounts in a shorter period of time, and thus taxed. Now a “designated beneficiary” (DB) must withdraw the entire plan balance within ten years after the IRA owner’s death.
This, however, does not have to be withdrawn pro-rata over the ten years. But, DB must still take required minimum distributions during the 10-year period.
2022 Proposed Regulations
Prior to the Proposed Regulations issued by the IRS in 2022, many commentators believed that a beneficiary could allow the funds to remain in the plan, growing tax-deferred, for the entire ten years and then withdraw the whole plan balance at that time.
Under the Proposed Regulations, required payments would begin the year after the of the account owner. Any funds remaining at the end of the 10 years would then be distributed.
The conflict between how the IRS is interpreting the Act and how practitioners believed that the Act would be implemented caused many beneficiaries of of participants who died in 2020 and 2021 after reaching their required beginning date to get caught in violation of the Section 401(a)(9) of the Act.
However, in Notice 2022-53, the IRS has indicated that the 50% excise tax won’t apply to those who should have taken required minimum distributions (RMB) but haven’t. Final Regulations won’t apply before 2023.
The new relief found in the Notice also applies to those with inherited IRAs and some beneficiaries of EBDs that died in 2020-2021.
Eligible Designated Beneficiaries
The new Act does allow for withdrawal over a life expectancy if the beneficiary is an “eligible designated beneficiary” (EDB). There are a couple of categories of EDBs.
1. A surviving spouse.
2. A minor child
3. Children are disabled or chronically ill
4. An individual not more than 10 years younger than the participant
Of note, once a minor child reaches the age of majority, they may no longer use the life expectancy payout method.
Just as before, if the beneficiary is not a DB or EDB, the IRA funds must be withdrawn within five years of the participant’s death. However, the entire a plan funds can be withdrawn in the fifth year.
How does the Secure Act affect you?
I suppose that the good news is that for most individuals, their existing estate plans will still “work” in the sense that their beneficiary is still a designated beneficiary and their trust is still considered a see-through trust. The bad news is that perhaps those plans will not work the way in which they were expected to.
And unfortunately, there really is not one simple fix for all existing estate plans. How you modify your current Trust will depend upon who is the intended beneficiary of an IRA.
There will, of course, be some clients for whom the secure act will not change their plans. For example, a client who does not own an IRA or other retirement plan. Or the client who desires to leave her retirement plan to a charity.
However, for those clients who have significant retirement plans (401k, traditional IRA, Roth IRA, etc.) and who intended that their estate plan be centered on the idea of a long-term stretch payout for their beneficiaries, must immediately review their estate planning documents and may even need to start over.
Many estate plans are designed so that the retirement benefits are passed to a conduit trust, which in turn requires that any “required minimum distributions” (RMD) received from the IRA be paid out immediately to the intended beneficiary of the trust.
The required minimum distributions were expected to be withdrawn from the IRA over the beneficiary’s life expectancy. The idea is to stretch smaller annual distributions over a more extended period of time.
However, in many cases, the conduit trust will no longer work as intended as the entire IRA benefits will be required to be paid out within ten years, which is contrary to the intent of the person creating the trust.
The conduit trust provisions will continue to work where the beneficiary is less than ten years younger than the plan participant. But in general, a conduit trust will frustrate the original intent of the trustor by requiring the full amount of the Plan benefits to be paid to the trust beneficiary within the ten year period required by the SECURE Act.
What about accumulation trusts?
For those who have utilized an accumulation trust, their estate plans may not need to be modified. Any accumulation trust allows the trustee to withdraw plan benefits and simply accumulate those assets in the trust for the trust beneficiary as the trustor intended. Now the trustee may take up to 10 years to withdraw the plan benefits.
What about a Supplemental Needs Trust?
If you have left your IRA to a Supplemental Needs Trust or a Special Needs Trust that is a see-through accumulation type trust for the benefit of a disabled individual, you may want to review the trust and update it as necessary to ensure that it qualifies as an eligible designated beneficiary.
As long as the disabled individual is the sole beneficiary, the trust could be eligible for the life expectancy payout as opposed to the 10-year rule.
Since most people are saving for retirement with pre-tax dollars, whenever distributions from the IRA are made, such distributions will be subject to income tax.
Also, Congress is considering new legislation, Secure Act 2.0. This includes various provisions. The proposed legislation would greatly affect 401k plans, as well as raise the required beginning date from age 72 to age 75.
To determine how you should modify your estate plan, if at all, I recommend that you contact your estate planning attorney as soon as possible for a review. This is especially true if you have a significant IRA or other retirement savings plan for which your living trust is the primary beneficiary.
To read more about the actual Secure Act, go here.