By: Judson M. Stein
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act (the“Act”) was signed into law drastically altering the administration of certain retirement plans such as IRAs and 401Ks. Although many of the provisions are favorable, not all of the provisions are benign. In particular, with limited exceptions, the Act eliminates stretch IRAs.
Under prior law, upon the death of an IRA owner or employee participant, the designated beneficiary could elect to have the remaining account balance paid to him or her over his or her remaining life expectancy (or the plan participant’s life expectancy under certain circumstances). This is what became known as the “stretch” IRA or the “stretch-out.” The stretch IRA was particularly useful in allowing designated beneficiaries to continue the tax deferred status of the plan for long periods of time after the death of the plan participant or IRA owner.
However, Congress was not pleased with prolonging the collection of income taxes. As such, beginning with those plan participants and IRA owners who die after December 31, 2019, the remaining plan and account balance must be paid to the designated beneficiary within the following ten years. The designated beneficiary can elect to take the distribution in any proportions and at any time or times he or she desires, so long as the entirety of the plan balance is distributed within ten years of the plan participant’s, or IRA owner’s, death. For example, the balance can be taken in ten equal installments, or all in the first year, or all in the tenth year, etc. In effect, this will require nearly all designated beneficiaries to recognize the entirety of the plan balance as taxable income to him or her in a significantly shortened time period.
There are, however, limited exceptions to the ten-year payout requirement for “eligible” designated beneficiaries. The Act defines an eligible designated beneficiary as a surviving spouse, an individual not more than ten years younger than the plan participant, a chronically ill or disabled individual, or a child who has not yet attained the age of majority. An eligible designated beneficiary may continue to take distributions over their life expectancy; however, when such eligible designated beneficiary dies, the remaining account balance must be distributed within ten years. Note, also, that once a child reaches the age of majority, he or she must take the remaining account balance with the next ten years.
While the Act also modifies other aspects of retirement plan administration - i.e., increasing the beginning age for required minimum distributions to age 72, allowing for contributions past age 70½, and increasing the yearly cap on plan contributions - the loss of the stretch IRA is troubling. Those who have large retirement accounts, and particularly those who have created and designated trusts as beneficiaries of such accounts, should promptly review their estate plans with a qualified professional to determine how the changes in the law affects these plans. Such trust planning typically involves the creation of so-called “conduit” trusts or “accumulation” trusts. Often, such trusts were created for the purposes of protecting otherwise individual designated beneficiaries from financial risk and improvidence, and to safeguard the future passing of remaining amounts at the individual beneficiary’s death to preferred recipients.
However, such trusts rely on minimum required distribution assumptions that may no longer apply. For example, a conduit trust that had been created on the premise that an IRA would be withdrawn and paid out to the trust beneficiary over many decades may now have to be fully withdrawn and paid out within ten years; thereby frustrating the intended trust protections. One strategy that is being suggested by many is for a Charitable Remainder Trust (“CRT”) to be the designated beneficiary. In such a case, the IRA would be paid to the CRT and the individual beneficiary would receive minimum 5% annual payouts.
In any event, it is clear that the Act warrants a careful review of estate planning; especially, when 401Ks and IRAs represent a significant portion of the anticipated estate and when existing plans include conduit or accumulation trusts.