Welcome to Part II of our two-part blog discussing the SECURE Act and its impact on retirement and estate planning. The Act was signed by the President on December 20, 2019, and is effective as of January 1, 2020. Today’s focus is on the not-so-good parts of the Act.
In Part I, we summarized notable provisions of the Act, focusing on the increase in the Required Minimum Distribution (RMD) age and the removal of age restrictions for making IRA contributions (the good news). Today we’ll discuss the changes to the RMD rules for inherited retirement plans and the elimination of the “Stretch IRA” (the bad news). Let’s start by breaking down the rules under both the old and the new law.
Pre-SECURE Act Law:
When the retirement account owner died on or after the account owner’s Required Beginning Date (RBD) for taking RMDs, the remaining qualified retirement account balance had to be distributed at least as quickly as it had to be distributed to the account owner before death. The RBD is April 1st following the year that an account holder reaches age 70 ½.
When the retirement account owner died before their RBD, distributions generally had to begin within the year following the account owner’s death and could be paid over the life expectancy of the designated beneficiary (with a few exceptions, below).
If the surviving spouse was the beneficiary, distributions could be delayed until the deceased spouse would have been 70 ½. If the surviving spouse died before his/her RBD, the same post-death RMD rules applied as if the spouse was the original account owner.
If there was no designated beneficiary, the entire remaining interest in the account had to be distributed by the end of the fifth calendar year following the account owner’s death (the 5-year rule).
SECURE Act (New) Law:
For retirement account owners who die after December 31, 2019, the remaining account balance generally must be distributed to designated beneficiaries within 10 years after the date of death, unless the designated beneficiary is an “eligible designated beneficiary” (covered later), the 10-year rule applies whether the employee dies before, on, or after the RBD. This rule also applies to ROTH IRA and ROTH 401(k) accounts.
Under the new 10-year distribution rule, annual distributions to the beneficiary are not required. The account can continue to grow tax-deferred with compounding for 10 years and then be distributed in its entirety at the end of the 10-year period.
Although the old law applies to beneficiaries who inherited qualified retirement accounts before January 1, 2020, the new law will apply to the deceased beneficiaries’ designated beneficiaries if the deceased beneficiary dies after January 1, 2020.
The 5-year period for distributions from accounts with no designated beneficiary has been replaced with a 10-year period.
The exception from the 10-year rule imposed by the SECURE Act applies to certain “eligible designated beneficiaries.” If the beneficiary is an eligible beneficiary, the remaining account balance must be distributed according to the Pre-SECURE Act law. Eligible designated beneficiaries include:
The only change to the law under this exception is that the distributions are now delayed until the deceased spouse would have been age 72 (not age 70 ½).
Chronically ill or disabled beneficiaries
For this exception, a “chronically ill” individual is defined as an individual certified by a licensed health care practitioner as:
Being unable, without substantial assistance, to perform at least 2 activities of daily living (such as eating, toileting, transferring, bathing, dressing and continence) due to a loss of functional capacity for an indefinite period of time (that is reasonably expected to be lengthy in nature), or
Requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment.
For this exception, “disabled” is defined as an individual who:
Is unable to engage in “substantial gainful activity” (meaning the activity, or a comparable activity, in which the individual engaged before the disability arose) by reason of any medically determined physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration, and
Furnishes proof of the disability in the form or manner required by the IRS.
Consideration is also given to other factors such as the individual’s education, training, and work experience.
Minor children of the account owner (up to the age of majority, or 26 if the child is still in school)
Once the minor reaches the age of capacity, the 10-year period will come into effect.
Beneficiaries who are not over 10 years younger than the original account owner.
Eliminating “Stretch” IRAs is bad news. The pre-SECURE Act law allowed account owners to leave their retirement accounts to younger generations, and “stretch” the period of withdrawal based on the life expectancy of a much younger beneficiary. The stretch became a useful estate planning tool because it extended the time that the account could grow tax-free and reduced the beneficiary’s annual taxable RMDs, minimizing income spikes and related tax consequences to the beneficiary.
For older qualified plan account owners, the potential significant reduction to the number of years of the RMD stretch available to beneficiaries is comparable to changing the rules in the 4th quarter of the game. It is too late to turn back the clock as qualified account balances may already be too high to prevent beneficiaries from getting huge tax bills on their inheritance.
Investors and advisors should evaluate the benefit of retirement plans in financial and/or estate plans. Other options, such as ROTH IRAs and life insurance policies, may become more attractive alternative tax planning vehicles under the new law, as compared to qualified retirement plans.
If you would like to discuss how the changes brought about in the SECURE Act affect your retirement and/or estate plans, call on The Tax Warriors® at Drucker & Scaccetti for help.