The holiday season is always a busy and eventful time, so you may have missed a new law that can impact how you plan for your retirement assets. On December 20, 2019, as part of a more comprehensive appropriations act, the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act was passed. In addition to updating certain administrative provisions for plan providers and incentives for employers, the SECURE Act made significant changes that have implications for individual owners and beneficiaries of retirement plans.
As described in more detail below, the changes are consequential and it is important to understand how the SECURE Act affects you. You should reach out to your estate planning attorney, financial advisor, or accountant for further details.
Changes for account owners
For account owners, the Act eliminated the maximum age for contributing to an Individual Retirement Arrangement (IRA). Previously, an individual could not contribute to an IRA after turning 70 ½, but after the passage of the SECURE Act, this age limit no longer applies. Now, you are generally permitted to contribute to your IRA at any age, as long as you (or your spouse) are working.
Also, the Act increased the age at which owners must start withdrawing from qualified plans and IRAs. Prior to the SECURE Act, an individual was required to begin taking minimum distributions from these retirement plans by April 1st of the year after the individual turned 70 ½. Now, the age at which these required minimum distributions (RMDs) must start is 72 years. The change is effective for those that turn 70 ½ in 2020, so if you were born before July 1, 1949, the old rules apply. If you were born on or after July 1, 1949, you have some additional time before you need to begin taking your RMDs.
Changes for beneficiaries
However, perhaps the most consequential change under the Act was the modification of a significant income tax deferral strategy for retirement plan beneficiaries. Under the old law, when a plan participant died, and if the participant had named a “designated beneficiary” on the account, such beneficiary could withdraw the account over the beneficiary’s remaining life expectancy. The amount withdrawn was then included in the beneficiary’s income during the year of withdrawal. Especially for younger beneficiaries, the period of withdrawal was often long and permitted the beneficiary to “stretch” the withdrawals over an extended period of time, thereby spreading out the income taxes due on the withdrawals while allowing the account to continue to grow in a tax-deferred manner. Generally, named individuals and certain trusts could be considered designated beneficiaries.
The SECURE Act changed the rules so that now, unless a beneficiary falls within a stated exception, the entire account must be withdrawn within 10 years of the death of the account owner. As a result, the account will be subject to income taxation over a much shorter period of time. Under the SECURE Act, the stretch provisions continue to apply to a surviving spouse, minors, individuals who are disabled or chronically ill, and beneficiaries who are not more then 10 years younger than the deceased account owner. However, once a child reaches the age of majority (18 in Massachusetts), the 10 year payout must begin, meaning that the retirement plan must be fully distributed before the child turns 28.
This change impacts any individual beneficiary who inherits a qualified plan or an IRA from a deceased participant. Because the new law does not require an equal amount to be withdrawn each year in the 10 year period, it is now even more important for a beneficiary to determine the most income tax-efficient way to take withdrawals within the 10 year period.
Traditional planning for retirement assets
As a result of these changes, estate planning for retirement assets will also change. In the past, it was common for a participant to name a trust as the beneficiary of a retirement plan, and include certain provisions in the trust to qualify it as a designated beneficiary. Often, these trusts were drafted to require a payout of the RMDs to the beneficiaries, thus enabling the longer stretch withdrawal period. However, the terms of the trust could still allow the trustee to maintain discretion over the distribution of other trust property. This arrangement resulted in lower income taxes on the retirement plan assets, while keeping other property in trust for asset protection purposes.
The longer stretch period meant smaller RMDs, which in turn meant that less of the plan was withdrawn and taxed each year. Further, the trust beneficiaries typically had a lower tax rate than the trust – in 2019, trusts hit the highest marginal tax rate of 37% on income above $12,750, but individuals only hit this top rate on income over $510,300 (or $612,350 for married couples). And because the RMDs were smaller, the bulk of the retirement assets remained in a deferred account that was considered an asset of the trust, and not an asset owned by the trust beneficiaries, keeping it safe from creditors.
Now, because the retirement assets must be withdrawn within 10 years, the withdrawal amounts will need to be substantially higher. If these withdrawals are distributed to the trust beneficiaries, then a larger portion of the trust assets will be immediately exposed to the beneficiary’s creditors. However, if the withdrawals are retained in the trust, the amount of taxes owed will most likely increase due to the higher income tax rates for trusts.
When planning for your retirement assets, you may now have to determine whether to prioritize income tax savings or creditor protection, and adjust your plan documents accordingly. You should review your current trusts and beneficiary designations and contact your professional team of advisors to help you understand how the SECURE Act impacts your financial and estate plan.
If you have questions about estate planning, probate, trusts, and tax matters, please contact one of Conn Kavanaugh’s experienced estate planning lawyers.
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