The Setting Every Community Up for Retirement Enhancement Act of 2019 a/k/a the “SECURE Act” made sweeping changes to expand retirement savings options.1 That’s the good news.
The bad news is that it also completely gutted the concept of the ‘stretch IRA’ for beneficiaries of IRAs and similar retirement plans.
Under the pre-SECURE Act tax rules, a beneficiary would be able to ‘stretch’ the required minimum distributions (RMDs) from an inherited retirement plan over his or her lifetime.2 For most beneficiaries, this means that an inherited IRA would be available as a tax deferred investment vehicle for the beneficiary’s lifetime.
Effective January 1, 2020, the SECURE Act provides that there are only 5 classes of ‘eligible designated beneficiaries’ who can in some way stretch an IRA:
- Surviving spouses;
- Minor children of the owner, up to the age of majority – but not grandchildren;
- Disabled individuals – as defined under fairly strict IRA rules;
- Chronically ill individuals;
- Individuals not more than 10 years younger than the IRA owner (e.g., siblings that may be around the same age as the account owner).
Eligible designated beneficiaries may ‘stretch’ RMDs over their lifetime (minor children may stretch RMDs only until they reach majority).
All other beneficiaries of inherited IRAs (including children after they reach the age of majority) are no longer subject to RMDs. Instead, they must draw down the account, i.e., fully withdraw the account and pay ordinary income taxes on it, over a 10 year period.
The SECURE Act greatly accelerates the withdrawals and taxation of inherited IRAs. It is estimated that the new rules will generate about $15.7 billion in taxes over the next 10 years.3
The SECURE Act impacts every retirement account owner, and we believe creates several retirement and estate planning concerns:
- Retirement cash flow and tax planning – Depending on your tax bracket and your beneficiaries’ tax brackets, does it make sense to take only RMDs from an IRA with the goal of passing the IRA to your children (a common approach under the old rules)? With this approach, your kids will have to draw down the entire account and pay taxes within 10 years of inheriting under the SECURE Act. As an alternative, should you use the IRA for living expenses, pay the taxes, and look to pass personal accounts with a step up in basis or other assets to your children? In our opinion, the answer requires multi-generational planning and consideration of a number of variables, including tax brackets.
- Retirement & estate planning – Should you consider a ROTH conversion when you are in a lower tax bracket and then utilize the ROTH as an estate planning vehicle? Under the SECURE Act, a child inheriting a ROTH IRA will still be required to withdraw the entire account over a 10 year period, but the distributions will be tax free. We believe this may be an alternative where a parent has a relatively large IRA, is in a low tax bracket at retirement and forecasts that their children will be in higher tax brackets.
- Estate planning – Have you named a trust as the beneficiary of your IRA? If so, we suggest that you revisit the language in the trust and your overall plan with your estate planning attorney. Under the SECURE Act’s new rules, a trust as beneficiary of an IRA would not have RMDs. This may limit distributions under your trust language. Within 10 years, the balance of the account would be paid into the trust (at higher trust tax brackets if the proceeds stay in trust under its provisions) or distributed to beneficiaries (at the beneficiaries’ tax brackets if it is a conduit trust). These are significant problems – our experience is that most people design trusts for regular income, do not want to pay higher taxes in their trusts and intend to protect assets in trust for longer than a 10 year period. The SECURE Act may go against all three of these goals depending on how your trust is written.
While the SECURE Act expands retirement savings opportunities, there is some truth to the old saw that ‘the road to perdition is paved with good intentions.’ Given the SECURE Act’s new inherited IRA distribution rules, we believe it is wise to review your beneficiary designations and consider multi-generational financial and estate strategies for your retirement accounts.
1 SECURE ACT https://www.congress.gov/bill/116th-congress/house-bill/1994/text
2 26 U.S. Code § 401(a)(9)(B) (Pre-SECURE ACT of 2019)
3 CRS Report https://crsreports.congress.gov/product/pdf/IF/IF11174