Revisiting the SECURE Act

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By: Elizabeth Morataya

The Setting Every Community Up for Retirement Enhancement Act or better known as the SECURE Act (the “Act”) was signed into law by President Trump on December 20, 2019.  Most changes under this Act went into effect on January 1, 2020, which did not leave a great deal of time for people and their tax professionals to consider the implications under the Act and implement changes.  Nearly a year after the Act was passed, we are revisiting the SECURE Act as well as what, if any, changes need to be made to your estate planning documents.

The purpose of the Act was to assist people to better save for retirement by incentivizing businesses to offer retirement plan options to their employees.  Other changes that were made included increasing the age at which required minimum distributions or RMDs must begin to be taken from a pretax retirement account.  The age increased from 70 ½ to 72 years old.  But the most important change from an estate planning perspective came with the elimination of the ability to stretch an IRA.  The Stretch IRA concept occurred when a non-spouse beneficiary inherited an IRA and the RMDs could be calculated using the new owner’s life expectancy.  That meant if an IRA was left to a younger beneficiary then the IRA would effectively be stretched out over a longer period of time, which results in less tax being paid early on, which in turns allows for the money to continue growing tax free for a longer period of time as well.  This same concept was also used when a trust was left as the beneficiary of an IRA.

The new rules under the Act gives most beneficiaries a maximum of 10 years to distribute the funds out of an IRA, specifically, the IRA must be fully distributed by December 31 of the 10th year following the owner’s death.  More interestingly, there are no RMDs required during that 10 year period, however, while no RMDs are required it would be prudent to consider a tax strategy to avoid distributing everything in one lump sum so taxes are not paid all at once in the 10th year.  This exact reason is why Trusts that were named as beneficiaries need to be reviewed.  Some trusts have conduit provisions, which have language that require a Trustee to only distribute the required minimum from a retirement account.  This would leave a tax bombshell waiting for the beneficiary in the 10th year since there are no RMDs required during the 10-year period.

Instead, there are different planning strategies that can be implemented to prevent this tax burden all at once.  Instead of a naming a conduit trust as beneficiary, a discretionary trust as beneficiary would be best.  These types of trusts allow the Trustee to work with the beneficiary and distribute money during this 10-year period, but ultimately distributions over a period longer than 10 years are gone for these types of trust beneficiaries.

However, not all is lost, the Act does provide some exceptions to this 10-year rule.  Namely, Eligible Designated Beneficiaries can elect either the 10-year period of withdrawal or take distributions based on their lifetime.  These types of beneficiaries include a surviving spouse, a minor child of the decedent until the age of maturity, a person with a disability or chronically ill person, and someone who is less than 10 years younger than the decedent.  However, upon a minor child reaching the age of maturity in their state they would have to comply with the 10-year rule.  Within this category of beneficiaries, there is going to be a strong inclination to name surviving spouses and individuals less than 10 years younger as direct beneficiaries to take advantage of these exceptions.

Another option for people to consider would be to name a charitable remainder trust as a beneficiary of an IRA.  This would allow the charitable remainder trust to generate a stream of income for the named beneficiary.  The maximum term for a charitable trust is 20 years or a beneficiary’s lifetime can also be used as the measuring life.  During the time a beneficiary receives this income they would pay the resulting tax, but it would be stretched over a longer period than 10 years.  Then at the death of the beneficiary or the end of the term of the charitable remainder trust, the remaining money would pass to the named charities in the trust.  There are strict rules that a charitable remainder trust needs to comply with so various scenarios should be run with your tax advisor.

Another strategy to consider would be making Roth IRA conversions.  These types of conversions allow you to move money considered pretax to an after-tax ROTH IRA.  This includes recognizing the tax liability in the year of the conversion, so it is especially important to plan this out with your tax advisor.  During the life of the ROTH IRA account holder there would be no required minimum distributions.  Then at their death a beneficiary would inherit this money tax free if all other ROTH requirements are met.  However, the account would still need to be depleted within 10 years.  ROTH conversions are particularly useful for those who have a longer investment time horizon and can plan for conversions over a longer period of time.

Finally, another option involves the use of whole life insurance.  Using this strategy, means taking taxable withdrawals from the IRA which are in turn used to pay life insurance premiums.  This has the effect of eliminating future required minimum distributions on those funds which lowers future tax bills.  Additionally, if life insurance is purchased through a trust then the same beneficiaries of the IRA can be the beneficiaries of the life insurance trust with the added bonus that a properly established life insurance trust can remove the life insurance from an individual’s taxable estate.  Then the insurance trust can receive the death benefit income and estate tax free.  This strategy effectively repositions the IRA in a more tax efficient manner.

The Act left much to consider and with the coming of the end of the year, it is always a good time to revisit your estate planning documents to ensure your documents are up to date and accomplish your goals. Please, don’t hesitate to contact us with any questions you may have regarding the SECURE Act or your estate plan.