The SECURE Act – IRAs and Estate Planning

The SECURE Act, signed into law in December 2019, has created significant retirement planning and IRA distributions changes. The most notable of these changes was the elimination of stretch IRA distributions. Before the SECURE Act, a non-spouse beneficiary could spread their Required Minimum Distributions (RMD) out over their remaining life expectancy immediately following the decedent’s death. This opportunity was historically utilized in various estate and tax planning techniques, specifically through naming younger beneficiaries. The younger the beneficiary, the smaller the beginning RMD, thus reducing the taxable income received by the beneficiary.

However, the SECURE Act requires all distributions to be made within ten years of death to a designated beneficiary for any account holder who passes away after December 31, 2019.  “Eligible designated beneficiaries,” which include surviving spouses, individuals ten years (or less) younger than the decedent, chronically ill and disabled individuals, and minor children (until they reach the age of majority) are still eligible to utilize the stretch rule. For other designated beneficiaries there is no obligation to distribute the assets through RMDs. All the assets can be distributed at the end of the 10^th year; however, doing so will most likely lead to a higher tax liability than annual distributions. It is crucial to review estate and tax plans with the new 10-year payout rule in mind, as it may compromise the plan’s original intent. Below are several planning considerations for the 10-year distribution rules.

 

Charitable Remainder Trusts

A Charitable Remainder Trust (CRT) is a type of irrevocable trust. A named beneficiary receives income for a specified period. At the same time, the remaining assets (which must be at least 10% of the initial value) go to a designated charity. The benefit of this option is that the inherent nature of the trust allows it to bypass the 10-year payout rule because the IRA funds can be spread out over the beneficiary’s lifetime. Further, when the trust is established, the retirement account owner will receive a charitable tax deduction for the projected value of the trust that will be distributed to the designated charity. The owner will also pay the estate tax for the portion that will go to the beneficiary. The drawback is that there are many administrative duties placed on the trustee and tax return preparer, which may get costly.

 

Roth Conversions

By converting the IRA account to a Roth IRA, the account holder will pay the income tax on the converted funds, while the beneficiary will receive their distributions tax-free. The 10-year payout rule will still apply to non-eligible designated beneficiaries; however, those distributions will not be taxable. The funds can remain in the account and grow tax-free until the end of the 10^th year. This option may be very beneficial for those with large IRA accounts, as tax rates are at historically low levels and are expected to increase in the future (depending on future legislative actions). Those considering this option should make sure that they have enough funds to pay the income tax on the converted funds and consider economic projections and estate planning.

 

Life Insurance Policies

An individual can either distribute funds from their retirement account to fund a life insurance policy or set up a life insurance policy to assist beneficiaries in paying income tax expenses. When allocating funds to a life insurance policy, it is crucial to set up an irrevocable trust as the beneficiary so that the policy will not be included in the policy holder’s estate. This option should only be used if the individual will not need these funds during their lifetime.

 

Remember, this is a critical time to review your estate plans, retirement accounts, and beneficiaries and adjust them according to the SECURE Act’s 10-year payout rule. Consult your tax advisor to discuss the above and other viable options.

 

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