The SECURE (“Setting Every Community Up For Retirement Enhancement”) Act was signed into law in December 2019 as part of the 2020 federal budget.  Among other things the Act changes the default rules relating to distributions from tax deferred retirement plans.  The effect of the new rules will be accelerated distributions of inherited retirement plans.  Generally speaking, nonspouse beneficiaries of qualified accounts will be required to draw down those accounts and pay taxes on the distributions in a shorter period of time than permitted under prior law.  This means diminished tax deferral benefits for most beneficiaries of retirement accounts.

Under prior law, beneficiaries of qualified accounts were generally entitled to draw out required minimum distributions (“RMDs”) based on their life expectancy.  Beneficiaries were permitted to accumulate gains in their inherited accounts tax free and postpone payment of income taxes due on the RMDs taken over their life span – a huge benefit due to the prolonged effects of tax deferral and compounding gains.    Under the SECURE Act, the life expectancy “stretch out” has been eliminated for all but the following 5 categories of “eligible designated beneficiaries”:

  • Surviving spouse of account holder
  • Minor child of account holder
  • Disabled beneficiary
  • Chronically ill individual
  • Individual who is less than 10 years younger than account holder

The 5-year payout rule for non-designated beneficiaries (i.e. estates, charities and nonqualified trusts) remains in effect.  All other designated beneficiaries must take distributions over a 10-year period.

There are other provisions in the SECURE Act that might apply to you but the limiting of RMD stretch out has the greatest impact on most of our clients.

Things to Consider

  • Does the individual you intend to benefit fall under one of the categories of “eligible designated beneficiaries”? If so, the individual will be entitled to the life expectancy stretch payout.  This is a favorable outcome from a tax standpoint. Remember, spousal beneficiaries will not be affected by the new limitations imposed by the Act.
  • Consider a Roth conversion. This option may be prudent for an account holder who is in a lower income tax bracket than his or her beneficiary.  A Roth conversion results in a big income tax bill when you make the conversion, but you (and your beneficiaries) get tax free distributions in the future.  Roth IRAs are not subject to RMDs during an account holder’s lifetime but beneficiaries (other than surviving spouse) must take RMDs after the account holder has died.
  • If your estate plan leaves retirement benefits to a “conduit trust”, you should determine whether the recent changes in the law warrant changes. A conduit trust is a type of “see through” trust that requires all distributions from the account to the trust to be distributed out to the beneficiary pursuant to the RMD rules (i.e. previously the beneficiary’s lifetime).  The primary purpose of setting up a conduit trust is to facilitate payment of RMDs to a beneficiary but also restrict the beneficiary’s ability to withdraw all at once the funds in the retirement account.  If your intent in initially setting up the conduit trust was to ensure that payouts occur gradually over the life expectancy of the beneficiary, the SECURE Act thwarts that goal.  The conduit function of the trust may continue to function as expected but the new law may result in a complete payout of the account within 10 years of the account holder’s death.  Depending on your goals, you may wish to change to a trust with accumulation provisions that allow the trustee to accumulate the RMDs in trust and a) distribute out to the beneficiary based on a discretionary standard or b) retain in trust.  Any undistributed income in an accumulation trust would be taxed at trust income tax rates, which kick in at lower levels than for individuals.
  • Nonspouse beneficiaries of qualified accounts should be prepared to accept (and pay!) the accelerated income taxes on their distributions or you may wish to look into alternative ways to pay the tax for them (e.g. life insurance).
  • As always, if you are charitably inclined, you should consider directing some or all of your retirement funds to your intended charities. The benefits of leveraging such funds to exempt entities is perhaps enhanced given the diminished tax advantaged options available for your individual beneficiaries brought about by the Act.

Please feel free to contact the office for an appointment if you would like to review how the SECURE Act affects your retirement accounts and designated beneficiaries.  Specifically we strongly advise clients whose retirement accounts name a trust as a beneficiary meet with an attorney to review their estate plan.