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The Setting Every Community Up for Retirement Enhancement (SECURE) Act, signed into law Dec. 20, 2019, will have a number of ramifications for retirement income and tax planning.

Main provisions related to IRAs

The three most significant provisions related to Individual Retirement Accounts (IRAs) are:

The Age for Required Minimum Distributions (RMDs) increased to age 72. This change affects only investors who turn 70 ½ in or after 2020. If you turned 70 ½ in 2019 or earlier, nothing has changed.

The Age Cap for IRA contributions has been removed. Previously, investors age 70 ½ or older were ineligible to make IRA contributions, although they were eligible to contribute to their 401ks. Effective Jan. 1, 2020, there is no age restriction on contributions. However, as always, the individual must have earned income to contribute.

Inherited IRAs must be fully distributed within 10 years of inheritance. On and after Jan. 1, 2020, investors who inherit an IRA have 10 years to distribute the account in its entirety. These beneficiaries are not required to make RMDs annually, but any remaining balance must be distributed as an RMD on the 10th year of the inheritance. This is a big change to the previous rule, which allowed a beneficiary to “stretch” distributions across his or her lifespan. This stretch was a tremendous benefit for younger beneficiaries, who were able to spread out the taxation of the distributions over a longer period of time, during which the account grew tax-deferred. While the other IRA changes under the Act generally were intended to enhance retirement savers’ options, this provision represents a decision by Congress that tax-favored retirement accounts are intended for retirement and not to pass on to heirs.

However, there are five exceptions to this rule for the following “Eligible Designated Beneficiaries.” They are:

  • Spouses
  • Individuals no more than 10 years younger than the original account owner (typically siblings)
  • Disabled individuals — under strict IRS rules
  • Chronically ill individuals
  • Minor children, up to the age of majority — but not grandchildren

For these Eligible Designated Beneficiaries, the same rules apply, and they may “stretch” distributions over their lifespan as directed by IRS tables. Minor children will be required to take annual, age-based RMDs under the old rules only until they reach the age of majority, and then the 10-year rule applies.
Any inherited IRAs in existence before 2020 are not affected by the new rules.

Bad news for trusteed IRAs

Under the old inherited-IRA-distribution rules, certain trusts, known as “see-through trusts,” also qualified for stretch provisions. So, for example, a person with a large IRA could name a trust for the benefit of a grandchild, and RMDs could be spread over 50 years or more under IRS tables, depending on the grandchild’s age. Many of our clients established these types of trusts as a legacy-planning technique. Some even converted Traditional IRAs to Roth IRAs, which carry no RMDs for the original owner, with the expectation that the immediate taxation on conversion would be more than offset by the tax-free growth on the account as RMDs ultimately were stretched over the beneficiaries’ lives.

With the SECURE Act, beneficiaries now will have to distribute the balance of the account within 10 years. Not only that, but for those who have a trust specifying only the RMDs be withdrawn each year, this could mean the beneficiary gets nothing until the end of the 10th year. This outcome is problematic for several reasons. For those grantors who intended to provide immediately for their younger children or spendthrift beneficiaries but used the trust to limit the amount of money that could be distributed in any year, this change will have the unfortunate effect of denying those heirs access to any funds during the initial 10 years. In addition, by lumping the RMD to the trust in one year, this larger amount will be pushed into higher graduated tax rates. Any RMD not distributed to beneficiaries, will be subject to the very unfavorable marginal tax rates for trusts which reach the highest tax bracket of 37% at just $12,950 in 2020.

To further explain, consider the following example:

Nancy Smith has worked as an executive for 25 years at a large corporation and has accumulated $1 million in her IRA rollover and is now 70 and retired. She has one child, John Smith, who is 40 and has had to declare bankruptcy in the past. With the help of her attorney, Nancy created a see-through trust to be funded with the IRA upon death. Provisions in the trust limited the distributions from the IRA to the RMDs over John’s lifetime, ensuring he will not run through the funds quickly, enhancing tax-deferred growth and minimizing potential taxes. Before the SECURE Act, John’s distribution in year one would have been roughly $25,000. If John worked and had taxable income on his tax return of $60,000 per year, the distribution would put him in the 22% federal tax bracket, and he would pay about $5,000 in federal taxes on the distribution. However, under the new rules, John wouldn’t receive anything until age 50, at which point, assuming growth of 6% per year, the account would be worth around $1.7 million. The $1.7 million distribution would push John into the highest marginal tax bracket of 37%, plus the 3.8% surtax on modified adjusted gross income over $200,000 — not to mention any applicable state, city and county taxes. Additionally, all of the funds now would be outside of the IRA and would no longer grow tax-deferred — a double whammy. Maybe most importantly, Nancy’s desire for John to receive distributions from the IRA over his lifetime without the ability to spend down the funds would be thwarted.

Action items

Consider reviewing your estate planning. With these changes, it is more important than ever to review your IRA beneficiaries and make any necessary changes to your estate planning documents. Cardan Capital Partners will be reviewing beneficiaries for all clients throughout the year, but please do not hesitate to call us or your estate planning attorney to discuss in more detail if you are unsure, or if you believe a see-through trust is listed as the beneficiary of your IRA(s).

Review the SECURE Act. You can find a link to it here.

This article is meant as an overview of certain impacts of the SECURE Act. Please consult with your wealth management, tax and estate planning professionals for a complete discussion on the aspects relevant to your personal circumstances.  The content contained within, or linked to, this article is meant for educational purposes and not meant to be a complete discussion of the SECURE Act. There is no assurance that any of the trends mentioned will continue in the future. Market performance cannot be predicted, so nothing in our commentaries is ever meant to provide any kind of guarantee of future results.

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