Your Retirement Planning and the SECURE Act
The Setting Every Community Up for Retirement Enhancement Act (or SECURE Act), signed into law on December 20, 2019, changes retirement planning significantly and unexpectedly. The bulk of the changes become effective as of January 1, 2020. Below is a brief overview of certain changes that may affect you and those who inherit your retirement assets.
- Contributions to traditional IRAs are deductible for income tax purposes regardless of the contributor’s age, meaning that those who continue to work past the age of 70 ½ (which was the age cut-off under prior law) are able to add to their retirement savings and defer the payment of associated income taxes until they take distributions.
- The age for required minimum distributions increased from age 70 ½ to 72, allowing for somewhat longer tax-deferred growth of retirement accounts.
- An inherited IRA passing to an individual or “see through” trust must be fully distributed by December 31 of the year that contains the 10th anniversary of the participant’s death, subject to certain exceptions. No distributions are required during the interim period so long as funds are out of the retirement plan by the deadline.
The change identified in the last point above is designed to raise tax revenue by escalating the depletion of inherited retirement accounts. Under prior law, distributions from an inherited IRA to an individual or “see through” trust could be stretched over the beneficiary’s lifetime. This is now the case only if an exception applies, such as for a spouse or minor child (until no longer a minor) of the deceased participant and for individuals who are not more than 10 years younger than the participant. It is a dramatic shift with potentially unintended consequences when retirement assets are left in trust instead of directly to individual beneficiaries.
For example, retirement assets that were previously expected to remain in trust for a minimum of 30 or 40 years, based on the beneficiary’s life expectancy, may now be forced out over a 10-year period as a result of so-called “conduit" trust provisions. Conduit trusts provide that all IRA distributions made to a trust in a given year must be distributed out to the trust beneficiary in the same year. Accordingly, trusts with conduit provisions no longer provide beneficiaries the long-term protection of retirement benefits and their proceeds that may have been anticipated by participants when they included conduit trusts as part of their estate plan.
As a result, some individuals may prefer to replace conduit trusts with accumulation trusts, where the trustee has the option to “hold” the distribution and accumulate it with the principal of the trust. A downside, however, is that accumulated distributions will be taxed to the trust rather than to the beneficiary, and trusts are subject to compressed brackets and generally taxed at the highest marginal tax rate. Thus, with this approach, more tax will be paid unless the beneficiary is already in the maximum tax bracket.
If an IRA owner has a lower income tax bracket than the intended beneficiaries of an IRA, such owner may wish to consider a Roth conversion during life, so that IRA distributions will be income tax-free to the beneficiaries, including any trusts.
Leaving traditional IRA accounts to charity remains a tax-efficient strategy for those who are inclined to provide for charity in their estate plans. Charitable split interest trusts can be employed to include non-charitable beneficiaries as well.
If you are a retirement plan participant, you may wish to contact your attorney for assistance in determining whether any updates to your beneficiary designations or estate planning documents may be prudent from a tax perspective or necessary to ensure that your intentions are still met following this new legislation.