Rarely do estate planning attorneys read national news that affects what we do. Unlike splashy headlines about Supreme Court decisions that affect civil rights or the Affordable Care Act, typically, landmark changes for estate planning come in the form of little-known Treasury Regulations or Tax Court cases. That is why the federal law known as the “SECURE” Act hit like a bombshell for us estate planners late in December 2019.
On December 20, 2019, the President signed the SECURE Act (short for “Setting Every Community Up for Retirement Enhancement”), effective January 1, 2020, and it is not an overstatement to say this Act is the most impactful legislation affecting retirement accounts in decades. And yet, the effects of the Act for individuals contributing to their IRAs or 401(k)s today may not be felt for some time. Frankly, the most profound effects of the Act will likely be on those who inherit IRA money from parents or grandparents, not those who save it for themselves. If you care about your kids or grandkids, continue reading.
For living IRA and 401(k) owners, the SECURE Act has a couple positive changes. For one, it increases the Required Beginning Date (RBD) for Required Minimum Distributions (RMDs) from 70 ½ to 72 years of age. This means you can hold off on taking those mandatory withdrawals from your IRA until 18 months later, saving you on income taxes during that window. Awesome! And it eliminates the age restriction for contributions to qualified retirement accounts, allowing you more time to catch up if you were slacking on your retirement savings for years. (No judgment here, just saying.)
However, probably the most significant change will affect the beneficiaries of your retirement accounts when you pass away. The SECURE Act requires most designated beneficiaries to withdraw the entire balance of an inherited retirement account within 10 years of the account owner’s death. (Caveat: this is a general rule and we are only briefly introducing the topic in this blogpost. If you have questions about specific features of your plan, call us.)
To understand why this 10-year requirement is huge, you should know the way the rules used to be. Before this Act was signed, the rule was that when an individual inherited an IRA, they had to start taking out distributions starting the year after the previous owner’s death—same as the SECURE Act—but how much the inheritor had to take out was based on how old they were when the person died. So just like Hollywood or the NFL, the younger you were, the better. The IRS would look at the inheritor’s life expectancy based on that age, and allow the inheritor to “stretch out” the distributions over the course of the rest of their life. The younger you were, the longer your life; the longer your life, the longer the stretch out. Taking out the minimum was almost always the best financial decision, as the less you took out each year, the less you paid in taxes, and the bigger the sum that remained untouched behind that IRA shield grew tax-free, compounded.
These old rules allowed us to carefully finesse how much an individual took out every year. If they needed more than the required amount, they were free to take it, but if they didn’t really need it, and if taking more would just push them into a higher income tax bracket, then we would take only the smallest required amount, and again, let the rest keep growing in that beautiful tax-favored IRA shelter. Now? We can no longer finesse those payments. The SECURE Act is more of a blunt instrument, requiring inheritors to take out big slugs of the inherited amount, no matter their age, to be completely depleted over 10 years. Whether the heir wants to take it out or not.
Under the SECURE Act, heirs can take out a fraction in Year 1, take out none in Year 2, take out 20% in Year 3, and so on up to Year 10—the combinations are literally infinite. But the rub is, the entire value of the inherited account must be completely withdrawn in those 10 years, all of it subject to the tax rates of the inheritor in the year in which they receive the distribution. In plain English: inheritors will have to take out comparatively much larger sums of inherited money, and pony up to the tax man, big time.
The SECURE Act does provide a few exceptions to this new mandatory 10-year withdrawal rule: spouses, beneficiaries who are not more than 10 years younger than the account owner, the account owner’s children who have not reached the “age of majority,” disabled individuals, and chronically ill individuals. However, don’t just rely on something you read online. Proper analysis of your estate planning goals and planning for your intended beneficiaries’ circumstances are crucial to ensure your goals are accomplished and your beneficiaries are properly planned for.
We have only scratched the surface of the effects of the Act in this blogpost, because we could sense your eyes glazing over ever since we used the phrase “Required Beginning Date.” What is important is that if you had your estate plan drafted at any point before January 1, 2020, it needs to be analyzed to see if it still accomplishes your wishes. Your estate planning goals likely include more than just tax considerations. You might be concerned with protecting a beneficiary’s inheritance from creditors, future lawsuits, and a divorcing spouse. In order to protect your retirement account and the ones you love, it is critical to be proactive. Please call me at 314-288-0061 or email firstname.lastname@example.org if you want to discuss the implications of this Act, or your planning in general. I look forward to hearing from you!
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