On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act is effective January 1, 2020. The Act is the most impactful legislation affecting retirement accounts in decades. The SECURE Act has several positive changes.  There are many benefits built into the Act to help individuals start, increase, and secure their retirement funds.  Unfortunately, there is also a significant change that will potentially make a big difference for IRA owners and their estate plans.

Benefits of the SECURE Act

Let’s look at the beneficial ways this new act can impact retirement savings.  First, from 2020 onward, the SECURE Act changes the age restrictions with traditional IRAs.  You are now able to make contributions to your IRA at any time.  Before the SECURE Act, you could not make a contribution to an IRA after reaching age of 70 ½.

For those people who reach age of 70 ½ during 2020 or later, you will now be able to wait until the age of 72 before you must withdraw annual required minimum distributions (RMDs).  The prior exception remains that if you are still working as an employee after 72 years old (previously 70 ½) and do not own more than 5% of your employer, you can postpone RMDs until after you have retired.

Warning: If you turned 70 ½ in 2019, you must take that 2019 RMD no later than April 1, 2020 or face a 50% penalty on the shortfall.  Then a second RMD must be taken by December 31, 2020 for the 2020 tax year.  And each year following you must take your RMD by the end of the year.

Good news for part-time employees as well.  Starting in 2021, the law guarantees 401(k) eligibility for employees who work at least 500 hours per year for 3 consecutive years.  Previous law required at least 1,000 hours per year to become eligible.

The SECURE Act also allows penalty-free withdraws of $5,000 by each parent in the year of birth or adoption of a child as long as that is paid back into the IRA.

The Bad News

For most Americans, a retirement account is the largest asset they own upon their death.  The reason is that most people use their tax-deferred retirement funds as a last resort.  This means that things get tricky in regards to non-eligible beneficiaries for IRAs.  In the past, IRA strategies allowed for continued tax-deferred growth to occur over the life expectancy (as defined by the IRS) of the beneficiary before distributions were completely disbursed.  This allowed younger heirs to prolong the life of the IRA by withdrawing the funds over their lifetime.  It significantly reduced their taxes.  (For Roth IRAs there will not be federal tax on the eventual withdrawals.) With the SECURE Act, however, non-spouse beneficiaries will have only 10 years from the date of death of the original account owner to drain the IRA.  This change can potentially hurt those who don’t need to use their own IRAs for personal retirement, but want to pass the long-term tax advantages on to heirs.

There are a few exceptions to the 10-year rule.  An eligible designated beneficiary will not be affected by the SECURE Act.  Eligible beneficiaries include a surviving spouse, a minor child of the deceased (although, upon reaching adulthood, the child will have 10 years to drain the account), a beneficiary who is no more than 10 years younger than the owner, or a disabled or chronically-ill individual.

With so few exceptions, the SECURE Act is estimated to generate upwards of $15.7 billion in tax revenue over the next ten years.

Examples of the SECURE Act’s Impact:

  1. James dies in 2020 leaving his IRA to his sister, Jane, who is five years younger. Jane is an eligible designated beneficiary and therefore MAY withdraw the IRA out over her life expectancy.  The SECURE Act had no impact on her.  However, if Jane was more than ten years younger, she would not be an eligible beneficiary and would have to withdraw the total amount of the IRA within 10 years.
  2. Barney’s rich aunt, Felicia, passes away in 2020 and leaves her IRA to him. Barney would like to defer taxation on the inheritance by stretching out the time of withdrawals over the period of his IRS life-expectancy. However, under the SECURE Act, he will be required to drain the account in ten years because he is not a spouse, and does not fit any of the exceptions to the rule.
  3. Sandra dies in 2020 and leaves her IRA to her spouse, Michael. There is no change under the SECURE Act because Michael is an eligible beneficiary.   However, upon Michael’s death, their adult daughter Samantha inherits the IRA.  Samantha is not an eligible beneficiary and must withdraw the IRA within 10 years.
  4. Robert designates his chronically ill and disabled daughter, Gloria, as his IRA beneficiary. Because Gloria is chronically ill or disabled, she qualifies as an eligible beneficiary under the SECURE Act and may withdraw the IRA over her life expectancy.  (However, this could jeopardize Gloria’s government benefits.  Robert should meet with an attorney to discuss options of how to leave the IRA to Gloria while minimizing the impact upon her government benefits.)
  5. Megan dies leaving her IRA to her daughter Rebecca. Rebecca is 12 years old when she inherits the IRA.  Rebecca is an eligible designated beneficiary because she is a minor.  However, upon turning 18, she reaches the age of majority in Arizona.  Rebecca will then have until age 28 to withdraw the IRA’s funds.   (Another problem with leaving an IRA to minor child is that a conservatorship will need to be created for Rebecca in order for her to receive the IRA if it is more than $10,000.)
  6. Denise and William, who are married, name each other as primary beneficiary on their IRA. Their living trust is the secondary IRA beneficiary upon both of their deaths.  No change when the first spouse dies as the IRA may be rolled over to the surviving spouse.  However, in all likelihood their trust will have five years (not 10 years) to withdraw the entire IRA.  The SECURE Act does not change current rules on trusts and estates inheriting IRAs, which requires a five year withdraw.  However, if Denise and William created an IRA Trust–sometimes called a Retirement Trust—the IRA Trust would have 10 years to withdraw the IRA while protecting the IRA for the beneficiary.

Non-Tax Considerations

A common concern about leaving an IRA to an heir is whether your hard-earned retirement money will actually end up benefiting your heir.  Divorce, lawsuits, bankruptcy and government aid disqualifications are all reasons why people are often more concerned about protecting the IRA than about tax concerns.  Once funds are withdrawn from the IRA, it could be subject to a divorce settlement if commingled in a joint account.  A judgment from a lawsuit or a bankruptcy can require the payment of the IRA’s funds  to creditors.  If the heir is receiving disability or other government benefits, they could lose their eligibility for such programs if they must receive the IRA’s funds outright.

These concerns are often the bigger issue.  After all, even if taxes reduce the IRA, it is better that a majority of the IRA remains rather than lose it all.

Potential Solutions Now That the SECURE Act is HERE

Often the best solution is creating an IRA Trust.  Although before the SECURE Act, such trusts could withdraw IRAs over the lifetime of the beneficiary, it is now 10 years.  However, the ability to keep the IRA funds within the trust prevents anyone other than your heir from receiving the funds.  In other words, such a trust protects the IRA from the heir’s divorce, creditors, lawsuits, bankruptcy and disqualification from government aid programs.

Another option to consider is to include purchasing life insurance and creating an irrevocable life insurance trust, if necessary, to offset the tax liability created by the SECURE Act.

For those who desire a charity to inherit a portion of their assets, a charitable remainder trust may be the best solution.  It enables a stream of income to your beneficiaries with the remainder going to charity.  Although the beneficiaries may not receive as much as they would in an IRA Trust, the difference is not as significant as the tax bill in an IRA Trust.

It Is Time for an Estate Plan Check Up

Now is a great time to review your estate plan.  It is important to review whether your plan meets your goals.  During such review, making sure your beneficiary designations on your IRA and other accounts is critical.  Frequently, other life events have occurred that also warrant an estate plan update.  Examples include a marriage or divorce, a change in relationship or health, the receipt of inheritance, an heir being on government aid or having an addiction. There are a number of reasons why estate plans may need to be updated.  However, the SECURE Act is a game changer for many people with retirement plans.

Schedule a free 30-minute consultation with attorney John Skabelund to review your estate plan by calling his paralegal, Jane Maasz, at 480 344-4994.