As often happens in Washington, speculation is just that, and Congress acts on its own timeline. The Setting Every Community Up for Retirement Enhancement (SECURE) Act was introduced earlier in the summer of 2019 and passed through the House of Representatives at that time. The bill, which proposed several changes to retirement plans and other tax legislation, appeared to be stuck in the Senate and seemed to be something that would not be given life until 2020, if ever.

However, at the eleventh hour, just before Christmas, there was a final push that got the SECURE Act slipped into an appropriations bill. This appropriations bill was required to be passed by Congress to avoid another government shutdown. The bill was quickly passed through Congress and then ultimately signed by President Trump on December 20.

The SECURE Act affects both individual taxpayers and business owners. There are substantial changes to 401(k) plans and other small business retirement plans as a part of this Act. For purposes of this article, I will focus the attention on the major changes made by this bill that will affect individual retirement plans and other planning items for individual taxpayers.

IRA Stretch Provisions Eliminated (for most beneficiaries) in Favor of New 10-Year Distribution Rule

One of the most significant changes as part of the SECURE Act is the elimination of the previous law allowing beneficiaries to “stretch” IRAs. The previous law allowed beneficiaries of retirement plans and IRAs to stretch distributions over their life expectancy or over the oldest applicable trust beneficiary’s life expectancy if a trust was named. The new law mandates most non-spouse beneficiaries who inherit retirement plans or IRAs after January 1, 2020, to draw down the account now over a 10-year period.

Under this new 10-year rule, there are no mandated distributions annually. Rather, the law simply states that the entire account must be emptied by the end of the tenth year following the year of inheritance. While this offers some flexibility to beneficiaries as to the timing of distributions during that 10-year period, it is, in essence, a tax increase on IRAs. Considering many beneficiaries are often much younger than the original account owners, the new 10-year rule is much harsher than the old standard of stretching over one’s remaining life expectancy.

It is important to note the exceptions to this law—certain designated eligible beneficiaries who are not subject to the new 10-year rule. The list of those beneficiaries includes:

1. Spousal Beneficiaries (Most Common)
2. Disabled Beneficiaries
3. Chronically Ill Beneficiaries
4. Individuals who are not more than ten years younger than the decedent
5. Certain minor children until they reach the age of majority

The most common class of people from this list is spousal beneficiaries. Spouses will still have the ability for a spousal rollover, allowing them to stretch distributions over their own life expectancy versus a much stricter 10-year period.

The 10-year rule exception for minor children applies only to a child of a retirement plan or IRA owner. Meaning a retirement account inherited from a grandparent, aunt, uncle, or other relative would still follow the 10-year distribution rule. The old stretch rule only applies until the minor child reaches the applicable age of majority in his/her state of residence, and then the new 10-year distribution rule goes into effect.

Consequences and Considerations Due to Death of Stretch/New 10-Year Distribution Window

It is important to remember that any retirement plan or IRA beneficiary designation trumps what is indicated in a will or trust. Thus, an essential part of estate planning is ensuring designated beneficiaries on retirement plans and/or life insurance coordinate with the rest of the estate plan.

Commonly, individuals designate a trust as the primary or contingent beneficiary of a retirement plan for greater control or an extra layer of protection for a spouse, children, or grandchildren. These trusts must have language in them to allow them to qualify as a “see-through” or “tax-qualified” trust to preserve the old stretch provision. Some of these trusts are restrictive in that only applicable RMDs from Inherited IRAs are allowed to be distributed each year. In the case of the new 10-year rule, the only year that technically has an RMD is the tenth year following the death of the owner.

Having the whole IRA or retirement plan distributed in the tenth year could have adverse consequences from a tax standpoint, especially for large retirement accounts and beneficiaries in higher tax brackets. Secondarily, other “see-through” trusts are set up to keep any distributions from Inherited IRAs inside the trust. This result may be undesirable given that trust tax rates are much more compressed than individuals’ tax rates, hitting the top tax bracket at around $13,000 of taxable income.

The challenges mentioned above around the 10-year rule should lead many to reevaluate their retirement beneficiary designations. In light of the new rule, I would recommend those who are charitably inclined to consider naming a charity or multiple charities as a beneficiary to receive a portion or all of certain retirement accounts. The 10-year drawdown rule will adversely impact beneficiary children who are in a very high tax bracket themselves. In some cases, it will mean losing 50% of the RMD to Federal and state taxes.

One planning opportunity that may arise due to the new 10-year rule is the option to name a charitable remainder trust (CRAT) as a beneficiary of a retirement plan. A CRAT is an irrevocable trust that makes fixed-income payments to annuitants/beneficiaries for an established length of time. These fixed payments are based on a percentage of the assets in the trust, and the current maximum length of time is 20 years. The caveat is that any assets remaining in the trust after 20 years, or the specified length of time, must then be transferred to the charity or charities indicated within the trust document.

Because the SECURE Act is so new, there is no precedence on this strategy. I would recommend consulting with an experienced estate planning attorney. Regardless, I expect to see people giving charities much greater consideration to naming them as beneficiaries of retirement plans and IRAs going forward.

Required Minimum Distributions (RMDs) to Begin at Age 72

The previous rule stated that RMDs from a retirement plan (retired workers) or IRA must begin at age 70 ½. This arbitrary age caused confusion relating to the timing of the first distribution and life expectancy factor used in calculating one’s annual RMD. The new law will now push the first RMD to age 72 for anyone turning 70 ½ on or after January 1, 2020. It’s important to note that individuals who turned 70 ½ or 71 in December 2019 are grandfathered in under the old rules and are still required to take an RMD in 2020. The new RMD rule will match the old rule in that the first distribution technically does not have to be made until April 1, following the year an individual turns 72. However, if the first RMD is delayed until the following year, a subsequent second RMD must also be taken before December 31 of an individual’s 73rd birthday year.

For many of our clients, this is welcome news because it delays taxes associated with the RMD. We often talk to individuals about the “retirement income gap”. Otherwise known as the time between one’s retirement and taking Social Security retirement benefits and RMDs. Upon retiring, many individuals see a dramatic drop in income for a period until they begin Social Security and mandated distributions from pre-tax retirement accounts. A popular recommendation is to maximize lower tax brackets during this period by converting funds from a pre-tax to a Roth IRA. The new RMD age of 72 helps lengthen that “retirement income gap” for many people and allows for a greater period of tax planning.

Qualified Charitable Distributions Still Permissible at Age 70 ½

Interestingly, even though the RMD age was pushed back to age 72, Qualified Charitable Distributions (QCDs) remain permissible once an individual turns age 70 ½. Individuals may still take up to $100,000 annually from an IRA and gift it to a 501©3 charity(s). Although it will not offset mandated income the first year and a half, QCDs taken before age 72 will lower the future RMD for an individual by reducing the IRA account balance. Starting at age 72, the QCD will reduce the then-necessary RMD.

Traditional IRA Contributions Allowed Beyond Age 70 ½

The old rule disallowed Traditional IRA contributions due to old age, restricting individuals from making contributions after turning age 70 ½. Beginning this year, individuals who remain working or have spouses who have earned income through wages and/or self-employment are permitted to make Traditional IRA contributions beyond age 70 ½. There is little benefit to individuals making traditional IRA contributions after age 70 ½, given the income limit to deduct contributions is still fairly low (AGI of $75,000 for Singles and $124,000 for Married Joint Filers in 2020) and individuals have to begin taking RMDs at age 72 anyway.

However, one advantage of this new law applies to potential backdoor Roth IRA contributions for high-income earners. Individuals who still have earned income and high AGI are now allowed to make backdoor Roth IRA contributions. This is done by making non-deductible Traditional IRA contributions that were previously exempt in the year someone turned 70 ½. One caveat is that post-age 70 ½ deductible Traditional IRA contributions will reduce any QCDs by the amount of cumulative deductible Traditional IRA contributions.

Other Miscellaneous Provisions of SECURE Act

• 529 plans can now be used for apprenticeship programs. This includes books, fees, supplies, and other required equipment for the program.
• 529 plans are now permitted to be used for up to $10,000 of qualified loan repayment of student loans. Additionally, $10,000 can be used to pay debt on each of the 529 plan beneficiaries’ siblings. This change is retroactive to 2019.
• The Kiddie Tax reverts back to previous laws before 2018. Per the kiddie tax, unearned income for children above $2,200 (like Social Security survivor benefits) will again be taxed at the parent’s tax rate and not subject to the compressed trust tax rates like it was in 2018 and 2019.
• Deduction of qualified tuition and related expenses remains effective through 2020.
• The AGI hurdle rate to deduct qualified medical expenses remains at 7.5%--extended for tax years 2019 and 2020.
• Individuals who receive taxable stipends or non-tuition fellowship income may make IRA or Roth IRA contributions beginning in 2020.

If you have any questions on how the SECURE Act affects your investments or taxes, please contact us.

IMPORTANT DISCLOSURE INFORMATION