By Jess Bolen
The SECURE Act, which was signed into law in late December 2019, has rightfully generated buzz among qualified retirement account holders nearing retirement. This is because the people who will be most affected the soonest by this law are account holders who turn 70½ after December 31, 2019 and their designated beneficiaries.
Prior to the SECURE Act, beneficiaries of qualified accounts were allowed the benefit of what came to be known as the “Stretch Inherited IRA.” Beneficiaries could inherit the balance of an IRA and take distributions based upon their own life expectancy, instead of the life expectancy of the original account owner. The SECURE Act has effectively ended this provision, except for spouses, qualified disabled beneficiaries, and current beneficiaries already receiving distributions
SECURE stands for Setting Every Community Up for Retirement Enhancement. It’s the most significant legislation affecting retirement planning since the Pension Protection Act in 2006. While certain provisions for small business employers/ employees and additional savings and ROTH IRA conversion allowances are appealing, the forced extinction of what has been known as the “Stretch Inherited IRA” is perhaps the biggest news. It has been replaced by what is known as the 10-Year-Rule.
This article looks at how this new rule will affect original qualified retirement account owners and their beneficiaries.
More time for planning and account growth
Original rules set up in the 1960’s for Defined Contribution plans were intended to keep people from passing generational wealth through tax-advantaged retirement plans. Prior to the SECURE Act, if you were retired and reached the age of 70½, you were required to begin taking RMDs from your defined contribution plan account (which are then taxable). This ensured funds were used for actual retirement purposes. The SECURE Act increases the age of Required Minimum Distributions (RMDs) from 70½ to 72 in order to account for increased life expectancy since the 1960’s.
This is good news for anyone nearing age 72 and means you’ll have a little more time for money to grow and more time to make planning decisions, including IRA rollover and conversion to a ROTH IRA.
As mentioned, prior to the 10-Year-Rule, the original intent of facilitating retirement savings with tax relief provisions using Defined Contribution plans did not include the intent for generations to pass wealth. In keeping with this, the new 10-Year-Rule requires non-spouse beneficiaries of inherited IRA accounts to empty the account within 10 years of the death of the original account owner. This same rule also applies to defined contribution plans such as 401(k) and 403(b) plans.
There are no required minimums for distributions and the only requirement is that the account balance must be zero after the tenth year. Current beneficiaries already receiving required minimum distributions are not affected.
Spouses and Beneficiaries who are Disabled or Chronically Ill are Exempt from the 10-Year-Rule
In addition to current beneficiaries, there are a handful of beneficiary classes excluded from the 10-Year-Rule. Most importantly, spousal beneficiaries are excluded and still able to use the old inherited ‘stretch’ provision.
For minor beneficiaries, the 10-Year-Rule doesn’t begin until the child reaches the age of 18. Beneficiaries who meet government definitions of disabled or chronically ill are also not subject to the 10-Year-Rule. Finally, non-spousal beneficiaries who are not more than ten years younger than the original account holder are allowed to take distributions under the old rules as well.
Downsides to the 10-Year-Rule for Non-Spousal Beneficiaries
One of the downsides to losing the ‘stretch’ provision as a non-spousal beneficiary is the potential loss of decades of tax-deferred growth. Additionally, higher distribution rates over ten years or having to drain the account on a final distribution to meet the 10-year-rule may subject the beneficiary to a higher income tax bracket.
4 Things to Consider with the 10-Year-Rule
There are several alternative strategies to the “Stretch Inherited IRA” for transferring wealth with tax savings.
1. Reevaluate your beneficiaries and beneficiary designations on retirement accounts. While wealthy IRA account holders used to be able to assign inheritances to the next generation that could grow tax free for decades with IRAs, the new 10-Year-Rule makes that strategy nearly obsolete. Alternative options for wealth transfer should be discussed with your estate planning attorney, CPA, and financial advisor.
2. Consider supporting beneficiaries with an income stream, while saving on taxes and benefiting a charity you love with a charitable remainder trust. Charitable remainder trusts can be used for an income stream for your beneficiary, with the charity of your choice receiving the remainder of funds after a specified period of time. This strategy involves naming the trust as beneficiary of the IRA, so the trust is funded upon the original account holder’s death. The tax deduction is claimed by the estate of the original account holder at the time the trust is created. Assets are then only taxed upon leaving the trust. The rate of tax deduction is determined by the length of the income stream; longer time periods allow for less deduction. Upon the death of the beneficiary or end of the trust term, any remaining assets in the trust go to charity tax free. This strategy is best discussed with a qualified estate planning attorney and CPA in order to meet your specific objectives.
3. Consider a conversion from regular IRA to a Roth IRA before turning 72. Roth IRA planning benefits have been extended. Since Required Minimum Distributions (RMDs) don’t have to start until age 72 now, users have an additional 1½ years to do a Roth IRA Conversion without the added worry about the impact of RMDs.
4. Consider permanent life insurance strategies. While discussion of permanent life insurance strategies are beyond the scope of this article, there are reputable and creative ways to leverage life insurance policies to enhance retirement income streams with tax benefits.
Revisit Estate and Retirement Planning
The SECURE Act’s 10-Year-Rule is good cause for revisiting both overarching estate planning and beneficiary designations.
Hammond Law Group attorney Jessica Showers says: “These changes bring with them the need for all clients to review not only their retirement planning strategy but also their estate planning documents for how wealth is transferred to the next generation This review is particularly important if, for any reason (divorce protection, desire to manage children’s inheritance without them receiving all of it in a short time, etc.) it is not desirable to fully put your retirement accounts in your beneficiaries’ hands within ten years of your death.”
We invite all clients to contact our office and schedule a review with an attorney so we can ensure your very careful planning continues to meet your goals in consideration of this new law.
Additionally, we recommend having a discussion with an independent financial advisor about your options. We’ve made this easy. Attendees of the upcoming workshop “Critical and Costly Retirement Mistakes and How You Can Avoid Them” will receive a one hour consultation with our in-house financial advisor Patrick D. Johnson, CFP®, CLU, ChFC. Click here to register for this exciting event.