On Dec. 20, 2019, President Donald Trump signed into law the Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act), one of the most substantial revisions to employee benefits legislation since the Pension Protection Act of 2006. The changes enacted in the SECURE Act, most of which are effective as of Jan. 1, will have a major effect on many individuals’ estate plans, in which retirement benefits often play an outsize role. Many beneficiary designations and estate plans that were designed with the prior law in mind will need to be updated to deal with the new provisions, which in many cases will substantially accelerate the distribution (and hence the income taxation) of retirement plan distributions. It therefore will be important for individuals to review their existing beneficiary designations and overall retirement planning with a knowledgeable wealth planning adviser or estate planning attorney. This article will outline the SECURE Act changes that are likely to have the greatest impact on current estate and retirement planning.
Change to Required Beginning Date
A major change brought about by the SECURE Act is the increase in the required beginning date, from age 70½ to 72, for required minimum distributions from qualified retirement plans and individual retirement accounts (IRAs). This change, which will apply to distributions required to begin in 2020, will be of most interest to individuals who do not need the income from a retirement plan at age 70 and who wish to maximize the tax-deferred growth of their retirement plans.
Elimination of Contribution Age Restrictions
Prior to passage of the SECURE Act, contributions to traditional IRAs were not permitted after age 70½. The SECURE Act repeals this prohibition and permits an individual to contribute to a traditional IRA at any age after 70½ provided the individual receives compensation, typically earned income from wages and self-employment, in such year.
The SECURE Act includes an important related change to the "qualified charitable contribution" rules governing certain direct charitable distributions from an IRA. Under prior law, an individual who had reached age 70½ was permitted to exclude from gross income direct charitable distributions from the individual’s IRA, up to a maximum of $100,000 per year. While qualified charitable distributions are still permitted under the act, the excludable amount of those distributions will be reduced, dollar for dollar, by the amount of the individual’s deductible contribution to the IRA in such year. In other words, an over-70½ working taxpayer who contributes to an IRA while also directing that qualified charitable distributions be made from the IRA will effectively reduce the excludable amount of the charitable distributions by the excludable amount of the taxpayer’s IRA contributions.
Accordingly, individuals over age 70½ who wish to make deductible contributions to their IRAs while also directing qualified charitable distributions from their IRAs should review the numbers with their advisers to ensure that both their contributions and charitable giving are structured as they wish and in the most tax-effective way.
Elimination of the ‘Stretch’ IRA in Most Cases
Perhaps the most widely discussed change in the estate planning context is the SECURE Act’s elimination of "stretch IRAs" for most nonspousal designated beneficiaries of IRAs and certain retirement plans. Under pre-act law, both spousal and nonspousal designated beneficiaries were permitted to defer the income taxation of IRA and plan distributions by taking required minimum distributions over the beneficiary’s lifetime or life expectancy. This option resulted in significant income tax deferral, particularly in the case of younger designated beneficiaries.
Under the SECURE Act, designated beneficiaries who do not qualify as "eligible designated beneficiaries" (as defined below) must withdraw all IRA or plan assets within 10 years after the death of the plan participant or IRA owner. This new 10-year rule applies whether the participant died before or after his or her required beginning date. (The act does not, however, change the distributions in the case of beneficiaries who are not "designated" beneficiaries, such as the participant’s estate, which are subject to different rules depending on whether or not the participant dies before his or her required beginning date.) The SECURE Act defines an eligible designated beneficiary as the surviving spouse of the plan participant or IRA owner, a disabled or chronically ill individual (as further defined in the Internal Revenue Code), any individual who is not more than 10 years younger than the plan participant or IRA owner and any minor child of the plan participant or IRA owner. Note that the 10-year period begins when the minor child reaches the age of majority or upon the death of a disabled or chronically ill beneficiary.
The potential effect of these changes on existing estate planning cannot be overstated. Under pre-act law, individuals with sizable IRAs or retirement plans often designated "conduit" trusts as beneficiaries of their IRAs or retirement plans. Conduit trusts, which would collect the required minimum distributions and then pass those distributions on to the trust beneficiaries, were designed to qualify for the maximum income tax deferral with respect to the IRA or plan distributions while at the same time protecting the underlying assets. The trustee of a conduit trust could ensure that only the required minimum distributions would be distributed to the beneficiaries, who would have no power to withdraw the underlying assets or accelerate the IRA or plan distributions.
For conduit trusts with beneficiaries who are not eligible designated beneficiaries, this kind of tax deferral is no longer available under the act. The trustee of a conduit trust created by a decedent who dies after Dec. 31, 2019, will now be required to distribute all IRA or plan assets to the trust beneficiary within 10 years of the decedent’s death. Whether the trustee decides to stagger the distributions over the 10-year period or wait until the end of the 10-year period to collect and distribute the assets, the beneficiary will still be required to have received all of the plan or IRA assets by the end of the 10-year period. For IRA owners and plan participants who are uncomfortable with that prospect, an alternative is a discretionary "accumulation" trust, in which the trustee receives the required minimum distributions but is not required to distribute those amounts to the beneficiaries. Under the new law, the trustee of an accumulation trust will still be required to receive the IRA or plan distributions by the end of the 10-year period but will have no obligation to distribute the plan or IRA distributions to the trust beneficiaries, depending on the trust terms. Distributions would be in the trustee’s discretion. The disadvantage of an accumulation trust is that the IRA or plan distributions generally will have a higher income tax liability as a result of the compressed income tax brackets applicable to trusts. It therefore will be important for individuals to discuss these complex issues with a qualified estate planning attorney in order to be in a position to make a fully informed choice with respect to their beneficiary designations and how they structure IRA and plan distributions after death.
Other Planning Aspects
The SECURE Act also contains several changes unrelated to retirement, two of which are noted here.
Under the SECURE Act, an individual now may elect to take a penalty-free IRA withdrawal of up to $5,000 upon the birth of a child or adoption of an "eligible adoptee," provided the withdrawal is made within one year of the child’s birth or the date on which the adoption is finalized. For purposes of the act, an eligible adoptee is any child (other than a child of the taxpayer’s spouse) who is under the age of 18 or any individual who "is physically or mentally incapable of self-support." The act also provides that any individual who receives a qualified birth or adoption distribution may repay the amount to the IRA by means of one or more payments, without adverse tax consequences. Thus, individuals who are considering reducing plan contributions while anticipating the birth or adoption of a child may want to consider taking a $5,000 penalty-free distribution instead.
Another significant change under the law is the expanded ability to make tax-free distributions from Section 529 accounts to pay for educational expenses related to a beneficiary’s participation in a registered apprenticeship program, which was not permitted under the prior law, and to make payments on outstanding qualified student loans of both the designated beneficiary of the account and any one or more of his or her siblings, up to a lifetime cap of $10,000 for the designated beneficiary and each such sibling (with certain reductions in deductions for interest on education loans as applicable). Unlike most of the SECURE Act provisions, which generally are effective as of Jan. 1, the Section 529 expansion applies to distributions from Section 529 accounts after Dec. 31, 2018.
Conclusion
The SECURE Act is a complex piece of legislation that will expand financial and tax planning opportunities for individuals with qualified plans or IRAs in some areas while severely reducing the possibility of tax deferral in others, as well as providing additional flexibility in certain nonretirement-related areas. It will be important for individuals with retirement plans or IRAs to review the relevant provisions of the new law with their financial and estate planning advisers in a timely manner to determine whether or not adjustments should be made to existing plans.
Naina Kamath is an associate in Duane Morris’ private client services and employee benefits and executive compensation practice groups. She practices in the areas of wealth planning and employee benefit plan compliance.
Nora Pomerantz is a partner in the private client services group at the firm. She advises individuals and families in their estate and tax planning, corporate and individual fiduciaries in the administration of estates and trusts, and charitable entities in foundation management and charitable giving matters.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.
