Late last year, Congress passed the Securing Every Community for Retirement Enhancement (SECURE), one of the most significant pieces of legislation to impact retirement planning in recent years. Among its many far-reaching provisions, the SECURE Act can potentially cancel out an IRA beneficiary’s ability to stretch distributions over the course of his or her lifetime.
What is the SECURE Act?
On December 20, 2019, the SECURE Act was signed into law as part of a $1.4 billion spending bill. Contained in the law are numerous provisions related to taxes, 401(k)s, annuities, and IRAs. If someone is approaching retirement age or just starting to research an estate plan to protect his or her retirement and loved ones, knowing the SECURE Act is relevant.
Here are just a few of the notable changes included in the SECURE Act:
- Rescinds the maximum age for making IRA contributions, now it is 70 ½.
- Raises the age when required minimum distributions (RMDs) must begin from 70 ½ to 72.
- Enables companies to merge to form multiple employer 401(k) plans.
- Reduces start-up costs for small businesses by increasing their credit limits and creating an auto-enrollment credit.
- Replaced the stretch IRA with a 10-year rule.
What is a Stretch IRA?
An IRA is an essential piece of an individual’s retirement package. The money someone invests on a tax-free or tax-deferred basis helps support the individual and his or her beneficiaries in the future.
Prior to the SECURE Act, non-spouse beneficiaries could apply the stretch strategy to spread out distributions over the course of their lifetime. This allowed the IRA account to continue growing, tax-deferred, while the beneficiary still received payments. Stretch IRAs did not apply to charities, trusts, and non-person entities because they have no life-expectancies.
How Does the 10-Year Rule Work?
With the SECURE Act, one of the major changes impacting non-spouse beneficiaries is that they no longer have a lifetime to empty inherited IRA accounts. Now, they must do so within a 10-year period. However, it is important to note that there are no required annual withdrawals over this 10-year timeframe. That means a beneficiary can take out any amount at any time during that 10 years, provided the entire balance is withdrawn by Dec. 31 of the tenth year after death.
Who is Exempted from the 10-Year IRA Rule?
The SECURE Act addresses three different groups of beneficiaries:
- Non-designated beneficiaries: Trusts, charities, and other non-person entities.
- Eligible designated beneficiaries: Spouses, minor children, those with a chronic illness or disability, individuals who are no more than 10 years younger than the decedent, and any designated beneficiary who inherited before 2020.
- Non-eligible designated beneficiaries: Any designated beneficiary who is not on the list of eligible designated beneficiaries.
Non-eligible designated beneficiaries are the only group subject to the SECURE Act 10-year rule. Yet, that group unfortunately includes most non-spouse beneficiaries and successor beneficiaries, which are beneficiaries of the original beneficiary. The 10-year rule applies to most trusts as well.
Important Considerations Regarding the SECURE Act
While the types of beneficiaries mentioned above have a decade to withdrawal their entire IRA accounts, there are no regulations as far as how much and how often they need to do so. If they are financially sound and do not need the money up front, they can wait until the deadline, allowing it to grow.
It is worth noting that withdrawing after the last day of the tenth year after death comes with a steep penalty, which is 50 percent of any amount left in the inherited account at that time.
Charitable Remainder Trusts a Possible Solution
One possible solution to reduce the tax burden on IRA beneficiaries is to name a charitable remainder trust (CRT) as an IRA beneficiary. Naming children as CRT beneficiaries allows them to receive payments over their lifetime or a 20-year period. Since CRTs are tax-exempt trusts, qualified funds transferred into them will not be considered as income.
How IRA holders will structure their CRT depends on the age of the dependents at the time of the holder’s passing. Since a CRT has a minimum payout of five percent and a remainder of 10 percent, younger heirs may not be eligible for a lifetime CRT; however, the 20-year term alternative is a good option in this case for deferring taxes.
Should I Consider a Pension Rescue?
Another option to address the removal of the stretch IRA is a pension optimization plan. This is ideal for clients who are 50 years old and older who have at least $1 million in their accounts. Using funds originating in an employer-sponsored contribution plan, one can purchase a life insurance policy to be appraised and distributed to the insured or a trust within a few years. This allows for more value, allowing the insured to pay lower premiums for a policy that has more value than an IRA account would have grown in that short amount of time. This option is for clients fortunate enough to have substantial assets dedicated for their retirement.
Tax Ramifications of the SECURE Act
If someone has a substantial IRA, say about half a million dollars or more, one should consider the tax ramifications for non-spouse beneficiaries. Beneficiaries can use payment flexibility to their advantage in terms of taxes, taking out less during low income years or during retirement for a smaller tax rate.
Converting an IRA to a Roth IRA in small amounts over time is another way to keep income from moving into a higher tax bracket. Since Roth IRA funds are already taxed, beneficiaries can withdraw it tax-free.
Qualified charitable distributions (QCDs) are good ways to give to others while reducing taxable income and can be directly transferred into an IRA. This is a smart way to donate to favorite charities, considering most people are no longer able to deduct charitable contributions because of the increased standard deduction that came with the Tax Cuts and Jobs Act (TCJA) of 2017.
Exceptions for Individuals Affected by COVID-19
As the nation and others around the globe continue to fight the spread of the novel coronavirus, special considerations have been made for individuals dealing with COVID-19. People and their spouses and dependents who are diagnosed with SARS-CoV-2 or COVID-19, and people who are experiencing financial hardships because of the quarantine, may be able to withdrawal up to $100,000 from an IRA, penalty-free.
While these withdrawals are still taxable, income taxes can be spread over a three-year period. There is no early-withdrawal penalty on COVID-19-related payments and individuals can recontribute these funds for up to three years from the day after the withdrawal.
This brief overview covers just some of the ways the SECURE Act may affect a person’s future financial picture. Schedule an appointment with an experienced elder law attorney for more personalized recommendations based on individual needs and goals, including Medicaid planning.
Brooklyn Elder Law Lawyers at Korsinsky & Klein, LLP Help Clients Avoid Common Retirement Pitfalls
You have worked hard to provide a secure future for you and your loved ones. It makes sense to take steps to protect it. One of our trusted Brooklyn elder law lawyers at Korsinsky & Klein, LLP will address all of your concerns and ensure that you and your family are protected. Call us at 212-495-8133 or complete our online form for an initial consultation today. Located in Brooklyn and Manhattan, New York, and Lakewood, New Jersey, we serve clients throughout New York and New Jersey.