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SECURE Act and What It Means

January 1, 2020, a drastic change for estate planning with retirement accounts by a new federal law. The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) comes with new rules regarding payout of retirement accounts to a deceased participant’s beneficiaries.

The previous law allowed most designated beneficiaries of an inherited retirement account to take the required minimum distributions from the account over the life expectancy of the beneficiary. This allowed the beneficiary to “stretch” out withdrawals over his or her lifetime. The beneficiary could indefinitely continue the benefit of allowing the account to earn investment returns on a tax-deferred basis.

The SECURE Act eliminates the ability to “stretch” these withdrawals from inherited retirement accounts over a beneficiary’s lifetime, in the majority of cases. Now, the funds must be completely distributed within 10 years after a plan participant’s death. At this point, the SECURE Act limits the potential use of the lifetime stretch rules to five classes of beneficiaries: (1) the participant’s surviving spouse; (2) minor children of the participant; (3) disabled beneficiaries; (4) chronically ill individuals; and (5) beneficiaries less than 10 years younger than the plan participant.

The SECURE Act affects the how your current beneficiary designations may be implemented as well as possible tax liability. Therefore plan participants will lose some control over planning options and most beneficiaries income tax will need to be paid at accelerated and higher rates.

It is recommended everyone with a retirement account review your beneficiary designations and estate planning documents, especially plans involving trusts as retirement plan beneficiaries. Strategic estate planning done now will help mitigate the impact of the SECURE Act.

Spouse as Beneficiary The SECURE Act dictates that a spouse named as full beneficiary still may: (1) stretch the distributions over the his/her lifetime; and (2) roll over inherited benefits into the spouse’s own IRA. As well as, where a trust is named as beneficiary of a retirement plan where a spouse is the sole beneficiary then the required distributions still may be stretched over the spouse’s lifetime.

You should review all plans event if a trust for the benefit of a spouse is the named beneficiary of a retirement account. Especially, if the retirement account pays to a trust in which the spouse is only entitled to receive annual distributions of income (and not the greater of the income or the required distribution), the retirement account will be subject to the 10-year payout rule — accelerating the income tax payments on the required distributions.

Children as Beneficiaries With little exceptions, most with children as beneficiaries of retirement accounts will now result in the accelerated 10-year payout of benefits.

Adult children and trusts for adult children will now be subject to the new 10-year payout rule. Minor children or trusts for minor children of the plan participant are beneficiaries, the 10-year payout will begin when the minor child reaches the age of majority. Other minors, such as grandchildren, are not considered eligible designated beneficiaries and are immediately subject to the 10-year payout rule.

Trust as a Beneficiary Prior to the SECURE Act, “conduit trusts” were used often in conjunction with the lifetime stretch rules for distributing retirement accounts to beneficiaries. A conduit trust is one in which all required distributions from a retirement account are distributed at least annually to the trust beneficiary, with income associated with the required distributions being taxed to the beneficiary at his or her individual income tax rate. Using this trust structure historically has minimized the income tax impact..

With the new 10-year payout rule under the SECURE Act, conduit trusts could trigger punitive income tax consequences. All plan benefits must be distributed outright to beneficiaries within the 10-year term, likely resulting in higher income tax rates. Trusts with conduit provisions no longer provide the long-term control or protection of retirement benefits and their proceeds for beneficiaries that many plan participants previously expected.

You may want to consider naming an "accumulation trust" as the beneficiary of a retirement account, instead of a "conduit trust," if your beneficiaries wish to avoid the retirement account being distributed in full within the 10-year term. An accumulation trust allows the required distributions to collect inside a trust, with the trustee maintaining discretion regarding distributions to trust beneficiaries. The retirement account, however, would be required to distribute to the trust in full under the new 10-year payout rule, resulting in accelerated income tax payments at higher tax rates charged to trusts (though actual distributions to a beneficiary will still carry out income).

Terms of trusts in existing estate plans should be carefully reviewed in conjunction with the new SECURE Act terms to ensure that a plan participant’s intentions are still met.

Roth IRAs Impact Roth Individual Retirement Accounts (“IRAs”) do need to adhere to the accelerated 10-year payout rule under the SECURE Act. Though, since Roth IRAs are not subject to income tax, the accelerated income tax liability is not a concern.

If you are an IRA owner with a lower income tax bracket than your beneficiary of your IRA, you may want to consider a Roth conversion. This way the you would pay income tax at your income tax rate, with distributions passing income-tax free to the named beneficiary. This equals less taxes in the long run.

The 10-Year Term All amounts to be distributed under the new 10-year payout rule must be distributed in full by December 31 of the year that contains the tenth anniversary of the date of death of the retirement plan participant. No distributions are required to be made until the end of the 10-year period, although distributions may be made before then.

Impact on Pre-2020 Deaths Even though the SECURE Act applies in full to all plan participants dying on or after January 1, 2020, it may still affect plans for a portion of those who die prior to January 1. For those who died in 2019, a disclaimer of retirement accounts to contingent beneficiaries should be considered to possibly lock-in lifetime stretch payments for the contingent beneficiaries. Also, plans in which the participant died prior to January 1, 2020, the 10-year payout rule will apply in most cases upon the death of the originally named beneficiary. Upon any death, analysis of the SECURE Act’s impact on retirement accounts should be considered.

Exceptions of the 10 Year Payout The SECURE Act allows lifetime stretch payouts to beneficiaries falling into the following categories: (1) disabled; (2) chronically ill; or (3) less than 10 years younger than the plan participant. There are new requirements and impacts on beneficiaries or trusts for beneficiaries who fall into these categories. Considerate planning is a must to ensure the longer payout period will apply.

How to Protect Yourself? We recommended that all retirement plan participants carefully review your current retirement plan beneficiary designations in conjunction with a review of your estate planning documents. National Legal Solutions Center invite you to contact us to discuss your estate plan and beneficiary designations and to review whether any updates may be needed.

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