Happy New Year everyone!
I know I haven’t written on this blog in a little while, but there are some brand new estate planning and estate administration changes that I will be discussing in the coming weeks and months.
Today I will outline the MAJOR change passed late in 2019 that will impact the way your beneficiaries will inherit retirement accounts and may impact how you choose to designate beneficiaries in your estate plan.
Do You Feel Secure?
The “Secure Act” (Setting Every Community Up for Retirement Enhancement Act of 2019) was signed into law on December 20, 2019 and became effective for deaths on or after January 1, 2020. The Secure Act implements the most sweeping changes to retirement accounts in 20 years. Most of the changes are beneficial, including:
- The date when an IRA owner must begin taking distributions (the “Required Beginning Date”) has been changed from 70.5 to 72. So for those born on or after July 1, 1949, you can now wait a couple years longer to begin distributions if you so choose.
- The age cap for contributing to a traditional IRA has been removed — you can now contribute as long as you have earned income.
- You can now use a 529 plan to repay up to $10,000 of student loans per year.
Congress Giveth and Congress Taketh (the Stretch) Away…
To pay for the beneficial changes, the rules relating to how beneficiaries withdraw retirement accounts following the death of the account owner have been completely rewritten.
Under pre-2020 rules, all designated beneficiaries (individuals and most trusts) had the option to stretch out distributions annually over the beneficiary’s life expectancy. For example, a 40-year-old beneficiary could stretch distributions over 45 years. Why was this good? Tax deferral and minimization, asset protection, post-death control by grantor, and so on.
But under the Secure Act — but for a handful of important exceptions (discussed below) — the life expectancy stretch is gone. It is replaced instead by a 10-year withdrawal period. Meaning that the designated beneficiary must fully withdraw (and recognize the tax on) the retirement account sometime within 10 years (not necessarily annually) after the owner’s death. This applies to both individuals and trusts alike. In next week’s followup post, I’ll discuss the new conundrum facing those naming a trust that had been intended to last the beneficiary’s lifetime.
…But Certain Beneficiaries are Still “Eligible” to Stretch
There are exceptions to the 10-year rule. Certain beneficiaries can still avail themselves of the prior “life expectancy stretch” rule. Under the Secure Act, these beneficiary are called “Eligible Designated Beneficiaries” (EDB). There are four categories of EDB:
- Surviving Spouse — the account owner’s surviving spouse can still do a rollover and the surviving spouse (or a “*conduit” trust for the surviving spouse) can still use a life expectancy payout. After the spouse’s death, the 10-year rule kicks in.
- Minor Child — the account owner’s minor child (or a “*conduit trust” for the minor child) can use the life expectancy payout. However, once the child reaches the age of majority (usually 18), then the 10-year rule kicks in. Note that this exception applies only to the owner’s minor child and not for just any minor beneficiary (like a grandchild).
- Disabled or Chronically ill Beneficiaries — the life expectancy payout method applies to any beneficiary (including any trust for the sole benefit of a beneficiary) that is considered to be either “disabled” or “chronically ill”. These terms are defined by statute and will be further refined by regulations. This is a very welcome exception and will make it easier to name a special needs trust for a disabled person.
- Less Than 10 Years Younger Beneficiary — the life expectancy payout applies to a beneficiary who is not more than 10 years younger than the account owner. This one is something of an odd exception, but may serve to benefit beneficiaries such as a younger sibling, unmarried partner, or friend.
*”Conduit trust” means a trust for the sole benefit of the beneficiary whose terms require immediate distribution of all withdrawals from the retirement account, rather than allowing the trust to retain withdrawals.
Those who name their estate or fail to name any living beneficiary will still be subject to the 5-year rule (for deaths before 72) or the owner’s remaining life expectancy (for deaths after 72).
For those currently withdrawing from an inherited IRA, rest easy. You can continue withdrawing over your life expectancy as before. However, once you die, your beneficiary will be subject to the 10-year rule.
What Does It All Mean?
In Part 2, I’ll outline the new issues created by these changes and some of the possible workarounds and planning considerations. In short, it’s time to dust off your beneficiary designations, analyze how the new rules will apply to your beneficiary designations as written, and consider whether any adjustments are appropriate. Careful review will be especially critical for anyone that had named a trust as beneficiary.