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In December 2019, U.S. lawmakers passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act. While the goal of this new law is to encourage more Americans to save for retirement, it also requires some to re-think their estate plans. Let’s take a closer look at the SECURE Act, focusing on how it impacts your retirement plans, estate plan, and taxes.
Impact on retirement plans (IRAs, 401(k) plans, and 403(b) plans)
Many estate plans were created with the concept of retirement plans being “stretched” over time to the beneficiaries. A stretch IRA allows the beneficiary, presumed to be younger, to draw from the account over his or her remaining lifetime. The main benefit of this strategy was the beneficiary could draw out the funds slowly over many years to avoid heavy tax burdens.
Under the SECURE Act, the IRA must be entirely paid out over 10 years. The result is that your beneficiaries may be subject to higher income tax brackets due to the accelerated recognition of income (for example, receiving $1,000,000 over a 10-year period rather than a 30-year period). Of course, there are some exceptions to this rule, but children and grandchildren are generally affected.
Another change to retirement plans under the SECURE Act is age restrictions. Previously, the required minimum distribution (RMD) age for these plans was 70 1/2. Now, to accommodate for longer life expectancy, the RMD age has changed to 72. In addition, older working Americans may continue to contribute to their plans, with no age restriction. This means you can keep building your funds, which may change some of your estate plan strategies.
Finally, if you hadn’t previously had access to a 401(k) plan due to part-time working status or employment in a small business, the new law provides eligibility for more workers. So, if you didn’t previously create an estate plan because you didn’t believe you had assets to consider, maybe it’s time to reconsider.
Impact on trusts and taxes
Many estate plans include trusts that contain “conduit” provisions. A conduit provision states that any funds distributed from a retirement plan into a trust should be distributed immediately to the beneficiary of that trust, regardless of the trust’s other age restrictions. The purpose for this was to allow the retirement plan funds to be reported on the beneficiary’s personal income tax return rather than the tax return for the trust (which usually pays more taxes for similar amounts of income). If you maintain these “conduit” provisions in your trust, then the entire value of your retirement plan will be owned directly by your beneficiaries within ten years after your death.
For people who wanted a trust to manage the funds for their beneficiaries for a relatively short period of time, then the “conduit” provisions may be sufficient. For others who may want funds to be protected and managed for the benefit of the beneficiary for much longer than 10 years, those people should consider changes to their estate plan. A potential solution is allowing the trust to retain those retirement funds in the trust; the trust will pay more taxes, but that may be an acceptable cost if the long-term goal is to protect the funds for the benefit of the beneficiary.
What to do about the SECURE Act now?
Overall, the SECURE Act was designed to create more revenue for the IRS. Individuals with estate plans and their beneficiaries are footing the bill. The Congressional Budget Office estimated that the removal of the “stretch” provisions will increase government revenue by $16 billion over the next ten years.
The content above covers the basics of how the new law will impact your estate plan. To protect your retirement and estate, be sure to schedule an appointment with your attorney, financial planner and tax advisor.
Don’t let the SECURE Act make you or your estate plan insecure.
Attorney R. Nicholas Nanovic counsels families in the administration of estates including large, complex estates involving trusts and complex tax matters. Nick is a certified Accredited Estate Planner® designee by the National Association of Estate Planners and Councils.