14 Jan CHANGE IN RETIREMENT ACCOUNT LAWS AND INCREASED TAXES (SECURE ACT) LEAVES MANY BENEFICIARIES INSECURE
Although the SECURE Act passage last month (which became effective January 1, 2020) covered 29 new provisions, the one provision likely to cause the most impact is the removal of “stretch” inherited IRA provisions to 10 years unless the beneficiary is an eligible designated beneficiary. Prior to January 1, beneficiaries of inherited IRAs could spread distributions over their life expectancy resulting in tax-deferral and usually compounded growth. Previously there was more real net present value dollars. The new 10 year limitation will result in a beneficiary not only having to pay taxes quicker without as much anticipated growth, but it will often result in a tax rate creep as their income could substantially increase (depending on the size of the IRA) landing the beneficiary in a higher tax bracket. There is no longer a RMD (just all out by the 10thyear).
There are some exceptions to the 10 year payout of distributions. The new law permits “eligible designated beneficiaries” to continue to stretch the IRA over such beneficiary’s life expectancy. The exceptions include (a) a surviving spouse; (b) a minor (under 18) child (not grandchildren); (c) a disabled beneficiary (unable to engage in substantial gainful activity); (d) chronically ill individual (unable to do at least two activities of daily living or if severe cognitive impairment or determined as disabled by the government); and (e) if the beneficiary is less than 10 years younger than the deceased original owner of the IRA.
As a result of the new law, it is anticipated that financial advisors and estate planning attorneys will discuss some (but not limited to) of the following options:
- Contribute to a ROTH IRA (instead of a traditional IRA) since no income tax to beneficiaries;
- Convert traditional IRA to Roth to mitigate income tax costs so future distributions are not subject to income tax under the 10 year rule;
- Consider non-tax reasons for naming a trust as a beneficiary (i.e., divorce or remarriage of beneficiary or their spouse, addictions, disability, spendthrift, etc.);
- Revise any IRA trust that is a conduit trust due to income tax bracket shift although an accumulation trust could still be considered;
- Consider sprinkle accumulation trust to shift income to the lowest tax bracket beneficiary;
- Consider charitable remainder trust for the charitably-inclined IRA holder (depending on child’s or beneficiary’s life expectancy) since that type of trust doesn’t pay taxes on IRA distribution or growth (beneficiary would get lifetime income stream similar to a stretch IRA);
- Possibly buy life insurance policy to pay the income tax for the beneficiary;
- Advise clients with special needs trusts that accumulation trusts will work (accumulate instead of distributing that would jeopardize SSI) – so IRA could name the special needs trust as a designated beneficiary and will get stretch over life expectancy;
- Existing trusts may be changed to allow allocation of retirement plans if there is a special needs share or potential special needs share to get the stretch for non-ROTH IRAs; and
- Review existing 3rd party special needs trust to make sure: (a) it does not directly or indirectly benefit anyone other than the disabled beneficiary as it must be for their sole (not primary benefit); (b) it does not go into a common or pot trust for both disabled and non-disabled children as it should be directly funded to each child’s separate trust including the special needs trust; (c) no provisions to allow decanting or amendments during special needs beneficiary’s lifetime; and (d) should not have charitable remainderman as beneficiary of special needs trust.
Other changes in the SECURE Act include (but are not limited to):
- Increased required minimum age for distributions from IRA, etc. to age 72 (previously 70½);
- Removal of age limitation or contribution to an IRA (previously limited to age 70½ unless to a ROTH);
- Increased annuity options within the retirement plan (some plan sponsors were previously concerned about liability for in-plan annuities within a 401(k));
- Distribution of up to $5,000 for birth or adoption without penalty (previously 10% penalty if before age 59½); and
- 529 plans can be used to pay off student debt up to $10,000 and up to $10,000 can be used for the student debt of each of the beneficiary’s siblings.
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