Impact of the SECURE Act on Retirement and Income Tax Planning
The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) was signed into law by the President on Dec. 20, 2019. Effective January 1, 2020, the SECURE Act expands some benefits associated with IRA, 401(k) and other qualified retirement plans. Perhaps the most significant benefit offered by the SECURE Act is the change to the required minimum distribution (“RMD”) rules. Under prior law, account owners were required to begin taking minimum distributions from IRAs beginning at age 70 ½. The SECURE Act increases that age to 72, providing some relief to taxpayers in the form of income tax deferral.
Effective for distributions made after December 31, 2019, IRAs and certain other defined plans may distribute up to $5,000 to an individual to pay for birth or adoption expenses for a period of up to one year after the birth or legal adoption of a child, with such distributions escaping the ten percent income tax penalty imposed on early distributions. The distributions are still subject to income tax, however, and the distributions may be repaid to the retirement account at any time.
While the SECURE Act does offer some relief to taxpayers, it also presents challenges to those who wish to use an IRA as a means of transferring wealth to younger generations. The SECURE Act restricts owners of inherited IRAs from withdrawing assets over a lifetime (a concept often referred to by practitioners as the “stretch IRA”). The stretch IRA formerly allowed beneficiaries to pay income tax on the withdrawals over time by taking RMDs in accordance with tables published by the Internal Revenue Service, thus lessening the annual income tax burden on IRA distributions. For example, a grandparent could pass an IRA to a grandchild at death and that grandchild could stretch the IRA distributions over his or her life expectancy, recognizing the income over a lifetime and minimizing distributions during years in which earnings are high. Under the SECURE Act, stretch IRA benefits are no longer available. Rather, a non-spouse beneficiary more than 10 years younger than an IRA owner generally must liquidate the IRA and pay the income tax applicable to the distributions within ten years of the IRA owner’s death unless the beneficiary meets one of the few stated exceptions. Surviving spouses, the disabled, the chronically ill, minor children and beneficiaries who are not more than ten years younger than the IRA account holder are exempt from the ten year mandatory RMD rule. It is important to note that once a minor child who inherits an IRA reaches the age of majority, the child must withdraw the IRA assets within the ten year period.
The elimination of the stretch IRA opportunity will require many IRA owners to consider the effects that the SECURE Act may have on their estate plans as well as the income tax consequences to their potential beneficiaries. Those who inherit IRAs should be mindful of the ten year liquidation requirements and should be prepared to pay the income tax due on the distributions. IRA transfers from parents to children often occur when parents are in the eighty to ninety year age range, with children in the fifty to sixty year age range. This may lead to unfavorable income tax consequences, as the children could very well be in their prime earning years at the time of the transfer and subsequent liquidation; the additional income from the mandatory IRA distributions could also push the children into a higher marginal income tax bracket.
Individuals who have designated trusts as IRA beneficiaries should also pay close attention to the impact of the SECURE Act, as the look-through provisions applicable to the SECURE Act require that IRA assets be distributed within the ten year period where a beneficiary does not meet one of the aforementioned exceptions. A trust document which limits a trust beneficiary’s distribution to the annual RMD could have unfortunate results under the SECURE Act, because such a requirement could prevent a beneficiary from receiving any distributions for a period of ten years, with a lump sum liquidation and corresponding income tax event occurring at the end of the ten year period. Accordingly, IRA account owners should reconsider their beneficiary designations and evaluate whether those designations need to be changed in light of the SECURE Act.
For questions regarding the SECURE ACT, wills, trusts and estate matters, corporate issues or business and personal taxes, please contact Donald R. Seifel at (860) 548-2676 or drseifel@uks.com or Jonathan L. Canestri at (860) 548-2648 or jcanestri@uks.com.