On December 16, 2019, Congress agreed to a spending bill which included a law called the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act was passed only by the House in the summer, but seemed to be falling by the wayside until it was attached to this spending bill. The new law is effective January 1, 2020. Below is some insight into the major implications of this new law, and some thoughts on how to lessen the impact of the most important change: the removal of the stretch RMD provisions on inherited IRAs.

What did the SECURE Act do?

The SECURE Act changed the tax consequences and rules regarding IRAs and other retirement accounts. The most impactful changes are:

  • Effective 1/1/2020, the start date for an IRA owner to take required minimum distributions (RMDs) will be age 72 (currently the start date is 70.5)
  • Inherited IRAs will have to be paid within a 10-year period (prior law allowed inherited IRAs to be stretched and paid out over a beneficiary’s life expectancy)
  • Age limitation on IRA contributions will be removed (prior law prohibited an IRA owner from contributing to IRAs after 70.5)

How does this impact taxes?

For the IRA owner, the later RMD start date (from 70.5 to 72) is favorable since the IRA owner can allow the IRA to appreciate tax deferred for another year and a half. The removal of the age limitation on IRA contributions is also favorable, as it allows an IRA owner to continue tax-deferred contributions to her IRA so long as she has earned income.

For the beneficiary inheriting an IRA, the 10-year payout provision starting in 2020 will be much worse than the life expectancy stretch period that is currently allowed. Because RMDs are subject to income tax, the 10-year payout period will force larger amounts to be paid out faster, pushing more taxable income out and likely pushing beneficiaries into much higher tax brackets. With the stretch period over a beneficiary’s life expectancy, smaller amounts of taxable income are paid out.

If a trust you’ve named as IRA beneficiary is a conduit trust, it will have to pay out all RMDs that it receives to the trust beneficiary within 10 years. This means that there is not only the negative tax consequence of accelerated taxable distributions, but also the loss of creditor protection the trust provided for the IRA after only 10 years.

What about owners who are age 70.5 before the end of 2019?

If an IRA owner was already 70.5 years of age before the end of 2019, then the current law still applies, and they must begin taking RMDs.

Does the 10-year payout provision apply to all IRA beneficiaries?

There are exceptions. Inherited IRAs for the following beneficiaries may still be paid out over the life expectancy of that beneficiary:

  • IRA owner’s spouse
  • IRA owner’s minor children
    • When the minor child reaches majority age (18 or 21 in most states), the 10-year rule kicks in
  • Disabled or chronically ill beneficiaries
  • Beneficiary less than 10 years younger than IRA owner

What if the IRA owner dies before the SECURE Act’s effective date (January 1, 2020)? Does the 10-year payout provision still apply to that inherited IRA?

No. If the original IRA owner dies before 2020, the IRA beneficiary’s life expectancy may be used to stretch the payout of inherited IRAs.

The SECURE Act’s 10-year payout provision applies only to inherited IRAs where the original IRA owner passes away after 12/31/19 (unless the beneficiary falls under one of the exceptions discussed previously).

Does the new 10-year payout provision also apply to Roth IRAs?

Yes, the SECURE Act also applies to Inherited Roth IRAs. However, since distributions from an Inherited Roth IRA are not taxable, this is not as impactful from an income tax perspective.

What can I do to reduce the impact of the new 10-year payout provision?

Though a thorough analysis of all the facts and numbers will be required, the following ideas may be considered:

  • If you currently have a trust named as beneficiary of your IRA, you should review the terms of the trust with your estate planning attorney to confirm whether the trust is a conduit trust, and if so, whether an accumulation trust should be named as IRA beneficiary instead. An accumulation trust will better protect a spendthrift beneficiary because the trustee will have the authority to keep and reinvest some or all of the RMDs it receives within the trust. If a conduit trust is named as IRA beneficiary, the trustee must pay out the entire IRA to the trust beneficiary within 10 years, eliminating that spendthrift protection more quickly than planned.
  • The IRA owner can convert portions of her IRA to a Roth IRA over time. While the Inherited Roth IRA is also subject to the 10-year payout provision, distributions from an inherited Roth IRA are not taxable. Converting your IRA to a Roth IRA is a taxable event, but if the conversion amount is relatively small each year, you can stay within a manageable tax bracket. If your tax bracket is in the lower or middle tiers, this is a good strategy. By converting small portions of your IRA over time and paying taxes on it now at lower tax rates, you will save your beneficiaries the taxes on large inherited IRA distributions that would likely be taxed at the highest tax rates because of the 10-year payout provision. The beneficiary would instead receive distributions from the inherited Roth IRA tax-free.
  • If the IRA owner has charitable intent, she can name charitable remainder trusts (“CRTs”) as IRA beneficiaries. When the IRA owner passes away, the IRA custodian pays the entire lump sum IRA to the CRTs. Because the CRT is a tax-exempt trust, the entire lump sum IRA amount will be left untaxed to fund the CRTs. You may name each child the beneficiary of his own CRT, for his lifetime or up to 20 years. During the child’s lifetime or a 20-year period, the CRT will pay a fixed percentage of the trust assets to the child each year. At the child’s death or the end of the 20-year term, whatever remains in the CRT will be paid to the named charity.
    • IRA owner must have a charitable intent.
    • Because the CRT can last for the child’s lifetime, it essentially simulates the stretch that is being eliminated by the 10-year payout provision.
    • Though the CRT itself is tax-exempt, the payments that the child receives from the CRT are taxable. However, this is more tax efficient because a) the payments are smaller than they would be under the 10 year payout provision and b) the CRT can invest so that eventually, part of the distribution is taxed at capital gains rates, which are lower than ordinary income tax rates.
    • There are limits to how long the CRT can last while still passing the 10% test (the present value of what the charity is actuarially projected to receive when the CRUT term ends must be at least 10% of the initial funding amount).

How We Can Help

Please have a discussion with one of our advisors to understand how the new SECURE Act impacts your specific situation, and to discuss potential solutions.

 

Wealthspire Advisors is the common brand and trade name used by Sontag Advisory LLC and Wealthspire Advisors, LP, separate registered investment advisers and subsidiary companies of NFP Corp.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors, LP cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2019 Wealthspire Advisors

Richard Yam, J.D.

Rich is vice president of trusts & estates, and is based in our New York office.