The SECURE Act may affect your estate plan

A new law effective Jan. 1, 2020, changes the rules for paying most retirement accounts to beneficiaries after the account owner’s death. The law affects, for example, all 401(k) plans and IRAs. For account owners who died before 2020, payments from their retirement accounts could (and still can) be “stretched” over the lifetimes of their beneficiaries. As discussed in more detail below, the new law applies a 10-year rule in many cases to payments to beneficiaries of account owners who die after 2019.  

This is a significant change that is causing many people to consider revising their trusts or beneficiary designations on their retirement plans and IRAs. 

Why Is the Stretch Being Shortened?

This new law is called the SECURE Act and was part of the large spending bill passed by Congress and signed by the president in late December. “SECURE” stands for “Setting Every Community Up for Retirement Enhancement.” The law provides new incentives and opportunities to make contributions to retirement accounts. For example, the SECURE Act allows for contributions to IRAs after age 70 1/2, and it pushes back the required beginning date for minimum required distributions from 70 1/2 to 72 (in most cases). Of course, there are transition rules and exceptions, so the applicability of any of these changes to your situation should be individually reviewed. 

To help pay for the new retirement savings incentives, Congress decided to limit the opportunity to stretch payments to beneficiaries, thereby accelerating tax revenues.  

It’s Time to Review Your Retirement Plan and IRA Beneficiary Designations 

It is always important to complete and monitor your beneficiary designations to make sure that they are consistent with your estate plan. Now that the SECURE Act has modified how retirement accounts can be paid to many beneficiaries, consider whether your existing designations still meet your objectives. 

A case-by-case review is needed, but we expect that some people will decide that they need a specially designed trust to manage the payments to beneficiaries; some will decide to remove or revise an existing trust that has been named as a beneficiary; and some will make no change. In any event, we expect that people will want to be sure that their beneficiaries will qualify for the 10-year rule or one of the exceptions to the 10-year rule that still allow for a stretch payout.

If the new 10-year rule applies, annual distributions are not required, but the entire retirement account must be paid to the designated beneficiary by the end of the year containing the tenth anniversary of the death of the account owner. (Note, this will allow reporting in 11 tax years, in most cases.) If the full account is not distributed in accordance with the 10-year rule, heavy penalties will apply in addition to the regular income tax.

There are important exceptions to the 10-year rule for “eligible designated beneficiaries.” Eligible designated beneficiaries still qualify to stretch payouts from retirement accounts over their applicable life expectancies. Eligible designated beneficiaries are:

• The surviving spouse of the account owner.
• Minor children of the account owner (but only as long as they are minors).
• Disabled beneficiaries.
• Chronically ill beneficiaries.
• Individuals who are not more than 10 years younger than the account owner.

In effect, the stretch is still available for these beneficiaries. However, if amounts remain in the retirement account at the death of an eligible designated beneficiary, then the 10-year rule will apply to the payout of the account. 

The stretch is also still available for beneficiaries who inherited retirement accounts from account owners who died before 2020. If amounts remain in the retirement account at the death of those beneficiaries, the 10-year rule will apply to the payout of the account.  

As with any new law, there will be questions about how it should be interpreted and applied, and we expect that the Treasury Department will be issuing regulations and other types of guidance to implement and clarify the 10-year rule and its exceptions.

Prompt Action May Be Needed 

In the meantime, prompt action may be needed. If you have designated a trust as the primary or contingent beneficiary on a retirement account, review that planning now. In some cases, those trusts were intended to create a mandatory stretch payout to one or more beneficiaries. The new law may cause the retirement payments to be paid to those beneficiaries within 10 years of death, which may be much sooner and taxed more heavily than planned. If that is not acceptable, then revisions will be needed.

If you are concerned about the loss of the opportunity to stretch retirement distributions to certain beneficiaries, there are other techniques to consider. For example, if your estate plan includes benefiting charities, a charitable remainder trust can allow you to approximate a stretch payout to adult children and benefit charity.  

It is always a good idea to review your planning every few years in light of changing personal or financial circumstances or changes in the law. We are shining a light on the SECURE Act now because the changes it makes might disrupt the estate planning that many people have done with their retirement benefits. 

If you are not certain whether or how the SECURE Act affects your planning, or if you would like to explore other planning opportunities, contact one of the attorneys below or any member of the McDonald Hopkins Estate Planning group.