On December 20, 2019, the “Setting Every Community Up for Retirement Enhancement” Act, otherwise known as the “SECURE Act” was signed into law. The SECURE Act brings changes to the tax treatment of Traditional IRAs and other types of qualified retirement accounts. These changes impact clients who are using retirement accounts to transfer wealth to their children.
Elimination of the Lifetime Stretch
The most significant change made by the SECURE Act is the elimination of the “lifetime stretch.” Under prior law, a child inheriting a parent’s IRA was required to immediately take distributions from the account each year and include those distributions as taxable income. However, prior law also allowed the child to spread out the account distributions over their lifetime, allowing the child to minimize annual income tax burden. This is referred to as the “lifetime stretch.”
Under the SECURE Act, the entire account must be fully distributed to the child within 10 years. Depending on the age and income status of the child when they inherit the account, this new rule can greatly increase the child’s income tax liability each year by concentrating distributions in a much shorter period than was allowed under prior law with the lifetime stretch.
Exceptions for certain Beneficiaries
A modified form of lifetime stretch payments are preserved for certain “Eligible Designated Beneficiaries.” The following individuals may still benefit from the lifetime stretch:
- Surviving spouses
- Minor children (but only until they reach majority)
- Disabled or chronically ill individuals
- Individuals who are less than 10 years younger than the account owner
It is also important to note that if an IRA or other qualified retirement account names a trust, estate, charity, or other non-person as a beneficiary, the account must still be fully distributed to that beneficiary within five years, as was required under prior law.
Effect on Trusts
The SECURE Act may also affect current estate plans using specialized trusts designed to hold retirement accounts. When an IRA names a trust as a beneficiary, the entire account must generally be distributed to the trust within five years. Because trusts are subjected to the highest income tax bracket (37%) much earlier than individuals are, many estate plans have implemented specialized trusts designed to spread out the trust’s tax liability over the lifetime of the trust beneficiary and avoid the five-year distribution requirement.
Depending on the type of trust and its specific terms, the SECURE Act could cause a retirement account to be paid out directly to the trust beneficiary muchearlier than was contemplated when the trust was set up. If your estate plan uses a trust that is named as the beneficiary of a retirement account, it is important to review the terms of your trust with your estate planning advisor to make sure it will function the way you intended it to.
Other Changes
The SECURE Act makes many other changes to current law, including:
- Increasing the mandatory withdrawal age from 70½ to 72
- Eliminating of the age cap on deductible contributions
- Penalty-free early withdrawals of up to $5000 for adoption or child-birth expenses
Because retirement accounts often make up a significant portion of an estate, it is important review beneficiary designations on your accounts with your estate planning advisors. Please contact our office to learn more about these changes and how they may affect your estate plan. One of our experienced estate planning attorneys will work with you to review and update your current estate plan or assist you in creating a new plan that best meets your goals.
