The SECURE Act
On December 20, 2019, as incorporated into Congress’s 2020 fiscal year appropriations bill, the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became law. For many individuals and small businesses, the SECURE Act will be a net positive. For those with significant savings in qualified retirement plans such as IRAs and 401(k)s (referred to hereafter as IRAs for simplicity), their beneficiaries may see a significant tax hit. This article highlights the positive and negative changes that affect estate planners and their clients.
Let’s begin with the SECURE Act’s positive changes for individuals. The required beginning date (RBD)—the age at which an IRA owner must begin taking required minimum distributions (RMD)—has increased from 70 ½ to 72. This allows investments in the IRA to grow tax deferred for longer. Additionally, if an IRA owner continues to work after their RBD, they may continue to contribute to their IRA. If an IRA owner has a birth or adoption in their family, they may now withdraw $5000 within one year of the birth or adoption.
On the employer or plan level, several changes should expand the pool of employees with access to IRAs. The SECURE Act creates “open multiple employer plans,” or “open MEPs.” MEPs existed before the Act, but only for businesses with a relationship such as a common owner. The SECURE Act removes that restriction. The ability of small businesses to band together should reduce cost and complexity for employers, which should then translate into increased access to retirement plans for full- and part-time employees. The SECURE Act allows qualified automatic contribution arrangement (QACA) safe harbor plans to increase the cap on automatically raising payroll contributions from 10 percent to 15 percent of an employee’s paycheck, with the ability to opt out. The SECURE Act requires that plan participants receive an illustration of how much monthly income their retirement savings will provide.
Now for the SECURE Act’s negative changes. The most significant one affects beneficiaries who inherit an IRA after Jan. 1, 2020. If that beneficiary doesn’t qualify as an eligible designated beneficiary, they must withdraw all IRA funds within 10 years after the IRA owner dies. Previously, an IRA’s designated beneficiary could stretch out the RMDs over the beneficiary’s life expectancy. This change can best be understood by outlining the three categories of beneficiaries that now exist (the first two of which existed prior to the SECURE Act’s passage).
Non-designated Beneficiary (NB)
Prior to January 1, 2020, when an IRA did not have a beneficiary listed, the beneficiary predeceased the IRA owner, or the listed beneficiary did not qualify as a designated beneficiary, there existed two payout scenarios. If the deceased participant died prior to their RBD, the NB had to withdraw the IRA’s assets by the end of the year that contained the fifth anniversary of the participant’s death. If the deceased participant died after their RBD, the NB had to withdraw the IRA’s assets over the participant’s life expectancy.
These two payout scenarios still exist, but some practitioners have noted that the SECURE Act creates an absurd result if a participant dies with a greater than 10-year life expectancy. Under actuarial tables going into effect in 2021, this situation would exist if the participant dies between the ages of 73 and 80. In this situation, a NB would have a longer withdrawal period than a designated beneficiary. To date, the IRS has not adopted a regulation addressing this issue.
Designated Beneficiary (DB)
The SECURE Act does not change the definition of a DB. However, post-SECURE Act, if a beneficiary is merely a “designated beneficiary,” as opposed to an “eligible designated beneficiary,” that beneficiary must withdraw all inherited IRA assets by the end of the year that contains the tenth anniversary of the participant’s death. The new 10-year rule does not require that distributions be equal. A DB could benefit from unequal distributions if they expect their other income to be lower during the 10-year period.
Certain trusts can still qualify as DBs. A conduit trust is the most common qualifying trust. Under such a trust, all distributions from the IRA to the trust are passed to the trust beneficiary more or less immediately. The IRS treats the conduit trust beneficiary as the participant’s DB, and the 10-year rule applies to the beneficiary. Another common trust in retirement benefits planning, an accumulation trust, allows the trustee to accumulate IRA distributions. In order to qualify as a DB, all beneficiaries who may be entitled to receive the accumulated funds must be identifiable individuals. The important takeaway for practitioners is that the SECURE Act did not change how a trust qualifies as a DB.
Eligible Designated Beneficiary (EDB)
This is a new category of beneficiaries created by the SECURE Act. An EDB is the surviving spouse, minor child, disabled or chronically ill beneficiary, or a beneficiary who is not more than 10 years younger than the IRA owner.
The EDB can stretch distributions out based on their life expectancy. This rule has two important caveats. For all EDBs, the 10-year rule will kick in when the EDB dies and their beneficiary inherits the IRA. For minor children, the exemption from the 10-year rule ends when the child reaches majority. The SECURE Act provides little definition of “majority,” and the IRS has yet to adopt regulations. In California, unless the child is in the process of “complet[ing] a specified course of education and is under the age of 26,” the 10-year clock will start when the child turns 18.
Conduit trusts may qualify as an EDB if the trust beneficiary is an EDB. Without additional regulations, accumulation trusts are not likely to qualify as EDBs unless they have a sole designated beneficiary and that beneficiary is an EDB. This harsh outcome may not come to pass if new IRS regulations allow for both life and remainder beneficiaries to qualify as EDBs.
What does this mean for estate planning attorneys and their clients? While some attorneys have begun reviewing estate plans for clients who sought to take advantage of the life expectancy rule, others note that beneficiaries often deplete an inherited IRA prior to the 10-year anniversary of the participant’s death. Regardless of approach, attorneys should keep an eye on regulations addressing some of the SECURE Act’s unresolved issues (e.g., definition of “majority” or accumulation trusts as EDBs).