In a bit of a surprise move, the “SECURE” Act was enacted on December 20, 2019. The SECURE Act dramatically affects the required minimum distribution rules applicable to IRAs and qualified retirement plans such as 401(k)s (“Tax-Deferred Retirement Accounts”). As is typical, the bad news was sweetened with some good:
- Required Minimum Distributions Start at Age 72: Most of our clients are familiar with the rules which require owners of Tax-Deferred Retirement Accounts to begin taking distributions at age 70 ½. These distributions are known as required minimum distributions (RMDs). You may also see them referred to as minimum required distributions (MRDs). The SECURE act changes the RMD age from 70 ½ to 72 for people who attained age 70 ½ after December 31, 2019.
- Traditional IRA Owners Can Continue Contributions Indefinitely. The prohibition on making contributions to traditional IRAs imposed in the year a person turns 70 ½ has been repealed. However, the other limitations on contributions remain. Note – this change also affects the rules regarding the amount of “Qualified Charitable Distributions” made from an IRA which may be excluded from income. If you desire to make IRA contributions at the same time you are making Qualified Charitable Distributions from the IRA, you should consult with your income tax advisor.
- Expanded 529 Account: 529 account monies can now be used to pay for registered apprenticeship programs and for up to $10,000 of qualified student loan repayments.
- Birth/Adoption Expenses: Penalty-free withdrawals of up to $5,000 can be made from 401(k) accounts to defray the costs of having or adopting a child.
- Benefits for Students: The SECURE Act will allow students and others receiving stipends or non-tuition fellowship payments to treat those payments as compensation for the purpose of making IRA contributions.
- “Kiddie tax” reinstated. Since 2018, unearned income reported to a minor or young adult was taxed at the compressed brackets and high rates applicable to estates and trusts. The SECURE Act reinstates the kiddie tax which instead taxes the income at the parents’ marginal rate.
The biggest SECURE Act changes have to do with how soon Tax-Deferred Retirement Accounts are required to be distributed after the original account owner dies. For Roth IRAs, distribution simply means that the funds will no longer be able to grow tax-deferred, but the beneficiary will not have to pay income tax upon receiving the distribution. For traditional IRAs and qualified retirement accounts, distribution means the funds will no longer grow tax-deferred, and the beneficiary will have to pay income tax on the funds received at ordinary income tax rates. Under the SECURE Act:
- Spouse “Stretch” Continues: For Tax-Deferred Retirement Accounts payable to a surviving spouse, the surviving spouse will continue to have the same options as prior to the SECURE Act which includes taking distributions over the surviving spouse’s lifetime and deferring the start of distributions until the surviving spouse turns 72.
- Stretch Distributions Ended for Most Non-Spouse Beneficiaries: Prior to the SECURE Act, distribution of Tax-Deferred Retirement Accounts left to children or grandchildren could be “stretched” out over the beneficiary’s life expectancy, allowing the remainder to grow tax -deferred and stretching out payment of any income tax. The SECURE Act now requires these accounts to be distributed in full by the end of the tenth calendar year following the calendar year of the account owner’s death. Thus the SECURE Act compresses the period of time over which the tax will be due which may also have the effect of increasing the applicable marginal tax rate. These new rules are effective for account owners dying after December 31, 2019.
There are exceptions if the non-spouse beneficiary is a minor child, a disabled or chronically ill person or is not more than ten years younger than the original account owner:
- A minor child may take RMDs using his or her life expectancy until the child attains the age of majority at which point the remainder of the account must be distributed within ten years.
- A disabled or chronically ill person will be entitled to take RMDs over his or her life expectancy.
- A person who is not more than ten years younger than the original account owner will be entitled to take RMDs over his or her life expectancy.
- Trusts are Trickier: If a non-spouse beneficiary is a trust, the rules get trickier. Some trusts, known as see-through trusts, will qualify for the 10-year rule. There are two types of see-through trusts: conduit trusts and accumulation trusts. However, if a trust does not meet the requirements for a see-through trust, the tax-deferred account could be required to be distributed in full within five years of the account owner’s death. If properly drafted, trusts for disabled or chronically ill persons will be entitled to take RMDs over the person’s life expectancy.
What Does This Mean For Your Estate Plan?
- Many clients will need to have their estate plans reviewed and updated. Unfortunately, even those estate plans which currently provide for “conduit” trusts will need to be reviewed. Under the prior law, a beneficiary’s life expectancy was central to the design of a conduit trust. Under the SECURE Act, for most non-spouse beneficiaries, life expectancy is no longer relevant.