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SECURE Act Changes Retirement Plans and IRA Rules

by Phil Levin, Esq. on February 4th, 2020
IRA

Retirement benefits (such as pension, profit-sharing, 401(k) or IRA benefits) make up a substantial portion of many people’s assets.

Congress recently passed, and the President signed into law on December 20, 2019, the Setting Every Community Up for Retirement Act (the SECURE Act) as part of the Further Consolidated Appropriations Act, 2020.

The SECURE Act made various changes to the rules governing retirement benefits.

The key changes are as follows:

Distributions After Death

The most significant changes in the law are that the rules governing required distributions after the death of an employee or IRA owner generally now require that any remaining assets be distributed to the designated beneficiary by the end of the tenth calendar year following the employee or IRA owner’s death. This substantially reduces the benefit of the stretch.

Until now, designated beneficiaries could take distributions over their life expectancy (or faster if they wanted). The ability to stretch the distributions over a long period of time provided a substantial income tax benefit.

There are exceptions for spouses, minor children, disabled or chronically ill persons, or persons not more than 10 years younger than the employee or IRA owner.

These changes are generally effective for persons dying after December 31, 2019.

Traditional IRA Contributions After Age 70 ½

Until now, an individual could not contribute to a traditional IRA if he or she reached age 70 ½ or would reach age 70 ½ by the end of the year for which the contribution is made. Beginning in 2020, this limitation is repealed.

Unlike a traditional IRA, an individual over age 70 ½ is already permitted to contribute to a Roth IRA. However, there are income limits for eligibility to contribute to a Roth IRA. These limits remain in effect.

When Distributions Must Begin

Until now, employees and IRA owners generally had to begin taking distributions at age 70 ½, though they could defer the distribution for the year in which they reach age 70 ½ until April 1 of the following year. However, an employee who is not a 5% owner (with attribution) may defer benefits until retirement; and no distributions are required from a Roth IRA.

The new law increases the age threshold from 70 ½ to 72. This change is effective beginning in 2020 for individuals attaining age 70 ½ after December 31, 2019.

This change benefits some IRA owners who want to do Roth conversions to the extent it will not put them into too high a tax bracket. They will have an additional year or two before they have to take distributions that would be added to their income.

This change also benefits IRA owners who do not need to take distributions from their retirement plans and IRAs. They will be able to accumulate money in their retirement plans and IRAs for a longer period of time.

Planning Considerations

Roth contributions and conversions

It generally makes sense to contribute to a Roth IRA or convert to a Roth IRA to the extent the tax rate on the conversion is less than, equal to, or not too much higher than the tax rate that would otherwise apply to the distributions.

The limitation on the stretch will bunch the distributions after death into a shorter period of time. This generally will result in the distributions being taxable at higher rates.

As a result, Roth contributions and conversions will be advantageous more often.

Spouses of IRA owners who died within the last nine months

Most married people name their spouse as the primary beneficiary of their retirement benefits. However, under the new law, the surviving spouse’s beneficiaries generally will not be able to stretch the distributions for more than 10 years.

As a result, if an employee or IRA owner died in 2019 within the last nine months, the surviving spouse should consider disclaiming the benefits. In this way, the benefits will pass to the contingent beneficiaries, who may be able to stretch them over their life expectancy under the old law.

Reviewing existing trusts

Many people left their retirement benefits in trust rather than outright for the same reasons they left their other assets in trust rather than outright. By leaving assets in trust, their beneficiaries’ inheritances will not be included in their estates for estate tax purposes, and will be better protected against their creditors and spouses, and Medicaid.

Some people designed their IRA trusts so that any distributions from the IRA to the trust would be paid out to the beneficiary on a current basis. They may have been willing to have the beneficiary receive modest distributions in the early years, but may not want the beneficiary to receive the entire amount at the end of 10 years. These trusts should be reviewed, and if appropriate, changed to discretionary trusts.

Charitable remainder trusts

A charitable remainder trust is a possible workaround to replicate the stretch.

A charitable remainder trust distributes a percentage of the trust assets to one or more individuals for life or for a term of up to 20 years, whereupon the trust ends and the balance of the trust assets goes to charity. The distribution percentage must be at least 5%. The client may select the charities.

The payments can be fixed based on the initial value of the trust, or may vary based on the value of the trust each year. The actuarial value of the charity’s remainder interest must be at least 10% of the value of the trust as of inception.

Since a charitable remainder trust is tax-exempt (except for New Jersey income tax purposes), it can take the benefits in a lump sum without any adverse tax consequences.

Since the individual beneficiaries receive distributions for life (or for a fixed term of up to 20 years), the result is similar to that of a stretch.

There are some tradeoffs to a charitable remainder trust. It is less flexible than a traditional trust since the payments may not vary from year to year except based on changes in the value of the trust assets.

The payments to the individual beneficiaries have to be outright. There is an economic cost since the actuarial value of the charity’s interest has to be at least 10% of the value of the trust as of inception. However, for some people, this may be a small price to pay to be able to replicate the stretch.

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