SECURE Act and the Death of the Stretch-IRA
As you may have heard, the Setting Every Community Up for Retirement Enhancement Bill of 2019 (the “SECURE Act”) was signed into law on December 20, 2019. We want to alert you to the implications of this new law, which substantially impacts inherited IRAs.
The SECURE Act went into effect on January 1, 2020 and makes comprehensive changes to the laws governing retirement plans, including but not limited to IRAs, 401(k) plans, and 403(b) plans. For purposes of this post, we will use the term “IRA” when referring to all retirement plans. While many of these changes benefit IRA owners, one of them has a dramatic negative effect; namely, under the SECURE Act, the maximum period of time a non-spouse beneficiary of an inherited IRA has to withdraw the entire IRA, with limited exceptions, is 10 years. The beneficiary can withdraw the funds anytime during the 10-year post-death payout period, by gradual withdrawals or by withdrawing the entire sum in year 10. This is a massive change from the law in 2019, which allowed a non-spouse individual beneficiary of an inherited IRA (or beneficiary of a properly drafted trust which receives an IRA) to “stretch” the inherited IRA out over his or her life expectancy by taking only the required minimum distributions each year.
Planning Opportunities Under the SECURE Act
Exempt Beneficiaries Under the SECURE Act. The rules have not changed for spouses. Spouses can still elect to take distributions over their life expectancy according to IRS tables, or can rollover inherited IRAs to their own IRA and take distributions over their life expectancy; however, on the spouse’s death, the 10-year payout applies.
There are three types of non-spouse beneficiaries (“eligible designated beneficiaries,” or “EDBs”) who are exempt from the 10-year time period to withdraw the entire IRA. It is crucial that plans with EDBs are looked at closely. These EDBs are:
Minor child of the IRA owner. The 10-year rule does not kick in until the child attains the age of majority, which in California is generally age 18. Thus, the guardian or custodian of a 10-year-old who inherits an IRA may take small required minimum distributions until the child is age 18, at which point the 10-year rule begins. The age of “majority” can be extended for children who have not completed a specific course of education and are under age 26. Note: grandchildren are not EDBs.
Disabled and chronically ill beneficiaries. A disabled or chronically ill beneficiary may continue to stretch out his or her inherited IRA by taking only the minimum required distributions over his or her life expectancy, and is not subject to the 10-year rule.
A beneficiary who is less than 10 years younger than the IRA owner. A beneficiary who is not more than 10 years younger than the IRA owner is not subject to the 10-year rule.
Leaving an IRA to Charity. If you have charitable intent, reconfiguring your estate plan so that any charitable gifts come from your IRA rather than your will or trust will become even more tax efficient than under the old law. Your individual beneficiaries will avoid having to pay income tax on IRA distributions within the compressed 10-year period and the charity will receive the gift from the IRA tax-free. Your individual beneficiaries can instead receive trust assets, which will get a new cost basis at your death and are income-tax-free.
Mimicking the Stretch-IRA by leaving it to a Charitable Remainder Trust (“CRT”). A CRT can be designed to draw out distributions for the lifetime of a child or other heir, or for a period of 20 years, with the remainder going to charity. With careful tax planning, a CRT may provide the beneficiaries with more money than if they received the IRA outright; however, there are some tradeoffs, including less distribution flexibility. There is also some cost and complexity to administer a CRT. Stay tuned for a more detailed analysis of this planning option in an upcoming blog.
Disclaimers. Did the IRA owner die in 2019 and name his or her spouse as the beneficiary? If so, and if less than 9 months has elapsed since the IRA owner died, it may be possible for the surviving spouse to “disclaim” the IRA in favor of the contingent beneficiary on file (i.e., children or other younger individuals), allowing the younger beneficiary to stretch out the inherited IRA over his or her life expectancy. This could mean a substantial increase in wealth for the family.
Pitfalls Under the SECURE Act
Existing trusts named as beneficiaries of IRAs should be reviewed. Many, if not most, trusts designated as beneficiaries of IRAs are designed to qualify for stretch-IRA treatment by forcing the Trustee to distribute each IRA required minimum distribution the trust receives to the beneficiary in the same year. The language of some of these trusts may cause the entire IRA to be distributed by the 10th anniversary of the IRA owner’s death, which could be a tax disaster.
Persons who own IRAs or other retirement benefits that are a significant part of their estate plan should review their plan. Failure to review your plan in detail may result in unintended, harmful, consequences such as a beneficiary receiving significant funds too soon, or being saddled with a hefty tax burden. All plans should be closely analyzed.
If you have questions about the SECURE Act or wish to review your estate plan, please call our office at (818) 338-3252 or email the attorney who has worked with you on your estate plan.