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Law Change: The Secure Act

How it Affects You

Just in time for Christmas 2019 the House and Senate delivered to many middle-class Americans a big lump of coal.  Legislation that has a significant impact on the way inherited IRA’s and 401k’s will be paid out was passed by the House and Senate and signed into law by the President as part of an enormous budget bill. The name of the legislation I will discuss is the SECURE Act.

I will try to keep my editorial comments to a minimum and stick mainly to the impact of the laws. I will conclude by discussing some strategies to consider if this development is of concern to you. But first, I’ll point out a few of the positive things that are associated with the SECURE Act. 

If you were under 70 ½ on January 1, 2020, you will now have the option to defer taking Required Minimum Distributions (RMDs) until you turn 72.  In addition, if you are still working at 72 you will be allowed to continue making contributions to your qualified plan.

Turning back to the more significant (and negative) impact of the SECURE Act, in a nutshell this new legislation eliminates an extremely valuable tax-deferral and growth strategy associated with inherited qualified plans commonly known as “stretch” rules and greatly accelerates the distribution of accounts and payment of income taxes. For most people who don’t work closely with a highly trained professional to explore the impact and what options exist, the opportunity to secure a financial legacy that could benefit children through their (the child’s) retirement has been taken away. And the only entity that will benefit is the United States Treasury.

Prior to the SECURE Act, when a person died owning a qualified plan (401k, IRA, or similar plan), the designated beneficiary of that plan could elect to handle the inherited plan in one of three ways:

  1. Take a lump sum distribution of the entire IRA amount and pay income tax on the entire distribution (obviously the worst choice from a tax and growth standpoint);
  2. Take distributions from the IRA over the course of five years and spread the associated income tax over that time period (a less-bad choice from a tax and growth standpoint, but still not the best choice); or
  3. Stretch the distributions over the course of their normal life expectancy (meaning smaller annual distributions, less income tax to pay, and a longer term during which the principal of the inherited IRA could grow; the best choice!).

For those participants naming a beneficiary who was significantly younger than them, the third option provided tremendous benefits to the beneficiary. A 40-year old beneficiary could “stretch” the distributions out for ~35-40 years, keep their tax burden very low, and allow the account to grow.

After passage of the SECURE Act, option 3 is no longer available in most long-term planning scenarios, and it has been replaced by a mandatory 10-year payout.

I must point out that the SECURE Act applies to the plans of participants who die on or after January 1, 2020. For a death prior to that date, the prior rules will continue to apply.

The only exceptions to the new 10-year payout requirement are for “eligible” designated beneficiaries.  Those who are “eligible” include:

  • Spouses (they can inherit it or roll it over and stretch distributions over their life expectancy)
  • A child of the participant who is under the age of majority (though that child must start the 10-year payout once they reach the age of majority – so completed by age 28)
  • A child of the participant who is disabled or chronically ill at the time of the participant’s death
  • A beneficiary who is not more than 10 years younger than the participant

Obviously, there are situations when an “eligible” designated beneficiary may exist and the impact of the SECURE Act will not be seen. For example, if you are married to a much younger spouse, that spouse will still operate under the old rules and be allowed to “stretch” distributions over the remainder of their life. Of course, the beneficiary that the surviving spouse designates for any remaining principal will be subject to the SECURE Act at their death… unless that designated beneficiary is also an eligible designated beneficiary.

The full impact and application of the SECURE Act is not yet known as the Treasury will develop and issue regulations which will need to be reviewed and interpreted.  For the time-being, I see the following significant impacts:

  1. The loss of the ability to name children or grandchildren as beneficiaries of a qualified account in order to realize the benefit of “saving for their retirement” on their behalf with the stretch.  Under the SECURE Act, those funds will be paid out faster, subjected to income taxes sooner and likely at higher levels, and will not be left in an instrument (a qualified plan) that would provide significant tax benefits to them into older age.
  2. For my clients who are qualified plan owners and have incorporated a Family Retirement Preservation Trust into their plan due to concerns over the ability of their beneficiary to (1) leave the funds in the qualified plan or (2) properly manage higher level distributions over a shorter amount of time, the government has taken away much of our flexibility and protections.  The ability to “protect and stretch” has been replaced by a 10-year payout of the entire qualified account.

Over time additional strategies will develop, but for now I see the following options as viable and worth considering if you are concerned about the impact of the SECURE Act.

  1. “Roth” your traditional IRAs.  This is one option you’d definitely only pursue after speaking with your accountant and financial planner, but the idea is to convert your traditional IRA to a Roth IRA (either in a lump sum or bit-by-bit) so that, ultimately, the distributions your beneficiaries take over their 10-year payout would be income tax free after you’re gone. In other words you pay taxes now, but allow tax-free growth and distributions in the future. This may be a particularly attractive option of your children will be amid their higher-earning years when distributions take place.
  2. Take your RMD’s or other distributions from your traditional IRA and use those proceeds to purchase life insurance. You may be able to leverage those dollars into a tax-free death benefit that you could either give outright to your beneficiary or you could name your trust as beneficiary with instructions for how those funds are to be handled and protected for the benefit of your beneficiaries after you’re gone.
  3. If you have charitable inclinations, you could use a Charitable Remainder Trust to structure deferral of the payouts/taxes for your beneficiary for a longer period than the SECURE Act allows.  Under this approach the charity must receive at least 10% of the actuarial value of the account for it to qualify. It is possible that this strategy could provide some additional protection and growth which would benefit both the charity and your beneficiary.
  4. If you currently have a Family Retirement Protection Trust as part of your Legacy Wealth Trust that serves as a conduit for RMDs to your beneficiary (in other words, the RMD’s must be paid out of the trust to the beneficiary), you may want to consider amending the trust to make it an accumulation trust instead. That way some or all of the RMD’s could be held back/protected to still maintain the protections that led you to elect the FRPT in the first place.

Isn’t it the truth that any time Congress does something, things generally seem to get more complicated? And seldom are they better. Well, this development is definitely not an exception. I realize that politics are politics and that’s the nature of the system we enjoy, but the fact that this legislation had wide bipartisan support as part of the larger budget bill is particularly disappointing to me.

If this causes confusion or triggers concerns about your qualified plans and how they fit into your estate planning goals, give me a call or send me an email. Again, we don’t know everything there is to know about things just yet, but I’m studying this and working with colleagues to be on top of whatever is going to be best for clients in the long-run.

Please feel free to pass this along to friends, family, or anyone else you know who might benefit from the information. I’m always happy to help your connections in the same ways I’ve been privileged to help you.

Mike Burgett
(254) 218-6288