2019 ended with President Trump signing a spending bill funding the federal government through Fiscal Year 2020. Included with the spending bill is the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act. The SECURE Act enacts major changes to rules related to individual and employer sponsored retirement accounts and may also substantially alter estate plans incorporating retirement accounts. Here are some key takeaways from the SECURE Act:
Individual taxpayers can now contribute to a traditional IRA at any age.
REQUIRED MINIMUM DISTRIBUTION
The age one must begin to take a minimum distribution from his or her retirement account is 72. Prior to the SECURE Act, the minimum distribution began at age 70 ½. This change affects participants who have not yet attained the age of 70 ½.
THREE TYPES OF BENEFICIARIES AND DISTRIBUTION RULES
The passage of the SECURE Act provides three different definitions of beneficiaries of a retirement account, and are very important to the distribution of the retirement account. There is the beneficiary who is not a designated beneficiary, designated beneficiary and eligible designated beneficiary.
Prior to the passage of the SECURE Act, the Internal Revenue Code provided that upon the death of a retirement plan participant, the balance of his or her retirement account must be distributed.
In annual installments over the life expectancy of his or her designated beneficiary. This is also commonly referred to “Stretch-IRA” provision. If the benefits were not left to a designated beneficiary, the retirement account must be withdrawn within 5-years of the participant’s death or annually over the participant’s life expectancy, had the participant not died.
Now, the distribution of the retirement account is subject to the 10-year payout rule unless the beneficiary of the retirement account is an eligible designated beneficiary. The eligible designated beneficiary is still entitled to (a modified version of) the life expectancy payout method, which is explained in further detail below.
Beneficiary who is not a designated beneficiary: the participant’s estate, a charity, or a trust that does not qualify as a see-through trust. The distribution period is the same as prior to the SECURE Act, which states a 5-year rule for benefits of participant who died before his or her Required Minimum Distribution, or participant’s remaining life expectancy if participant died on or after Required Minimum Distribution.
Designated beneficiary: individual(s) or see-through trust, must withdraw benefits within 10-years after the participant’s death.
Eligible designated beneficiary:
The surviving spouse. The surviving spouse can still use the life expectancy payout. However, on his or her death the exception ceases to apply and a 10-year payout applies. Common to estate plans, a spouse who is the beneficiary of a Q-TIP Trust under which the spouse receives the greater of the income or the RMD each year, will remain unchanged. However, if the spouse is a beneficiary of an accumulation trust, the surviving spouse will not be eligible for the life expectancy payout, even if the spouse is sole life beneficiary. An example of this accumulation trust is an “income only” marital trust. This type of trust would have to cash out all the benefits within 10 years after the participant’s death.
Minor child of the participant. The life expectancy payout applies to a child of the employee who has not reached majority. However, upon reaching majority, the 10-year rule kicks in.
Disabled beneficiary. The life expectancy payout applies to a designated beneficiary who is disabled (within the meaning of §72(m)(7)). Upon his or her death, the 10-year payout rule kicks in.
Chronically ill individual. The life expectancy payout applies to a designated beneficiary who is chronically ill (within the meaning of § 7702B(c)(2)). Upon his or her death the 10-year payout rule kicks in.
Less than 10 years younger beneficiary. The life expectancy payout applies to an individual who is not more than 10 years younger than the participant; upon his or her death, the 10-year payout rule kicks in.
All amounts must be distributed by December 31st of the year that contains the 10th anniversary of the date of death; and in the interim, no distributions are required, as long as funds are out of the plan by that deadline. As indicated above, there are exceptions to the 10-year payout rule.
SEE- THROUGH TRUSTS: CONDUIT vs. ACCUMULATION TRUSTS
The “see-through trust” has been an exception to the traditional rule that a trust is a non-individual beneficiary. If a trust meets the “see-through trust” requirements, the trust will be disregarded if it is designated as the beneficiary of a retirement benefit. If the trust is disregarded as the beneficiary of the retirement benefit, the beneficiaries of the trust are considered the beneficiaries of the retirement benefit.
Conduit: The conduit trust must direct the trustee to immediately distribute the annual minimum required distribution received from the inherited retirement benefit to a trust beneficiary, who must be an individual. The conduit trust can contain language to authorize the trustee to take distributions from the inherited retirement benefit that are in excess of the annual required minimum distribution. If the beneficiary of the conduit trust is one of the eligible designated beneficiaries, then the beneficiary can continue to receive the life expectancy payout. If not, then the retirement account will be subject to the 10-year payout rule.
Accumulation: An accumulation trust allows the trustee to accumulate annual minimum required distributions inside of the trust after they are received from the inherited retirement benefit. An accumulation trust will be subject to the 10-year payout rule.
As a general rule, there is a ten percent (10%) penalty applied to withdrawals prior to the age of 59 1/2. The SECURE Act now allows individuals to receive a penalty-free withdrawal with certain exceptions of up to five thousand dollars ($5,000) from retirement account for birth and adoption events. This is an addition to some of the preexisting penalty free withdrawals which include first-time homebuyers, medical expenses and distributions to active duty military. Special rules apply to each withdrawal.
The SECURE Act also provides small business owners an easier opportunity to provide retirement plans for their employees which include tax credits and Open Multiple Employer Plans. The Open Multiple Employer Plans allow small businesses to pool their resources together in order to offer a workplace retirement plan which is cost effective and easier to administer.
Many of these components of the SECURE Act take effect on January 1, 2020. However, how may that affect individuals who passed prior to December 31, 2019? Nothing changes directly, however upon the death of the designated beneficiary of the retirement account who receives the Required Minimum Distribution from his or her life expectancy, the designated successor beneficiary will now have to take this account subject to the 10-year payout rule.
Since the new rules cause a host of tax changes to families and small businesses, you should contact a qualified professional to discuss how the SECURE Act relates to you, your business or your estate plan. Please contact our office if you would like to discuss how the SECURE Act may impact your estate plan.