No More Stretch IRAs: Estate Planning Considerations in Light of the SECURE Act
For the second time in three years, end-of-year wrangling by Congress has resulted in significant tax-related legislation. The Setting Every Community Up for Retirement Enhancement Act – better known by its acronym, the SECURE Act – was signed into law on December 20, 2019.
The Act will have far-reaching tax, retirement, and estate planning implications, both positive and negative, for many Americans.
No More Stretch. One of the more drastic changes resulting from the Act will affect nearly all non-spouse IRA beneficiaries: the elimination of the stretch IRA. Under prior law, a non-spouse beneficiary who inherits an IRA would immediately begin taking required minimum distributions from the IRA, but these distributions would be based on the individual’s age and “stretched” over his or her calculated life expectancy. A 25-year-old beneficiary, for example, would expect to take distributions every year over the next 60 or so years; a 45-year-old beneficiary would take distributions every year over the next 40 or so years. Because distributions from an inherited IRA are taxable income to the beneficiary, the income tax liability is diluted over the beneficiary’s lifetime. This stretch also allows the underlying IRA assets to grow over time.
For IRA owners dying on or after January 1, 2020, the Act eliminates this income tax perk, requiring instead that nearly all non-spouse beneficiaries take distributions within a 10-year period. This means for the 25-year-old beneficiary, the IRA will be fully withdrawn at age 35, and the beneficiary will have paid income tax over that 10-year period – a significant acceleration of income tax liability for many inheritors.
The 10-year rule will not apply to some beneficiaries; namely, a surviving spouse (who may still roll over the IRA and treat it as his or her own), minor children (but not grandchildren or other minors) until the age of majority, disabled or chronically ill adults, and beneficiaries who are less than 10 years younger than the original owner. IRAs inherited prior to January 1, 2020 are also exempt from the 10-year rule and will retain their current tax treatment.
So, what does this mean for you?
Although the effects of the SECURE Act will continue to be analyzed in the coming months, for many, an estate plan review is a good starting point. From an estate planning perspective alone, there are several items every IRA owner should consider.
Beneficiary Designations. Special attention should be paid to IRA beneficiary designations, particularly those that currently name a trust, and even more so if minor children are intended beneficiaries. If a trust is named as the beneficiary of an IRA, individuals should consult with their estate planning attorney to decide whether an accumulation trust (where IRA distributions may be "accumulated" and passed out to the beneficiary only at the trustee's discretion) or a conduit trust (where the IRA distributions must be passed out to the beneficiary) makes more sense moving forward.
For IRA owners with no surviving spouse, consideration should also be given to naming additional beneficiaries to inherit the IRA, perhaps spreading the assets among grandchildren as well.
Life Insurance. For individuals who do not need the income from IRA distributions, using the distributions to purchase life insurance may be a good strategy. At the owner’s death, the insurance proceeds will be tax-free and, better yet, should far exceed the IRA value. If a trust is named as the beneficiary of the insurance policy, the IRA owner, as trust grantor, can also better control the intended beneficiary’s access to the assets and protect the trust estate from the beneficiary’s creditors. Plus, if there are any assets remaining in the IRA, those assets will then be passed on to the beneficiary (within 10 years, of course).
For younger IRA owners, reallocating assets from IRA contributions to whole life insurance or fully funding Roth IRAs may also be sound long-term plans.
Charitable Planning. For those charitably inclined, the Act provides greater incentive to satisfy post-death charitable bequests from IRA assets, freeing up more tax-advantaged assets for non-charitable beneficiaries. As such, leaving an IRA to a qualifying charity or charitable remainder trust (where the owner's family may still benefit) may make more sense.