By: Michael D. Wilhelm
On December 20, 2019, President Trump signed a fiscal year 2020 appropriations bill that included the Setting Every Community Up for Retirement Enhancement Act, better known as the “SECURE Act,” which went into effect January 1, 2020. While there are many aspects to this legislation, this article focuses on the so-called “10-Year Rule” and the “Death of the Stretch.” The SECURE Act affects traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, 403(b) plans, 457(b) plans, profit sharing plans, and other tax-deferred defined contribution plans, which will be referred to as “retirement plans” in this article.
A key change included in the SECURE Act is that retirement plan participants can now wait until the year they turn age 72 before beginning Required Minimum Distributions, or “RMDs.” Prior to January 1, 2020 retirement plan participants had to start taking RMDs the year they turned 70 ½. Retirement plan participants still have to wait until age 59 ½ before they can make voluntary withdrawals from their retirement plans without incurring a penalty.
Another key change is that there is no longer an age cap on making contributions to traditional IRAs. Prior to the January 1, 2020, a traditional IRA participant could not make contributions the year the participant turned 70 ½ or any year thereafter. There is still the requirement that the participant has earned income in the year the participant makes a contribution. Also, there is still a contribution limit of $6,000/year if you are under age 50 and $7,000/year if you are age 50 or older.
Another key change brought about by the SECURE Act, and the focus of this article, is the so-called “Death of the Stretch,” which affects beneficiaries of retirement plans. Prior to January 1, 2020, a beneficiary of a retirement plan who was a “designated beneficiary” (a person or a see-through trust) had the option to stretch distributions from an inherited IRA account over his or her life expectancy. The life expectancy stretch was a valuable option for designated beneficiaries who did not have an immediate need for the inherited funds. The inherited IRA account could grow tax-deferred, with the designated beneficiary only taking RMDs each year based on the beneficiary’s life expectancy. This delayed and reduced the income taxes of inherited IRA distributions to the beneficiary.
The SECURE Act eliminates the life expectancy stretch when the participant dies January 1, 2020 or after, unless a designated beneficiary is also an “eligible designated beneficiary.” The five categories of eligible designated beneficiaries are:
- Surviving spouse
- Minor children
- Disabled individuals
- Chronically ill individuals
- Beneficiaries less than 10 years younger than the plan participant
The SECURE Act does not affect a surviving spouse’s ability to treat the retirement plan as his or her own by becoming the account owner or rolling the account over. The surviving spouse can then continue to make contributions to the retirement plan, defer RMDs until age 72, and roll over any amount into or out of the retirement plan.
Minor children are required to take RMDs based on their life expectancy until they become an adult, at which point the “10-Year Rule,” which is explained below, applies.
Disabled and chronically ill individuals, as defined by the Internal Revenue Code, can continue to receive RMDs each year based on their life expectancy. The disabled or chronically ill determination is made as of the date of death of the retirement plan participant, which means that if a beneficiary wasn’t disabled or chronically ill on the participant’s date of death, but later becomes disable or chronically ill, the beneficiary will not qualify for the life expectancy stretch.
Beneficiaries who are less than 10 years younger than the plan participant can also continue to receive RMDs each year based on their life expectancy.
For each designated beneficiary who is not an eligible designated beneficiary, which includes but is not limited to adult children and grandchildren of any age, the beneficiary must withdraw all funds from an inherited retirement plan within 10 years after the plan participant’s year of death. This is the so-called “10-Year Rule.” During this 10-year period, there are no RMDs. This shortening of the distribution period will result in increased income taxes and earlier income tax payments on many inherited retirement plans.
Existing estate plans may need to be reviewed and revised in light of the changes brought about by the SECURE Act. Planning options under this new legislation may include but is not limited to changing beneficiary designations, establishing Charitable Remainder Trusts, revising existing Retirement Plan Conduit Trusts, setting up Special Needs Trusts, and converting existing retirement plans to Roth IRAs. Estate and trust planning attorneys at DeFur Voran LLP are available to make a comprehensive review of your estate plan and goals, account specifically for SECURE Act changes and planning options, and craft a plan uniquely tailored to your needs. Please contact our Estate Planning Team or me directly at your convenience.