The SECURE Act

“The SECURE Act,” that is the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Jonathan Michael, ACTEC Fellow from Chicago. The new SECURE Act is working its way through Congress. To tell us about this proposed legislation and how it affects non-spouse beneficiaries of retirement accounts, you will be hearing today from ACTEC Fellow Nancy Welber of Farmington Hills, Michigan. Nancy.

Thank you, Jonathan. SECURE, Setting Every Community Up for Retirement Enhancement, has some very interesting changes to the way people will collect their retirement benefits in the future. It passed the House in late May by a vote of 417 to 3, but it has been stalled in the Senate. It is unclear whether it will pass in 2019, although, it may pass in 2020. It is very important to be ready for it should it become a law.

SECURE Overview

SECURE changes a number of items concerning retirement plans. Among them, it raises the age for required minimum distributions to 72 from age 70-1/2. It allows contributions to traditional IRAs at any age as long as the taxpayer is still working. It expands penalty-free early distributions for account owners under age 59-1/2, for up to $5,000 within one year for the birth or adoption of a child, or it also allows an early distribution to be recontributed to the same plan or IRA and treated as a rollover without any time limit, and even has some nonretirement benefits. A 529 College Savings Plan may be used on a limited basis to repay student loans. So, there are important changes, but the most notable change for estate planning purposes, and what I will discuss for the rest of this podcast, is the end of what is often called the stretch IRA for A non-spouse beneficiary.

A non-spouse beneficiary, regardless of age, is required to take minimum distributions after the death of the account owner. In most cases, the beneficiary establishes an inherited IRA to take the required minimum distributions. Currently, non-spouse beneficiaries who are usually the account owner’s children use their own life expectancies to take minimum distributions after the death of the account owner. In other words, they calculate these minimum distributions based on life expectancy factors found in tables that are part of the Treasury Regulations. The current tables assume that a beneficiary will live until about 83 years or so. So, if a beneficiary inherits an IRA at age 40, for instance, they will have 43.6 years to take out the benefits. The change under SECURE, however, is profound. Most non-spouse beneficiaries will have to liquidate inherited accounts such as IRAs, including Roth IRAs, and 401(k) and 403(b) plans by the end of the tenth year following the death of the account owner. So, for example, if SECURE were to pass this year, for someone who dies in 2020, the account would be required to be liquidated by December 31, 2030. For that 40-year-old beneficiary, under SECURE, he or she could lose 33.6 years of possible tax deferral or “stretch” as we like to call it.

SECURE Exceptions

This being the tax code, of course, there are exceptions to this 10-year rule. These beneficiaries who are the exception beneficiaries are called eligible designated beneficiaries and the current rules will still apply to them during their lifetimes although their beneficiaries will be required to use the 10-year rule. Who are these eligible designated beneficiaries? Well, they are the surviving spouse for one, so the rules for a surviving spouse will not change under SECURE; you will still be able to do the rollover as has always been the case or even create inherited IRA accounts in some instances.

In addition, a beneficiary who is not more than 10 years younger than the account owner is also an eligible designated beneficiary. This could be someone, for example, like a sibling, who might even be a little bit older than the actual account owner. And the other three important categories are beneficiaries who are either disabled or chronically ill, as defined in the tax code, and children of the account owner until they reach the age of majority. Note that this latter exception for the children of the account owner is just that. It does not apply to all minor beneficiaries, so would not apply for example to the grandchildren of the account owner. But what is the age of majority for the purpose of this particular exception? You might think it is age 18 or perhaps 21, but interestingly, under the regulations governing actually defined benefit type plans—those plans that pay installment payments to their beneficiaries and also the account owner–the minor children of the account owner don’t reach the age of majority until they are age 26.

What is the age of majority for the purposes of SECURE? Interestingly, it may not be age 18 or 21. It may be as long as age 26, as long as the child is in a specified course of study under the regulations. We are not sure yet what specified course of study means because it is not defined in the regulations, but it is an opportunity to encourage your children to become PhDs and MDs because typically, their specified course of study will go that long. Once the minor attains the age of majority, the 10-year payout period will then apply. So, the maximum payout will be until the child attains the age of 36, but it is likely to be before then.

Concerns Related to SECURE

Many estate planning clients have made their IRAs and 401(k) or 403(b) plans payable to trusts often under the careful supervision of their estate planning attorneys. With regard to the administration of SECURE, retirement accounts payable to trusts are likely to be the area that causes the most concern to estate planning attorneys. The rules are quite technical. It is very interesting because the tax code, Section 401(a)(9), which governs the minimum distribution rules, never discusses trusts. All of the rules for retirement accounts payable to trusts are governed by the Treasury Regulations and probably thousands of private letter rulings that interpret the regulations for specific taxpayers. Current trust rules under the regulations just don’t mesh well with SECURE. The 10-year rule applies to most non-spouse beneficiaries and for those eligible designated beneficiaries that are likely to take their inherited IRAs in a trust, like minor children or the disabled and chronically ill, it will be particularly important that the regulations address how those beneficiaries are to be treated when they obtain their benefits through the trust.

The focus of the current regulations is actually on who might be entitled to the retirement benefits as it flows through the trust. Under the current rules, the Treasury Regulations look not only to the current beneficiary under the trust, but also those beneficiaries who may take after the current beneficiary dies. And if anyone is entitled to possibly take even a penny of their retirement account, we use their life expectancy, perhaps, to determine how quickly the required minimum distributions come out and also whether the trust qualifies for the longest possible distribution of those retirement benefits. Typically, the type of retirement account that would be used for a minor child or another eligible designated beneficiary, such as someone who is disabled or chronically ill–someone that we might call a special needs beneficiary–is what is called an accumulation trust, and it would not automatically pay out the retirement benefits. Therefore, at their death, you would typically look to the next generation to see whether they take those retirement benefits outright, and if they do, that’s is a pool of people from which we determine whose life expectancy will be used for purposes of determining the required minimum distribution. That accumulation trust is what is really needed to protect the benefits of those who are the eligible designated beneficiaries and would not work well under SECURE. Why is that? Under SECURE, it is going to be very important for the regulations to reflect the current beneficiary as the focus of the accumulation trust going forward. The remainder beneficiary, the person or persons who take after the death of the current beneficiary, will have to take out over 10 years and that should become irrelevant so that we can focus on getting that long stretch to the eligible designated beneficiaries.

Why is that so important under SECURE or any scheme that governs retirement benefits? Because that tax deferral is so necessary for their support and Congress has recognized that by making them eligible designated beneficiaries. These are the most vulnerable people, and we need to protect those retirement benefits for as long as possible. Again, if someone is aged 40, they may be able to stretch out those benefits until they are 83. That could be very important for someone with disabilities and who needs to have that income protected. So, it is going to be imperative for everyone who is looking at SECURE to look at their trust and see the best way to be able to plan for different scenarios.

Some scenarios might be planning for young children when they are not your own children. What do I mean by that? Well, if you are taking care of your grandchildren, you may need alternative ideas for how you might protect your grandchildren’s benefits because, like buying life insurance for them, or setting up different types of trusts, or using Roth IRAs, there are many planning implements that people are thinking about in order to lessen the blow that SECURE is going to cause from a tax point of view.

Summary

So to sum up, keep your eye on the SECURE Act. It will become effective beginning in the year after it is enacted and if SECURE becomes a law, those individuals who have IRAs or other retirement accounts should have their estate plans reviewed by an estate planning attorney who is familiar with the SECURE Act and the different techniques that may become available in order to lessen the impact [of the] end of the stretch IRA. I hope you found this helpful. Thank you very much.

Thank you for teaching us more about the SECURE Act, Nancy.

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