Death of the Stretch IRA!
by Stan Corey
In December 2019, Donald Trump signed into law new legislation called “Setting Every Community Up for Retirement Enhancement” (HR 1994) or the “Secure Act.”
There has been very little publicity about this, and only now are banks, brokerage firms, and some estate-planning law firms sending communications of generic information to their clients. The problem is that most clients will either not read the notice or will have difficulty understanding the impact to their own situation. Here are a few of the headlines of the Act to ponder:
- Non-spouse beneficiaries of an IRA (traditional and Roth) will now need to take all withdrawals within a 10-year period after the death of the IRA owner, with a few exceptions. This is a dramatic change over the ability to take Required Minimum Distributions (RMD) over the beneficiary’s lifetime.
- The RMD beginning date for making withdrawals from an IRA has changed to age 72 from age 70-½. This affects anyone who was born after June 30, 1949. In addition, persons who have attained age 70-½ may make contributions to a traditional IRA or Roth IRA if they have eligible income.
- Enhanced employer-qualified plan participation will now include part-time employees and increases the auto enrollment safe-harbor rules from 10% to 15%.
- The Act expands the opportunity for small businesses to band together to form multiple-employer plans (MEPs) using a pooled plan provider. This will significantly open the opportunity for small employers to offer qualified retirement plans such as 401(k)s.
- The Act expands the availability and portability of lifetime annuities within qualified employer plans. Allows the employee to take a retirement annuity with them when they leave an employer or when the annuity is no longer being offered by the plan.
- People now may use 529 College Saving Plans to repay student loans up to $10,000 per year. This applies to the 529 beneficiary and/or their siblings.
- A penalty free withdrawal of up to $5,000 from qualified plans or IRA within one year of the birth of a child or adoption. For married couples, each spouse may take up to $5,000.
- The “kiddie tax” rules have changed back to being taxed at the parent’s tax rate and not the trust tax rates, up to 37%.
Will you be affected by these changes?
The answer always starts with “it depends.” However, it is very likely that if you are nearing retirement or already in retirement, these changes will have far-reaching consequences. For those saving for retirement, the enhancements will prove to be a benefit if you are able to make contributions to employer retirement plans or to an IRA. Let’s take a deeper dive into the biggest change that is going to significantly affect retirement planning before, during, and upon death.
By far the most significant change is the repeal of the “stretch IRA” so that, with few exceptions, a designated non-spousal beneficiary or spousal beneficiary who is more than 10 years younger than the owner/participant will no longer be able to take lifetime withdrawals from an inherited IRA. The Act’s new rule provides that, after a participant’s death, the designated beneficiary must take the full distribution from the inherited IRA by the end of the 10th year following the year of death. Therefore, if the participant dies in January, the designated beneficiary may have almost 11 years to take the full distribution! The only exception to this new rule is if the beneficiary is an “eligible designated beneficiary,” which is a new class of beneficiaries defined in the Act as follows: “a surviving spouse, a disabled or chronically ill individual, any individual who is not more than 10 years younger than the participant, or a minor child of the participant” (this excludes grandchild, step-child, niece, or nephew). This new rule applies regardless of whether the participant dies before or after the required beginning date for distributions, now age 72. The minor child’s distribution period is limited to the number of years to majority plus 10 years. There is still ambiguity about what constitutes age of majority (18, 21, or 26).
A surviving spouse continues to have the ability to roll over the IRA into their own IRA or elect to treat it as an inherited IRA and make withdrawals based upon their own life expectancy. However, upon the surviving spouse’s death, the beneficiary, whether eligible or not, must make withdrawals under the 10-year rule.
For estate planning, if a trust is the beneficiary of an IRA the new rules may have a significant impact if the estate plan intended to provide controls over the income to beneficiaries or offer spendthrift provisions to protect the assets. If the trust beneficiary is an “accumulation trust,” the trustee may not need to pay out the distributions by the end of the 10th year but will need to make the required withdrawals from the IRA by the end of the 10th year paying income taxes at the trust’s highest tax rate (currently 37% plus any applicable state income tax). Even if a trust is a conduit trust and the beneficiaries are the children of the participant, they may not be considered “eligible beneficiaries” and will need to have the distributions made under the 10-year rule. However, the income-tax liability falls upon the trust beneficiaries and not the trust in this instance.
The change to the distribution options for IRAs will have dramatic and long reaching consequences for many individuals from developing a tax-efficient retirement distribution plan to managing distributions from their estates to the named beneficiaries.
And, as with most all new tax legislation, this legislation can also be referred to as the “full employment and equal opportunity act for lawyers, accountants, and financial planners!”
The information presented is for informational purposes only and is not intended to provide specific legal, tax, or financial advice. Individuals should seek expert advice regarding these matters to answer any questions you may have that pertain to your own situation.
Artwork by: “Even Godzilla Pays Taxes” by SkyroreDraws and “taxes” by Adam Sanderson (Seattle WA).
Stan Corey has been a Certified Financial Planner Professional (CFP), Chartered Financial Consultant (ChFC), and Certified Private Wealth Advisor (CPWA) for almost 40 years. Though retired from the day-to-day activity of providing financial advisory services, he continues to consult in specialized areas as a financial fiduciary. Stan is a sought-after expert who regularly provides financial commentary at national conferences, in print and online publications, and on TV. He has a reputation for taking complex financial issues and making them understandable to the average person. He likes to say he is a “financial translator.” He has published two books: a novel, “The Divorce Dance,” in 2016, and a non-fiction work, “When Work Becomes Optional,” in 2018. Web site: www.stancorey.com.