The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which was signed into law in December 2019, introduces a number of new rules and provisions that impact retirement savings in both employer-sponsored and individual retirement plans. While the changes included in the SECURE Act will not reshape the landscape of retirement savings, the Act contains provisions that could have a significant effect on retirement and estate planning for those individuals with tax-deferred retirement savings accounts. Here is a summary of the provisions that are most likely to impact retirement and estate planning in the coming years.

Changes Impacting 401(k)s and IRAs

Post-Death Required Minimum Distribution Rules

Effective for plan participants who die after December 31, 2019, the SECURE Act implements a much shorter distribution schedule for designated beneficiaries of a 401(k) or an Individual Retirement Account (IRA). The new rules generally require full distribution of the applicable plan account within 10 years of the plan participant’s death.

Previously, the designated beneficiary was generally permitted to receive distributions over the beneficiary’s remaining life expectancy. For illustration, a 50-year-old beneficiary would have been entitled to 35.2 years of ratable distributions from an inherited retirement savings account. Now there is no requirement for annual distributions, and the beneficiary may take periodic distributions or request one lump sum payment.

There are exceptions to the 10-year pay-out rule if any of the following individuals are named beneficiary (each known as an “eligible designated beneficiary”):

• Surviving spouses

• Disabled individuals

• Certain chronically ill individuals

• Minor children of the participant

• Individuals who are no more than 10 years younger than the deceased participant

Generally, an eligible designated beneficiary may still spread out distributions using his or her own life expectancy, except that minor children will be subject to the 10-year distribution rule once they reach adulthood (i.e., when a child reaches age 18, she will have until she is 28 to withdraw all remaining amounts from the inherited plan account).

The SECURE Act has not changed the rules for non-designated beneficiaries (e.g., the decedent’s estate or a charity). Thus, the rules require either (1) full distribution of the account within five years of the plan participant’s death, if the plan participant died before his or her required beginning date (e.g., the date by which the participant must take his or her first required minimum distribution), or (2) distributions be made in annual installments over the plan participant’s remaining life expectancy, if the plan participant died after his or her required beginning date.

Impact on Estate Plans

While most estate plans essentially still work because the new rules have not changed the definition of a designated beneficiary, the income tax impact of those plans may change dramatically.

Generally, there are two types of trusts that qualify as see-through trusts for IRA distribution purposes – a conduit trust and an accumulation trust. Under a conduit trust, all retirement plan distributions made to the trust during the lifetime of the life beneficiary must be passed out immediately to that beneficiary. Before the SECURE Act, the required distribution would be based on that beneficiary’s life expectancy. An accumulation trust, on the other hand, is one where the trustee may continue to hold and manage the distributions in the trust. All potential beneficiaries are counted for purposes of determining the required distribution amount, which before the SECURE Act was based on the life expectancy of the oldest possible beneficiary.

Both types of trusts are now subject to the new 10-year pay-out rules. The beneficiary of a conduit trust will receive an outright distribution of 100 percent of the account value within 10 years of the participant’s death unless the beneficiary is an eligible designated beneficiary. If the client’s goal is asset protection, this goal is defeated. It may also create a significant income tax burden on that beneficiary.

While the trustee of an accumulation trust will still be authorized to hold and manage the distributions, those distributions will be subject to the condensed trust and estate income tax schedules. If the client’s goal is to conserve assets to provide for multiple generations, that goal may be severely impacted by the upfront tax consequence and loss of deferred income taxes.

Planning Opportunities

Various planning opportunities exist in light of the new rules. For example, clients in lower income tax brackets relative to their beneficiaries might consider Roth conversions. Although Roth accounts are also subject to the new rules, the distributions are income tax-free to those beneficiaries. Clients in lower income tax brackets relative to their beneficiaries might also consider spending down their retirement accounts and bequeathing taxable assets instead. This strategy would benefit heirs in two ways – first, an heir would benefit from the step-up in basis, and second, the heir could sell assets and realize capital gains at his own pace, rather than incur a forced ordinary income stream or lump sum payment.

Additionally, there are sophisticated tax and trust planning opportunities that may be appropriate depending on the client’s individual circumstances. For example, a client who is charitably inclined might make qualified charitable donations from his IRA or leave the assets to a charitable remainder trust.

Estate planners should be mindful of these provisions when designating beneficiaries and allocating retirement savings. Plan sponsors should consider contacting plan participants to confirm the accuracy of their current beneficiary designations in light of these new rules.

Finally, plan documents that allow for beneficiary distribution schedules that extend beyond the limits set forth in the SECURE Act will need to be amended to comply with these more restrictive distribution requirements.

Other Notable Changes

Delayed Required Beginning Date for Required Minimum Distributions

Prior to the passage of the SECURE Act, qualified plan participants would begin taking required minimum distributions from their plan account by April 1 of the year following the year in which they reach age 70 ½ (the “required beginning date,” or RBD). The SECURE Act extends the RBD to April 1 of the year following the year in which a participant reaches age 72, with respect to distributions that occur after December 31, 2019 and which are paid to participants who reach age 70 ½ after December 31, 2019.

For example, before passage of the SECURE Act, the RBD for a participant who reaches age 70 ½ in August 2020 would have been April 1, 2021. Under the new law, this participant’s RBD will instead be April 1, 2023 (they will reach age 72 in February 2022). This participant’s RBD is delayed two full years under the new law.

Plan sponsors should be aware that although this change in the law allows required minimum distributions to be delayed until after age 72 for certain participants, it does not require plan sponsors to amend their plans to provide for this later start date. The language of a plan document is controlling, and a plan document can still provide for an earlier start date (for example, April 1 of the year following the year a participant reaches age 70 ½). However, many plan sponsors will want to amend their plans to provide participants with additional flexibility to delay required minimum distributions.

Age Limits for IRA Contribution

Under former law, individuals could not contribute to an IRA after age 70 ½. The SECURE Act removes this age limit for tax years beginning after December 31, 2019, so individuals may contribute to an IRA at any age. Note, however, that if a taxpayer contributes to his or her IRA after reaching age 70 ½, and also uses the IRA to make qualified charitable distributions, the $100,000 annual limit on such charitable distributions is reduced by the amount of the contributions.

Section 529 Education Savings Plans

The SECURE Act expands the permitted distributions to include expenses associated with registered apprenticeships. In addition, tax-free distributions are permitted to pay principal or interest on a qualified education loan for the account beneficiary and that beneficiary’s sibling. Distributions for loan repayment are limited to $10,000 in the aggregate on behalf of any one beneficiary.

Kiddie Tax

Prior to the Tax Cuts and Jobs Act (TCJA), a child’s unearned income was generally taxed at the parent’s income tax rate. Under the TCJA, a child’s unearned income was taxed at the trust income tax rates, which could be much higher than the parent’s rate. The SECURE Act fixed this inequity and reverts back to the prior system – once again, a child’s unearned income is taxed at the parent’s rate.