Recently-enacted legislation known as the SECURE Act (the “Act”) would severely limit the use of stretch IRAs and will cause many individuals to amend their estate planning documents and retirement planning generally.
On the positive side, the Act permits individuals to defer required minimum distributions and make tax deductible contributions until age 72. In addition, individuals with 529 plans would be able to withdraw up to $10,000 to pay down student loans, which will help reduce the student loan epidemic nationwide.
Another upside is that the bill allows new parents to withdraw up to $5,000 without being penalized from their IRAs or 401(k) plans to help defray birth and adoption expenses. Also, employers would be permitted to offer annuities as an investment option in their employer-sponsored 401(k) plans and would receive a $500 tax credit for automatically enrolling new employees and up to a $5,000 credit for plan startup costs.
The Act increases the cap on automatically raising payroll contributions from 10 to 15 percent of an employee’s gross paycheck. Enactment of these incentives would come at significant cost for many taxpayers, and the price tag may far outweigh the Act’s benefits.
To pay for the incentives, the Act will raise over $15.7 billion over the next decade by requiring IRAs and other qualified retirement plans to be liquidated within 10 years following the death of the plan participant.
Significant exceptions to the mandatory distribution rule are available for surviving spouses, minors, disabled and chronically ill individuals, and certain other limited situations.
Many of you may have elected to use a “conduit trust” through which IRA and other retirement plan benefits flow following the death of a surviving spouse. Alternatively, you may have simply designated your children or grandchildren as beneficiaries of the retirement accounts. In most cases, these beneficiary designations will require that by the 10th year following the surviving spouse’s death, all the funds must be paid to the designated beneficiary (i.e., usually, the surviving children or other designated beneficiary).
This may not meet your estate planning goals and therefore may require amending your trusts or beneficiary designations. To minimize the income tax on the funds that pass to that trust, you should talk to your accountant regarding the value of converting all or a portion of your IRAs, destined for your children or grandchildren or trusts for their benefit, to a Roth IRA.
You also may want to discuss the extent to which any of your IRAs are payable to an accumulation trust for your children or grandchildren. When the IRA is paid to an accumulation trust over the 10-year period of time, it is very likely that substantial wealth will be trapped in the trust and taxed at the highest trust income tax rate.
Again, to overcome this you may want to examine the utility of Roth conversions prior to your deaths. Conversely, the use of accumulation trusts may make sense if you desire to protect the IRA assets from your beneficiaries’ creditors.
Roth conversions and other strategies may make sense in light of the change in law imposed under the SECURE Act. In addition, the delay in the required minimum distribution date (from 70-1/12 years to 72 years) and the revised life expectancy tables under new Treasury regulations make planning for retirement assets more complex than ever and will require input of your estate planning team members.