By: Stephen R. Elville, J.D., LL.M. – President and Principal Attorney of Elville and Associates, P.C.
On March 7, 2020 at our recent Client Care Program continuing legal education event at Anne Arundel Community College, I stated that the SECURE Act, and the income tax ramifications it has for most of our clients (mainly, the acceleration of income tax to beneficiaries of inherited IRAs), is arguably the most important tax and asset protection issue clients have been presented with in the past 10 years. Before we go any further, amidst all the confusion there are, in my view, basically two main issues (or questions) clients and their families need to address. They are: (I) determine whether any changes need to be made to your estate planning documents (in consultation with your estate planning attorney); and (II) determine whether you wish to (or should) address the income tax and other impacts of the SECURE Act on your retirement plan assets, your non-exempt beneficiaries, and your estate plan as a whole, including the acceleration of income tax to your beneficiaries, loss of tax deferral to your beneficiaries, and potential loss of asset protection to your beneficiaries (in consultation with your financial advisor, CPA, and estate planning attorney). If you can focus on these two main overarching issues (questions), I believe you can determine what to do about the new SECURE Act law (if anything) from an estate planning and income tax planning perspective, and act accordingly with minimal confusion or anxiety. In the paragraphs below, I will try to help make sense of the SECURE Act, including what it is, who it affects, and who is exempt. After all of this is summarily explained, I will recommend certain SECURE action steps for estate planning, tax planning, and financial planning, and then I leave you with some questions that only you will be able to answer, about SECURE and whether it represents anything positive despite its negative implications for many people.
Let us begin. About seven months ago I wrote an article for this Newsletter describing the then vague prospect of the SECURE Act, proposed legislation that would constitute a series of expansions for individual participation in and contributions to retirement plans in the U.S., along with tax credits, incentives for businesses and individuals, changes to certain long-standing retirement plan-related policies, and the unfortunate elimination of the “stretch” IRA. Introduced by way of two separate colossal proposals in early 2019 – one by the House of Representatives and one by the Senate – the then-proposed SECURE Act would change the length of time that non-exempt persons could defer income taxation upon their receipt of an inherited IRA from a plan participant. Now the mere prospect of the SECURE Act has become a reality with broad-reaching implications. The SECURE Act, signed into law on December 20, 2019 and effective January 1, 2020, now incentivizes employers to establish retirement plans for employees through small business tax credits, and eases the time limitations for employers to implement retirement plans; it removes age limitations for contributions to an IRA (beyond age 70-1/2), changes the required beginning date for minimum distributions from age 70-1/2 to 72, allows for the continuation of Qualified Charitable Contributions with certain adjustments, allows limited penalty-free withdrawals from IRAs ($5,000) for childbirth or adoption (Qualified Childbirth or Adoption Distribution), allows certain annuities to be investments in a 401(k) plan, and many more similar or related changes. And yes, the now-effective SECURE Act exempts certain persons from the effects of the acceleration of income tax on retirement plan assets. But SECURE is largely not favorable for estate planning clients who diligently saved retirement plan dollars throughout their lives and anticipated that the minimum distribution rules for beneficiary IRAs would continue to provide long-term tax deferral for children, grandchildren, nieces and nephews, and other beneficiaries. So after much speculation, what was formerly described by me as a “ballistic missile red alert” but hopeful “false alarm” has now materialized as a full-fledged strike, a direct hit where the damage is similar to that of a neutron bomb – trillions of dollars of retirement plan assets will now be taxed on an accelerated basis, but with a remaining infrastructure, some old, some new, still standing in the aftermath.
The SECURE Act affects most estate planning clients by eliminating the “stretch IRA,” the ability for retirement plan participants to leave an IRA or Qualified Plan to their “designated beneficiary” (an individual or certain trusts) over a period of many years during which the beneficiary could, if desired, annually remove only the required minimum distribution from the inherited IRA and leave the balance of funds invested in a tax deferred status over a calculated life expectancy. That is, SECURE affects most, but not all, plans. Specifically, the SECURE Act affects any person who is a participant in a retirement plan and whose goal it is to provide for the lifetime stretch out of required minimum distribution payments to beneficiaries; and also persons who have beneficiary designated their retirement plans to a “conduit” trust for a beneficiary (a conduit trust is a trust for a retirement plan beneficiary that is designed to immediately pay out any required minimum distribution to the beneficiary). Persons who are specifically not affected by the SECURE Act are those persons who do not have a retirement plan, and/or persons who plan to leave their retirement plan assets directly to charity at their deaths.
Under the old regime, there were two classes of beneficiaries for inherited IRAs: (I) designated beneficiaries (hereinafter referred to as (“DBs”) (those persons or certain trusts that qualified for life expectancy treatment for required minimum distribution purposes); and (II) non-designated beneficiaries (hereinafter referred to as (“NDBs”) (those persons, trusts, or entities such as an estate, that did not qualify for life expectancy treatment for required minimum distribution purposes). Now under the new regime we have three (not two) classes of beneficiaries of inherited IRA assets: (a) Eligible Designated Beneficiaries (hereinafter referred to as (“EDBs”) – this is the new “preferred case” of retirement plan beneficiaries – persons who are eligible to continue stretching inherited IRAs – and then the old original classes of (b) DBs, and (c) NDBs. Probably the most confusing thing about SECURE is that much of the old law continues to be effective (notwithstanding several unanswered questions that will be clarified when the complete Treasury Regulations are eventually promulgated). In any event, the following EDBs are exempt: (1) spouses; (2) minor children; (3) disabled persons as defined by IRC Section 72(m)(7); (4) chronically ill persons as defined by IRC Section 7702B(c) (2); and (5) persons who are not more than ten (10) years younger than the plan participant. For all persons who are not EDBs (non-EDBs), the ability to stretch out the inherited IRA is now limited to ten (10) years. So to reiterate, DBs, or ordinary “designated beneficiaries”, will no longer have preferred status and will have to take 100% of their inherited IRA funds no later than ten (10) years after the death of the plan participant; while EDBs, the new preferred class of beneficiaries so to speak, will be able to continue the lifetime stretch out of retirement plan assets – that is, so long as beneficiary designations are correct, and in the case of beneficiary designation to a trust, so long as the trust is drafted properly in accordance with the IRS Code and the Regulations. The non-designated beneficiary class of beneficiaries (NDBs) remains part of the law and it is extremely important to consider that NDB treatment can still be triggered, even for EDBs. One important point that is of concern to many clients and families with loved ones who are disabled or chronically ill – although we are still early in the SECURE environment, it is clear that properly drafted special needs trusts will qualify for treatment as EDBs for the protection of these individuals.
Is the SECURE Act the monster it has been described to be, or more of a friendly dragon, one that forces us to take a much closer look at retirement plan assets (savings) and how they are actually taxed (and remember, they all (retirement plan assets) are eventually taxed in some form, even for the person who contributes after-tax dollars to a Roth IRA or Roth 401(k))? Doesn’t the SECURE Act potentially have a silver lining (maybe the government should have called it the Silver Act for all the older Americans it will impact), in that it will cause estate planning clients to examine the real outcomes of what happens to inherited IRAs after their deaths, and how they may be able to get ahead of the effects of SECURE by being proactive, thereby making a winning play in the end? The answers may be “yes.” After all, for example, it is generally better to die with a Roth IRA or Roth 401(k), and it is better to provide charities with the full benefit of tax-free contributions from retirement plan assets where the plan participant has genuine charitable intent, and other planning positives that can result after closer scrutiny. So I will leave you to think about and answer these questions for yourself. But to properly do so, it will be necessary for most clients to consult with their advisory team – CPA, financial advisor, estate planning attorney, and in some cases, insurance broker. Do this within the next 12 to 24 months, and you will be doing everything you can to address the estate planning and income tax ramifications of the SECURE Act. Along these lines, there are several potential strategies available to address and deal with the effects of SECURE on your estate planning. I will be available to address your questions and concerns, along with our estate planning team of attorneys, in coordination and collaboration with your Advisors. Remember that any SECURE-related adjustments to your estate planning documents will be relatively straightforward, and Elville and Associates is currently reaching out to all clients to schedule update meetings. We are also doing everything possible to keep you updated, provide action-related advice, educate you and your advisors, and collaborate in the solution process. If you have not yet made an appointment for your SECURE Act update meeting, please contact Mary Guay Kramer via telephone at 443-741-3635 or via email at email@example.com.