New 401(k) and IRA law might affect how you plan your estate
On December 20, The SECURE Act ("SECURE") passed into law as part of a budget bill. SECURE drastically alters retirement account distribution requirements for a beneficiary inheriting a retirement account.
What are the new inherited retirement account distributions?
SECURE provides that following an account owner's death, all of the decedent's retirement accounts must be distributed by December 31 of the calendar year in which the 10 year anniversary of the decedent's date of death falls ("Ten Year Rule"). There are no longer any annual distribution requirements. A beneficiary inheriting a retirement account can now elect to fully defer all taxes on the inherited retirement account until the final tax year within the Ten Year Rule. This is a radical change from the previous law that required annual distributions, but allowed an inherited retirement account beneficiary to stretch those annual required distributions over the course of the beneficiary's actuarially determined lifetime.
Since distributions from traditional retirement accounts are taxed as ordinary income, SECURE's Ten Year Rule should be a revenue generator for the IRS. The Ten Year Rule accelerates the tax event and lumps distributions into fewer tax years, which may cause a beneficiary to jump into a higher marginal income tax bracket.
SECURE primarily adds to the current retirement laws, so a few important exceptions to the old law still apply. The most important exception is that if a surviving spouse is the beneficiary of a retirement account, the Ten Year Rule does not apply, and the spouse continues to have the option to either use the life-expectancy payout or roll over the inherited benefits to the spouse's own retirement account. Other beneficiaries who receive special treatment and escape the Ten Year Rule, at least for a period of time, include minors, disabled persons and those beneficiaries who are born within ten years of the decedent account holder.
What are potential planning strategies?
You might consider the following strategies to minimize the tax effects of SECURE on any non-spouse beneficiaries of your plan:
1. Reconsider Trust Planning:If a trust is the beneficiary of your retirement account, you will want to review its terms to determine if it still meets your intent now that all inherited retirement accounts must be distributed within ten years. One possible idea would be to allocate your retirement accounts within your trust so the trustee can sprinkle the distributions among beneficiaries in lower income tax brackets. If you also wanted to make sure you provided adequately for other beneficiaries, you might replace the retirement account with an insurance policy whose death benefit would be distributed among beneficiaries in higher income tax brackets.
2. Reconsider conversions from a traditional retirement account to a Roth IRA:Generally, Roth IRA conversions are not advisable because it accelerates an income tax event. Unless you can convert in a year when you are in a lower tax bracket than you or your beneficiaries would otherwise expect to be, a Roth conversion often does not make tax-sense. However, if you've considered a Roth conversion in the past, you should rerun the numbers now that SECURE has been passed to determine if this changes the tax outcome.
3. Charitable Inclinations:If you are charitably inclined and you still want your beneficiaries to stretch the retirement account withdrawals over the course of their lifetimes, then you might consider a charitable remainder trust as a retirement account beneficiary. A charitable remainder trust avoids the Ten Year Rule and allows for lifetime distributions to a beneficiary or beneficiaries. Following the death of the last beneficiary, the trustee will distribute any remainder to charity.
All of these planning techniques are totally dependent on individual circumstances and have various nuances. Both SECURE and the planning associated with SECURE are complex and beyond the scope of this article, so any implementation of these techniques should be reviewed carefully with your own professional adviser. You should prioritize a review of your estate plan in conjunction with SECURE and in conjunction with your other New Year's financial resolutions.
• For more information, contact Bill Ellsworth (www.icemiller.com/people/william-ellsworth/) or another member of Ice Miller's Trusts, Estates and Private Wealth Team (www.icemiller.com/practices/trusts-and-estates/). This article is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.