The SECURE Act: Estate Planning for Inherited IRAs

Have you heard of the Setting Every Community Up for Retirement Enhancement Act of 2019 ("SECURE Act"), passed by Congress in January of this year? You may not know that the SECURE Act could impact your existing estate plan. Here's how:

If you have previously named a trust as the beneficiary of a retirement account (such as an IRA) because you wanted to control the distribution to your beneficiary, the SECURE Act may affect your planning.

Old Law vs. New Law

Under previous law, a non-spouse beneficiary (such as a child) could take distributions from an inherited individual retirement account (IRA) over his/her life expectancy, thereby minimizing the income tax payments over his/her lifetime (called the "stretch" IRA). Historically, trusts holding an inherited IRA can provide desirable controls and protections for your chosen beneficiaries : (1) asset protection from creditors and divorce, (2) reduction of a substantial, lump-sum gift that the beneficiary could squander in a short time, and (3) income tax deferral on distributions from the IRA. If the beneficiary was much younger than the IRA owner, the Required Minimum Distributions ("RMDs") were calculated based on the child or other young person's lifetime so the proceeds would be paid out over their life expectancy and only the minimum distributions would be income-taxable to the beneficiary.

Under the SECURE Act, payments to most beneficiaries have been reduced to a 10-year term. No withdrawals have to be made during the 10-year period, but at the end of 10-years from the date of the plan holder's death, the entire balance in the plan must be withdrawn and all of the income tax paid by the beneficiary.

Exceptions to the Payout Rule

There are some exceptions to the new 10-year SECURE Act payout rule for persons who may still withdrawal the IRA proceeds over their life expectancy:

  • Surviving spouses
  • Chronically ill and Disabled persons
  • Persons within 10 years of age of decedent

Minor children are also exempted so that the 10-year payout will not begin until they reach adulthood (age 18 in California) and be paid out by year 10 (age 28). There is one exception to this timeline: a child may be treated as having not reached the age of majority if the child has not completed a specified course of education and is under the age of 26. This delay will help parents better plan for their minor children who intend to pursue college or university without worrying about a lump sum payment at age 28; however, more guidance from the IRS is needed to clarify how this exception will work in actual application.

What Should You Do?

If you have designated a trust as the beneficiary of your retirement accounts, you should review the drafting of that trust with your estate planning attorney to understand the implications of the SECURE Act. Some key issues to address include:

  1. If you have named a trust as beneficiary and might wish to revise that trust to avoid the beneficiary receiving a large lump sum distribution after 10 years.
  1. If you would prefer to gift some or all of your IRA outright to the beneficiary and abandon the shelter of the trust.
  1. If you wish to keep a trust in place despite the poor income tax treatment because your beneficiary cannot manage money on his/her own or suffer from significant substance abuse problems that is not considered a "chronic illness" or "disability."

Note that the SECURE Act only applies to retirement plans that are inherited after January 1, 2020, not to those already in place from a prior inheritance.

If you wish to review your estate plan and designated beneficiaries on your retirement accounts, please call or email to set up a free twenty (20) minute consultation with a Mortensen & Reinheimer attorney to determine how the SECURE Act potentially affects your estate planning. You may not need to change your plan due to the new law, or you may simply need to change the beneficiary designation of your IRA and not your estate plan.

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