Michael Panebianco | January 31, 2020
In the final weeks of 2019, the federal budget was passed by Congress and signed by President Trump. The new law includes changes to the federal tax code that were originally included in the SECURE Act; changes that went into effect Jan. 1.
The changes may affect your retirement plans, such as IRAs and qualified retirement plans, like your 401(k), both during your lifetime and the way assets in those plans may be distributed to your beneficiaries after death. They may require you to revisit your estate plan and these new provisions.
Previously, most people were required to begin taking required minimum distributions (RMDs) from their qualified plans or traditional (non-Roth) IRAs once they reached age 701/2.
Under the SECURE Act, the age was increased to 72 for those who were not yet required to take distributions under the old law. This means if you turned 701/2 in 2019, the prior law applies and you must begin taking RMDs by April 1, 2020. Otherwise you can, but are not required, to take distributions once you are age 591/2 without penalty, but must begin taking RMDs once you are 72.
Although RMDs do not begin until age 72 under the new law, you can still cause distributions of up to $100,000 a year to pass directly to charity once you have reached age 701/2. In addition, the new law removes the age cap for funding traditional IRAs and deductible plans, so individuals over age 701/2 are now permitted to make contributions to a traditional IRA, provided they have earned income. And there is a new exception to the 10% excise tax on withdrawals prior to age 591/2: Up to $5,000 for child birth or adoption expenses may be withdrawn.
Some non-retirement plan changes include the ability to use 529 Plans to pay for student loan repayments of up to $10,000, and also certain apprenticeship programs, including fees, books, supplies and equipment. In addition, the “Kiddie Tax” reverts back to prior law so that the parent’s tax rate will apply to the child’s unearned income, rather than applying trust and estate tax brackets.
With respect to estate planning, arguably the most significant changes brought about by the SECURE Act relate to how retirement assets are distributed and taxed after death to avoid penalties.
Under the prior law, it was possible to stretch the distribution of retirement plan assets over the life expectancy of a beneficiary, if that beneficiary met the requirements of a “designated beneficiary” under the law. This ability to stretch out the distributions offered potential advantages in terms of income tax-free growth of the retirement assets during the beneficiary’s life, the cumulative amount of income tax paid on distributions from the retirement account, and protection of the retirement assets from the beneficiary’s creditors, or even from a beneficiary who might not have the ability to handle significant amounts of money at one time. The law also permitted these advantages for retirement assets left in a trust, as long as the trust was structured to meet certain requirements.
The SECURE Act changed these rules so that most designated beneficiaries of retirement plans will be required to receive the full amount of an inherited qualified plan or IRA within 10 years after the death of the person who funded the plan or IRA. The exceptions to this general rule include the retirement plan owner’s surviving spouse, minor children of the owner (but not their grandchildren or someone else’s children), beneficiaries who are disabled or chronically ill, and individuals who are not more than 10 years younger than the plan owner.
The excepted classes of beneficiaries are still permitted to take distributions over their expected lifetimes, as under prior law, though children who are minors at the time of the owner’s death must now take the full distribution within 10 years after reaching the legal age of adulthood, which is age 18 in New Hampshire and most other states.
It is important to note that the beneficiary can wait until just before the expiration of the 10-year period and take it all out at once. There is no requirement that distributions occur annually throughout the 10-year period.
As under prior law, if the surviving spouse is the beneficiary of the retirement plan, he or she can withdraw over their life expectancy, but, upon the spouse’s death, the next beneficiary, if not in a qualified group, must take the payout within 10 years of the surviving spouse’s death.
‘Conduit,’ ‘accumulation’ trusts
The SECURE Act does not change the method of designating a beneficiary or beneficiaries to receive inherited retirement assets.
Accordingly, if you have existing beneficiary designations in place, those designations are still valid. However, the desired result may no longer be achieved unless you revise your estate plan.
For example, many current estate plans are structured so that, after death, retirement assets are given to a trust commonly referred to as a “conduit trust.” The basic idea of this plan is that the conduit trust, not the individual who is the beneficiary of the trust, is the owner of the retirement plan and the retirement assets paid to the conduit trust will pass immediately from the trustee to the beneficiary.
Under the prior law, this was a commonly used technique because the distributions would be stretched over the expected lifetime of the trust beneficiary while ensuring the beneficiary would not prematurely withdraw all the assets from the retirement plan. However, under the SECURE Act, that same conduit trust may now require distribution of the retirement assets to the beneficiary within 10 years after the death of the plan participant or plan owner, or when the minor child reaches adulthood.
Depending on the intended beneficiary’s situation, or owner’s desire, other planning techniques may better serve the desired result, given the new rules.
One such technique is the use of what is known as an “accumulation trust” rather than a conduit trust. Like a conduit trust, an accumulation trust would be the owner of the retirement plan after the plan owner’s death, except retirement assets paid to the accumulation trust do not have to pass immediately from the trustee to the beneficiary, as it would with a conduit trust. This allows the retirement plan assets to be protected by the terms of the trust rather than going outright to the beneficiary.
The specific changes brought about by the SECURE Act, and potential planning strategies related to the changes, are too extensive to cover in depth here, and may present new opportunities to take advantage of the tax-deferred savings offered by qualified plans and traditional IRAs. Your attorney, accountant or financial advisor should be consulted to advise you of these changes in the law and whether and how you might benefit from them.
This article was originally published in the NH Business Review and can be found here.