This article was originally published in the New Hampshire Bar News and can be found here.
Estate Planning After the SECURE Act
By: Michael Panebianco
March 18, 2020
In the final weeks of 2019, the federal budget bill was passed by Congress and signed by President Trump. The budget bill included changes to the federal tax code that were originally included in the SECURE Act (H.R. 1994) and which went into effect January 1, 2020. The changes affect retirement plans, such as IRAs and qualified retirement plans, e.g., a 401(k), both during lifetime and the way assets in those plans (“retirement assets”) may be distributed to beneficiaries after death. Accordingly, estate planning with retirement assets going forward will require an understanding of these changes and knowledge of available options in light of the new legal landscape.
Under prior law, most people were required to begin taking Required Minimum Distributions (“RMDs”) from their qualified plans or traditional (non-Roth) IRAs once they reached age 70 ½. 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 70 ½ 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 59 ½ 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 70 ½. In Estate Planning After the SECURE Act addition, the new law removes the age cap for funding traditional (non-Roth) IRAs and deductible plans, so individuals over age 70 ½ 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to the 10% excise tax on withdrawals prior to age 59 ½: up to $5,000 for child birth or adoption expenses may be withdrawn.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 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 canwait 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 ten years of the surviving spouse’s death.
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 for your client may no longer be achieved unless the estate plan is revised. For example, the current estate plan may be structured so that, after death, the client’s 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. This has been 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 years after the death of the plan participant or plan owner, or when the minor child reaches adulthood – which may be contrary to your client’s desire. One alternative is what is known as an “accumulation 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, which may be the client’s primary objective. Another potential option, in the right situation, is having a charitable remainder unitrust receive the retirement assets upon death, where payments would be made to the beneficiary over the course of their lifetime with the remainder distributed to charity upon the beneficiary’s death.
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, but all lawyers that do estate planning should familiarize themselves with the changes, and various planning options in light of the changes, some of which may present new opportunities for current clients.