Secure Act of 2019 and the Stretch IRA
The Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act of 2019”) is, from a taxpayer’s perspective, both “good news” and “bad news.” The “good news” includes helping small employers establish 401(k) retirement plans and allowing more employees to save for retirement.
The “bad news” is that the new tax law eliminates the much-loved income tax deferral—called “Stretch Out”—enjoyed by non-spousal death beneficiaries who inherit Individual Retirement Accounts (“IRAs”) and 401(k) retirement plans on or after January 1, 2020. That is, the new SECURE act of 2019 applies to IRAs and 401(k)s where the owner dies on or after January 1, 2020. Thus, the longstanding “stretch out” tax deferral rules continue for IRA’s and 401(k)’s inherited before 2020.
Under the new law, most non-spousal death beneficiaries are required to receive full distribution of the inherited IRA within ten (10) years of the owner’s death. Thus, nonspousal beneficiaries generally cannot “stretch out” the “Required Minimum Distributions” (“RMD’s”) to themselves from the inherited IRA over their own lifetimes. Stretchout of the inherited IRA allows younger beneficiaries with long actuarial life expectancies to receive much smaller annual RMD’s; both reducing annual income taxes owed on RMD’s and allowing the continued accumulation of tax-free growth inside the inherited IRA.
The new ten-year rule allows certain flexibility and tax planning: The distributions could occur as ten annual payments or as one lump sum payment in the tenth year.
Certain designated death beneficiaries, however, are excepted from the ten-year rule: the IRA owner’s surviving spouse, a beneficiary who is not more than ten (10) years younger than the owner, and the deceased owner’s minor, disabled or ill child.
Surviving spouses who are death beneficiaries continue to be able to “roll over” their deceased spouse’s IRA or 401(k) into their own IRA, as if she had funded the “roll over” account with her own earnings. Accordingly, the surviving spouse does not have to commence annual RMD’s until he or she reaches the Required Beginning
Date (“RBD”). The RBD is now increased to age 72. A modest improvement from 70.5 years old.
However, the new ten year rule may motivate some married couples with multiple retirement accounts to leave some retirement accounts to their children and not the surviving spouse.
That way their children commence the ten year period on some accounts at the first spouse’s death and not on all accounts at the death of the surviving spouse.
Losing “stretch out” deferral of RMD’s is particularly troublesome if the designated death beneficiary is a so-called “Conduit Trust.” Conduit Trusts require all annual RMD’s to be paid each year either to or for the benefit of the trust beneficiary and are drafted in contemplation of the annual RMD’s received by the trust being “stretched out” over the beneficiary’s lifetime; a period usually greater than ten years. Thus allowing the inherited IRA to last longer and be spent more appropriately by the trustee.
With full payout occurring within ten (10) years of the owner’s death, some Conduit Trusts, where possible, can be modified into so-called Accumulation Trusts. Accumulation Trusts—as the name suggests—allow the Trustee to accumulate (rather than distribute) the annual RMD’s received by the trustee from the inherited IRA.
Like all trusts, however, Accumulation Trusts suffer from a big tax disadvantage: Trusts are taxed at the highest marginal tax rate once their undistributed net taxable income reaches $12,750 (2019); one reason why Conduit Trusts were used. A possible solution is to convert traditional IRA’s into Roth IRA’s—whose distributions are nontaxable income to the beneficiary.
The IRS needs to issue regulations to implement the SECURE Act of 2019. These IRS regulations will provide important details and thus allow further planning opportunities. Anyone concerned about the foregoing issues should discuss them with a qualified financial advisor and/ or tax professional.