A Late 2019 tax change will have a major impact on retirement planning!
On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the “SECURE Act.” Although it passed the House in July, the SECURE Act only recently passed through the Senate on December 19, as part of an end-of-year appropriations act. The SECURE Act implements quite a few technical changes which will affect retirement planning in general. However, some of the most significant changes will have a direct and very substantial impact on estate planning.
In previous years, a plan participant (i.e. the individual who initially established and funded the IRA) could pass unused IRA assets to a so-called “stretch-IRA” for the benefit of a designated beneficiary (i.e. a person inheriting IRA funds on the participant’s death). The purpose of a stretch IRA was to extend the tax-deferral of the IRA. This would allow the minimum required distributions to be stretched out over many years, thereby increasing the overall tax benefit of the account. Often, participants would establish stretch-IRAs for their young grandchildren, hoping that the minimum required distributions would be based on each grandchild’s age. This would allow more assets to retain tax-deferred status longer and thereby decrease the overall tax burden. For large IRAs, this decreased tax burden could be very significant.
The SECURE Act eliminates the stretch-IRA for participants dying after 2019. Under the new rules, inherited IRA assets must be distributed within 10 years of the participant’s death. A few exceptions to this rule apply, for example, where the beneficiary is a surviving spouse, a minor, or a child (but not a grandchild) that is disabled. But the new 10-year distributions rule will apply in most other circumstances.
Obviously, the loss of the stretch-IRA is important for tax planning purposes, but its significance goes even deeper. For example, when planning for a stretch-IRA, a participant is likely to have established one or more trusts in his or her estate plan. This type of planning would be particularly important where minors (like grandchildren) were expected to be the designated beneficiaries of the IRA. Often, these trusts directed that no distributions were to be made from the trusts except for the required minimum distributions which would have been required under then-applicable law. The expectation was that the IRA would be depleted incrementally over years. This would give the beneficiary limited access to the IRA assets with marginal tax impact triggered by each distribution. Under the new law, however, the required distribution comes at the end of the 10-year period. Not only does this prevent the beneficiary from enjoying the extended use of the IRA assets, but the lump-sum distribution can have a seriously detrimental tax impact on the beneficiary.
Estate planning around retirement assets has always been complicated. The SECURE Act will actually make that planning a little bit easier moving forward (albeit at the cost of losing a pervious tax benefit). However, for clients whose planning was carefully tailored to the old regime, significant changes may be needed to avoid a major tax trap.
If you’d like to discuss how your estate plan might be impacted by the SECURE Act, please contact our office to set up a consultation.
Christian S. Kelso, Esq. is a partner at Farrow-Gillespie Heath Witter LLP. He draws on both personal and professional experience when counseling clients on issues related to estate planning, wealth preservation and transfer, probate, tax, and transactional corporate law. He earned a J.D. and LL.M. in taxation from SMU Dedman School of Law.