By Patricia A. Rauh, Esq.
For many retirees, their retirement account is their biggest asset and one that they spent decades growing, but major changes could be coming to these accounts thanks to the pending SECURE Act, which is expected to be passed into law by 2020.
The SECURE Act (“Setting Every Community Up for Retirement Enhancement Act of 2019”) was passed by the House of Representatives by a remarkable 417-3 majority back in May. The purported goals of this act are to increase the availability of workplace retirement savings plans and change the current rules surrounding retirement plans to adjust for the increased life expectancy of Americans. To accomplish these goals, the law would provide tax credits to smaller companies that set up a retirement plan, thereby offsetting the steep cost to employers. The law would also make it easier for part-time workers to participate in their employer’s retirement plans, a workplace benefit they historically would not have been eligible for.
If the SECURE Act is ultimately passed by the Senate, which is expected, it would be the biggest legislative change to retirement policy since the Pension Protection Act was passed in 2006. While it may help those individuals who were not previously eligible for a retirement savings plan, the biggest changes will be felt by those who have established retirement plans already and are either at retirement age, or already retired.
First, the required minimum distribution (“RMD”) age would increase to age 72, instead of its current age of 70 ½. Additionally, the law currently states that the maximum age for contributing to a traditional IRA is 70 ½. The SECURE Act would repeal this provision and there would be no maximum age for contributions.
While increasing the RMD age can benefit many individuals, especially those staying in the workforce later in life, another provision of the SECURE Act is not so positive and will have a significant impact on the middle class. The most controversial provision of the SECURE Act is the elimination of the “stretch” provision for non-spouse beneficiaries of Traditional Inherited IRAs. Currently, non-spouse beneficiaries of inherited IRAs are allowed to stretch distributions over the course of their lifetime. Since distributions from Traditional Inherited IRAs are taxable, the longer a beneficiary can postpone or defer those distributions, the better. Under the SECURE Act, however, it would be required that the balance of an inherited IRA be distributed by the end of the tenth year following the death of the IRA creator. However, this 10-year rule would not apply to spouses, minor children, or chronically ill/disabled beneficiaries. Once a minor child beneficiary reaches age 18, however, the 10-year clock will begin.
It is important to note that the 10-year rule will also apply to an inherited Roth IRA, but those distributions will not be taxable. However, although the distributions themselves are not taxable, the earnings on them are. For example, even if a beneficiary reinvests all the money that was withdrawn from the inherited IRA and puts it into a brokerage account, he or she would still be responsible for paying income taxes on capital gains, dividends, and interest earned. This 10-year rule can have steep tax consequences for non-spouse beneficiaries.
As a result of the elimination of the stretch provision, many people are looking for alternatives so as not to leave his or her beneficiaries with a huge tax bill. One way to “mimic” the stretch provisions of the IRA that may soon be a thing of the past is to fund an irrevocable trust with a life insurance policy. An IRA owner could take a distribution from his or her account and use that money to purchase a life insurance policy, naming the trust as its beneficiary. This is called an “ILIT” (Irrevocable Life Insurance Trust). At the IRA owner’s death, the death benefit would be used to fund the trust and pay a regular and consistent stream of income to beneficiaries of the trust, similar to an inherited IRA.
A second alternative is creating a Charitable Remainder Trust. The IRA creator can name the trust as the beneficiary of the IRA. After the IRA owner’s death, the trust will be funded, and the trust beneficiary will be entitled to a stream of income. At the beneficiary’s death, the named charity will receive anything that is left over.
While there is no guarantee that the SECURE Act will ultimately be passed, it seems pretty likely. In order to prepare for these sweeping changes, retirement account owners should look closely at his or her beneficiary designations and maybe consider alternative ways to not only save for retirement, but also ensure that something is leftover for loved ones.
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