Legal Update: New Legislation Changes the Estate Planning Landscape for Retirement AccountsJanuary 2020
The SECURE Act was signed into law on December 20, 2019, and became effective on January 1, 2020, fundamentally changing estate planning for retirement benefits.1
The “stretch” is gone (for the most part). Most significantly, gone is the “stretch IRA,” which allowed a plan participant to leave an IRA or other retirement plan assets to a “designated beneficiary” or carefully drafted “conduit trust” for the “designated beneficiary” in a manner allowing the designated beneficiary to “stretch” distributions from the retirement account over the life expectancy of the designated beneficiary. This “stretch” had the effect of deferring income tax and allowing the retirement plan assets to grow tax free over the lifetime of the designated beneficiary.
Under the SECURE Act, except for five eligible designated beneficiaries who may withdraw retirement plan assets over their life expectancies, an IRA must be withdrawn by a designated beneficiary within 10 years of the death of the plan participant. The five designated beneficiaries still eligible for the “stretch” are:
- The Surviving Spouse: The SECURE Act does not change the withdrawal provisions for the surviving spouse, who can continue to make withdrawals from the retirement plan over the surviving spouse’s life expectancy. But on the surviving spouse’s death, the new 10 year rule applies for the surviving spouse’s designated beneficiaries.
- Minor child of the participant: No distributions are required until the plan participant’s child reaches majority (age 18 in California). When the child reaches age 18, the 10 year rule applies. This means that the full retirement plan must be withdrawn by the child (who was a minor at the plan participant’s death) by age 28.
- Disabled beneficiary: An individual is deemed disabled if he or she is unable to “engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment.”
- Chronically ill beneficiary: An individual is deemed chronically ill if he or she has been certified by a licensed medical professional as being unable to perform certain tasks of daily activity or requiring supervision due to severe cognitive impairment.
- Beneficiary who is less than 10 years younger than plan participant.
Conduit trusts may no longer be the answer. For many years, where appropriate, we have recommended that our clients include “conduit trusts” in their estate planning documents to allow for retirement plan assets to be paid out to their children over their lifetimes, often for 30 or 40 years, with small amounts paid out in the earlier years while the child is young, with increasing amounts over the child’s lifetime. Not only did this allow for tax deferral, and allow for the plan assets to grow tax free over the child’s lifetime (as is the case in naming the child as a designated beneficiary individually), but the use of the “conduit trust” ensured that the child would not control large sums of money at a time when the child was not responsible enough to handle such assets. The SECURE Act requires all conduit trusts (except for those established for beneficiaries who fall within the five categories described above) to terminate after 10 years. In the case of a minor child who is the beneficiary of a conduit trust, plan assets will be fully distributed by age 28, requiring the child to pay income tax on the plan assets earlier than under the prior “stretch” rules, and giving the child control over the plan assets earlier as well. This may not be ideal for some individuals.
How these new changes in the law affect you will depend upon your family, the size of your retirement accounts, your estate planning goals, and the makeup of your assets. No one plan fits all clients, but every client needs to evaluate how to proceed. Please contact us with questions regarding your specific circumstances.
1 Important Note: The SECURE Act does not apply to retirement benefits where the plan participant died before January 1, 2020.