The Secure Act - How It Could Impact Your Estate Plan
Saving for retirement is an important part of being able to ultimately enjoy it when you get there. Fortunately, the IRS gives you some incentives to save for retirement by getting up-front tax breaks that reward you now for contributing to your future financial security. Until now, investors in retirement plans have been able to give unused funds to their heirs which has been a huge benefit because the beneficiaries of those accounts could “stretch out” Required Minimum Distributions over his or her life expectancy. Wealthy IRA owners certain that their spouses, and often their children, wouldn’t need the money, could leave the IRA to grandchildren. A 20-year-old beneficiary could, for instance, stretch out the period of withdrawal for another 63 years with the obvious benefit of compounding interest.
In recent years, Congress took notice that retirement accounts intended to benefit retirees were being used as estate planning vehicles for the wealthy. In December 2019, Trump quietly signed the Secure Act into law, effective on January 1, 2020, which changed the way beneficiaries will receive money from inherited retirement accounts. The new rules require that non-spouse beneficiaries of qualified retirement accounts must withdraw all the money out of those accounts within 10 years of the death of the original account owner. There are no required minimum distributions within that time frame, but the account balance must be zero by the ten-year mark. Here are some answers to common questions about retirement savings:
What is a “Required Minimum Distribution”?
Required Minimum Distributions (“RMD’s”) are yearly minimum amounts that must be withdrawn from the retirement account and they're based on your account balance and life expectancy. See IRS.gov for specific information.
Why do RMDs exist?
The reason the law forces you to take required minimum distributions has to do with the tax benefits that retirement accounts offer. With a traditional IRA, 401(k), or similar account, you get an up-front tax deduction for the amount that you contribute toward retirement. You also get tax-deferred treatment of any income and gains that the assets in your retirement account generate. That means no tax is due until you start making withdrawals. In other words, without RMDs, you could let your savings sit untaxed, for your entire life. You could then pass those savings on to your heirs, who could pass it on to their heirs, and so on.
Lawmakers didn't like the idea of letting our investments go un-taxed for generations, so they implemented RMDs, essentially putting a time limit on how long retirement savers can defer taxation. By forcing withdrawals, the RMD rules make retirement savers eventually pay taxes on their savings -- even if they don't really need the money at that point.
What is a “Qualified Retirement Plan?”
A qualified retirement plan is a retirement plan recognized by the IRS where investment income accumulates tax-deferred. Common examples include individual retirement accounts (IRAs), pension plans, and Keogh plans.
At what age do RMD’s kick in?
If you're the original account holder, then the new law states that you'll need to start taking withdrawals in the year in which you turn 72 years old. Those who've just turned 72 in a given year have until April 1 of the following year to start taking their required minimum distributions. After that one-time extension, withdrawals in subsequent years must be complete by the end of the calendar year. Before the Secure Act the law required distributions at 70 1/2.
Are there exceptions to the 10-year withdrawal requirement?
The rule does not apply to spousal beneficiaries, as well as disabled beneficiaries and those who are not more than 10 years younger than the account holder (such as a slightly younger sibling, for example). Minor children are also exempt, but only until they reach majority age. After that, they will have 10 years to withdraw the assets in an inherited account. Spouses, disabled beneficiaries, and others under the exception will still be allowed to take distributions over their life expectancy.
If part of your estate planning includes giving your retirement plan to younger family members then you should probably think again. No longer can your grandchildren stretch out this gift for the maximum benefit of lifetime interest accrual. Some planners are rethinking how to deal with this asset and one option is to purchase life insurance with your distribution amounts. For those that are not intending to use their retirement accounts as part of an overall retirement financial plan, it is something to consider.
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This article is not intended as tax or financial planning advice.