Ethan R. Okura
Hawai‘i Herald Columnist
On Dec. 20, 2019, the Setting Every Community Up for Retirement Enhancement — or SECURE — Act was signed into law by President Trump. The SECURE Act made some major changes to the way that retirement accounts must be distributed, especially after the original account holder passes away. Most of these changes went into effect on Jan. 1, 2020.
Age to Contribute and Start Required Minimum Distributions. Prior to the enactment of the SECURE Act, the holder of an IRA could not make any contributions to the account after age 70½, regardless of whether he or she were still working. Additionally, pre-SECURE Act, anyone with an IRA or a 401(k) had to start withdrawing at least the minimum amount from their retirement accounts when they turned 70½, as required by the Internal Revenue Service.
With the SECURE Act now in place, IRA and 401(k) holders can continue to make contributions to their retirement plans beyond age 70½. The Required Minimum Distributions will not take effect until the holder turns age 72. Anyone who reached age 70½ by Dec. 31, 2019, will continue to take RMDs under the old starting age.
The SECURE Act also includes a few other tax benefits, such as allowing limited penalty-free distributions from a 401(k) to help with the expense of having or adopting a child and allowing for the use of 529 higher education accounts for some student loan repayments.
However, the most important changes benefit the government because they can collect taxes earlier, which end up hurting most taxpayers. The government is expected to take in an estimated $17.5 billion in tax revenue as a result of the SECURE Act.
Elimination of the “Stretch” IRA. Before the SECURE Act became law, any non-spouse (such as a child, sibling, other family member or friend) who inherited an IRA from its original owner could take distributions from the IRA over his or her own life expectancy.
Extending, or “stretching,” the IRA in this manner allowed the beneficiary to reap the benefits of the IRA’s tax-deferred growth for a longer period of time.
The SECURE Act now requires that an inherited IRA be distributed within 10 years of the original IRA owner’s death, with a few exceptions.
Eligible Designated Beneficiary. This term, “Eligible Designated Beneficiary,” was created and defined as a result of the SECURE Act. Who is considered an EDB? An EDB is the spouse of the IRA owner, or a disabled or chronically ill person, or someone who is no more than 10 years younger than the original IRA owner or 401(k) plan participant. EDBs are the “exceptions” mentioned in the last sentence of the previous paragraph. They can use the old “stretch” rule to take retirement benefits over their own life expectancy instead of requiring the full distribution of the account within 10 years of the original account owner’s death. Also considered an EBD is a minor child of the IRA owner or plan participant as long as he or she is a minor. Once the child becomes an adult, the 10-year distribution rule is in effect.
Potential Problems with Your Estate Plan. Given all of these changes, the first thing you should consider is whether your existing beneficiary designations still make sense now that the law has changed. Before the SECURE Act became law, most financial advisors, accountants and estate planning attorneys recommend that you do one of two things: 1) Name a “conduit trust” as the beneficiary of your IRA (to preserve the “stretch” distribution for your trust beneficiaries); or 2) Name your spouse as the primary beneficiary with your children as contingent beneficiaries.
Although these two strategies were highly recommended in most cases before the SECURE Act became law, they probably will not provide you with the best tax benefits now and into the future. Most conduit trusts were designed in a way that creates a terrible tax outcome under the new rules. No wonder it has been nicknamed the “Conduit Trust Disaster.” What happens is that most of the IRA must be distributed in the 10th year, possibly putting your beneficiary in a higher tax bracket for most of the IRA distribution.
Also, having your spouse inherit your IRA as a rollover may look attractive at first because it was usually the best thing to do under the old rules. However, you may end up getting caught in what is called the “Spousal Rollover Trap.” If you name your spouse as the primary beneficiary, more of the distributions are likely to be taxed at higher rates than they might otherwise had you planned properly.
Set These Goals. Considering the new 10-year distribution rule for anyone who is not an Eligible Designated Beneficiary, here are some factors to balance between and plan for:
• Defer as much of the tax as possible until later;
• Strategically, do not use an Eligible Designated Beneficiary;
• Take advantage of current lower tax rates, as they are scheduled to rise in 2026;
• Manage the different income tax brackets among family members;
• Manage the income needs of your spouse and other family members;
• Manage your state income taxes;
• Convert ordinary income to capital gains (at lower rates);
• Protect against divorces and creditors; and
• Fulfill charitable objectives using retirement funds.
Possible Solutions. Some of the strategies we use to deal with the problems created by this change in the tax law include:
• Staggered, early and continuous Roth IRA conversions;
• Changing beneficiary designations to disinherit the surviving spouse;
• Using a qualified disclaimer for the surviving spouse to refuse the inheritance;
• Amending revocable conduit trusts;
• Decanting, reforming or replacing irrevocable conduit trusts; and
• Creating an out-of-state trust to be the beneficiary of the retirement account.
Summary. There is no simple, one “correct” answer regarding who you should name as your IRA or 401(k) beneficiary. Achieving the best tax, asset protection and income outcomes requires effort and coordination with your financial advisor, accountant and estate planning attorney. With proper planning, however, you can still save large amounts on taxes and avoid adding too much of your own retirement funds to the estimated $15.7 billion headed for the IRS.
© OKURA & ASSOCIATES, 2020
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Ethan R. Okura received his doctor of jurisprudence degree from Columbia University in 2002. He specializes in estate planning to protect assets from nursing home costs, probate, estate taxes and creditors.
This column is for general information only. The facts of your case may change the advice given. Do not rely on the information in this column without consulting an estate planning specialist.