THE SECURE ACT: A WHOLE NEW WORLD FOR RETIREMENT ASSETS
The recent enactment of the SECURE Act, which took effect on January 1, 2020, dramatically impacts IRAs, Roth IRAs and qualified plans (retirement assets). One of the most significant changes brought about by the SECURE Act is how quickly a retirement account must be liquidated by a beneficiary after the death of the retirement account owner. To fully understand the changes the SECURE Act brings, it is important to understand what the rules were under the “old law,” as the SECURE Act amended the old law, utilizing much of the same apparatus. Following the death of the retirement account owner, post-death Required Minimum Distributions (RMDs) of qualified retirement accounts were calculated based on whether the beneficiary was a “Designated Beneficiary” or a “Non-Designated Beneficiary.”
Simply stated, a Designated Beneficiary is an individual or trust that qualifies as a “see-through” trust. A Non-Designated Beneficiary is an estate, a trust that fails to qualify as a “see-through” trust or other “nonindividual” beneficiary (i.e. no measurable life expectancy). Prior to SECURE, qualified retirement accounts payable to a Non-Designated Beneficiary were subject to the “5-year rule.” The 5-year rule provides that if the owner dies prior to his or her Required Beginning Date (RBD) (previously age 70½ under the old law and now age 72 under the SECURE Act), all benefits must be distributed no later than the fifth anniversary of the owner’s death. If the owner dies on or after his or her RBD with a Non-Designated Beneficiary, prior rules provided that the Applicable Distribution Period (ADP) is the owner’s single life expectancy. The SECURE Act has had no impact on the payout rules as they relate to Non-Designated Beneficiaries.
The significant changes brought about by SECURE impact the payout rules for Designated Beneficiaries of qualified retirement accounts. Prior to SECURE, the ADP was based on the life expectancy of the beneficiary (or on Non-Designated Beneficiary rules if they proved more favorable). The SECURE Act largely replaces the life expectancy payout for Designated Beneficiaries with the “10-year rule.” The 10-year rule provides that all benefits must be withdrawn by the Designated Beneficiary within ten years of the owner’s death, unless one of the limited exceptions, discussed below, applies. The beneficiary has the ability to determine whether the distributions are staggered over those ten years, are taken all in year ten or are based on some other distribution schedule so long as all benefits are withdrawn by December 31st of the ten-year anniversary of the owner’s death. Failure to withdraw all assets in the retirement account by the deadline imposed by the 10-year rule results in a 50% tax on the missed distribution. In such cases, the required distribution continues to be 100% of the account balance in subsequent years, with the 50% tax penalty accruing each of those subsequent years until the account is entirely liquidated.
The SECURE Act creates a new class of beneficiaries, called “Eligible Designated Beneficiaries.” Eligible Designated Beneficiaries are not subject to the 10-year rule imposed upon other Designated Beneficiaries. Instead, these Eligible Designated Beneficiaries can benefit from traditional life expectancy payout rules, subject to certain exceptions:
- Spouses: Spouses named as beneficiaries of qualified funds can still use the life expectancy payout.
- Minor Child: Minor children of the owner are able to take advantage of the life expectancy payout until they reach the “age of majority,” at which time the 10-year rule is triggered.
- Disabled Persons: Disabled individuals are entitled to the life expectancy payout. Under SECURE, a “disabled individual” is one who is “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.”
- Chronically Ill: Individuals deemed “chronically ill” are likewise entitled to the life expectancy payout. A “chronically ill” person is one who has been certified by a licensed health care provided as (i) being unable to perform (without substantial assistance from another individual) at least two activities of daily living for a period of at least ninety days due to a loss of functional capacity; (ii) having a level of disability similar to that described in (i) above; and (iii) requiring substantial supervision to protect such individual from threats to health and safety due to severe cognitive impairment.
- Not More Than 10 Years Younger: The life expectancy payout applies where a sole named beneficiary is not more than 10 years younger than the owner.
The SECURE Act, no doubt, has turned planning for retirement assets on its head. From an estate planning standpoint, we are being proactive where we can and are reviewing existing plans where possible. In instances where retirement assets are flowing through a trust, for example, many trusts won’t work as they were originally intended. In some such cases, greater latitude and flexibility may be given to trustees by amending certain trust provisions. That said, there is no “one-size fits all” approach to planning for retirement assets post-SECURE, and there is no better time than the present to understand how the SECURE Act may affect you and your family.