The U.S. House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act on May 23, 2019 (the “SECURE” Act). The bill is not yet a law and is currently working through the Senate. If the bill passes the Senate, and is signed by the president, it will significantly increase access for individuals to save for their retirement under an employer plan and will significantly affect how their beneficiaries inherit their retirement assets. The bill seems likely to pass in some form. Given its proposed sweeping changes on how individuals can inherit retirement assets, it is important to understand how the changes may impact your estate plan.
The bill includes many provisions that will be beneficial to employees saving for retirement and to employers seeking to provide a means for their employees to save for retirement. For those who already have retirement accounts, the bill proposes very few changes that would affect retirement savings and financial planning for retirement. The bill does not affect the options available to a surviving spouse who inherits a retirement account.
The most significant changes proposed in the bill are to what are commonly called “stretch IRAs.” Under current law, when an individual who is not your spouse is named as a beneficiary of your retirement account, that individual has options for how to receive those retirement assets. For example, your child could choose to withdraw all of the account and pay the income tax owed on the total value of the account, or, he or she could choose to take the retirement account as a new “inherited IRA” account.
Assets and investments inside an inherited IRA account remain tax-exempt for the beneficiary’s lifetime. The beneficiary who inherited the account only has to pay income tax on withdrawals from the account. The beneficiary will be required to withdraw a certain amount each year. Specific IRS rules govern how much the beneficiary has to take out each year based on the beneficiary’s life expectancy. This is where the term “stretch” IRA comes from. An inherited IRA essentially allows a beneficiary to “stretch” the retirement account over his or her lifetime by deferring income tax on the account to only amounts withdrawn.
This can create significant tax savings and tax-deferred growth for beneficiaries, especially younger beneficiaries. The younger the beneficiary, the longer the stretch, the bigger the tax-deferred growth and the larger the income tax savings.
The SECURE Act proposes to change how non-spouse beneficiaries inherit retirement assets. The SECURE Act, in its current form, proposes to eliminate “stretch” IRAs. Instead of allowing a beneficiary to stretch the retirement assets for his or her lifetime, the SECURE Act would require a beneficiary to withdraw all of the retirement assets from the inherited IRA account within 10 years.
The effect of this change is that the income tax imposed on inherited retirement assets would be accelerated. Under current law, a non-spouse beneficiary does not have to pay income tax on the total inherited retirement account – only on withdrawals, both those required to be withdrawn each year and any other additional amounts withdrawn. Under the SECURE Act, a non-spouse beneficiary would have to pay income tax on the total inherited retirement account within 10 years. There is no requirement that a certain amount be withdrawn each year, just that the entire account must be withdrawn within 10 years of the original account owner’s death.
Certain eligible beneficiaries are exempt from this 10-year payout rule. These include minors and disabled beneficiaries. Minors are able to stretch the retirement account until they reach the age of majority. Once the minor has reached majority, the 10-year payout rule then applies.
It is not yet clear how the proposed elimination of “stretch” inherited retirement accounts will impact retirement accounts that are made payable to a trust. Under current law, you can name a trust as a beneficiary of your retirement assets, but the IRS has very specific rules and requirements for how a trust may receive retirement accounts. These rules operate to allow the “stretch” and income-tax benefits of inherited retirement accounts to apply when a trust is the beneficiary instead of an individual person. If the SECURE Act passes, there will most likely be a period of time that estate planners will have to wait for further guidance from the IRS on how the Act impacts planning for retirement assets made payable to a trust.
If the SECURE Act passes and becomes law in the fall legislative session, it will be important for every person with retirement assets to have their beneficiary designations and other estate planning documents reviewed by an estate planning attorney and updated as needed. Although the Act in its current form may have little impact on your financial planning for retirement, it may have significant impact on your estate planning with your retirement assets.