The SECURE (Setting Every Community Up for Retirement Enhancement) Act represents the first significant change to retirement legislation since the Pension Protection Act of 2006.
Any shift in how Americans save and plan for retirement is going to have its supporters and detractors. It's essential to understand the changes before making adjustments to your retirement and estate plans.
Before we dive into the most impactful change, the changes to how IRAs will be inherited, let's outline three other changes of the SECURE Act.
- Instead of RMD's (Required Minimum Distributions) starting at 70.5, it is now 72.
- It is now easier to include annuities in 401(k) plans, by eliminating some of the fiduciary requirements used to vet companies and products before they can be included in a 401(k) plan.
- It allows workers to continue contributing to a traditional IRA after the age of 70.5, which is now the same as the rules for 401(k) and ROTH IRA contributions.
The Big Change: The "Stretch IRA" disappears
The most significant change brought forward by the SECURE Act is that inherited IRA's, with few exceptions, will have to be distributed within ten years of being inherited.
Before passage of the SECURE Act, anyone named as a beneficiary could choose to take distributions throughout their lifetime. You could then pass on what remained to the next generation, hence the "Stretch IRA" name.
With the change, the inherited IRA will need to be fully distributed within ten years of the account holder’s death. This can result in a heavy tax burden to those inheriting accounts, as adult heirs may be in their highest tax years, due to being in their peak earning years.
How This Affects Estate Planning
This law will go into effect on January 1, 2020. Therefore, Americans will need to reevaluate their estate plans immediately, especially if you include a Stretch IRA as part of your succession planning.
An interesting strategy is that instead of passing down an IRA, one should instead pass down a brokerage account. The primary benefit is that when an heir inherits the assets, they increase the tax basis of any asset to its current fair market value. Any gains on any asset during your lifetime will not be subject to capital gains.
Another common strategy is to leverage the trust structure. Instead of passing down the IRA to an individual, the IRA holder instead forms a trust and names it as the beneficiary of the IRA. The trust would name the intended heirs as the beneficiaries.
Here is where it gets interesting. Here is an example timeline of how a trust works:
- The trust would then take out a life insurance policy on the original IRA holders
- Insurance premiums are paid for by taking distributions from the IRA while using the annual gift tax exclusions to gift the premium amount to the trust.
- Upon the death of the account holder, the policy benefit would be paid to the trust and inherited by the trust beneficiaries.
While the SECURE Act does bring significant changes to the way estate planning happens, its passage does usher in an opportunity for creativity in the way that assets are distributed, planned for, and ultimately passed down from generation to generation.