How Does the Secure Act Affect your Retirement Beneficiaries?
The Secure Act has made several changes to the way we advise naming a beneficiary to a retirement account. In the past, it was very common for clients to request we name their revocable living trust as the beneficiary of their retirement accounts due to the distribution language of the trust. This allowed the trust to act as conduit which dictated that a beneficiary was only to receive the required minimum distribution every year rather than a part of the principal. The goal was to stretch the applicable distribution period of an inherited account over the longest period of time possible. In the past, the oldest beneficiaries age was used to stretch the distributions to the beneficiaries over the older beneficiary’s life expectancy. The older the beneficiary, the shorter the stretch period; the younger the beneficiary, the longer the stretch period. The longer the period stretched, the better for the beneficiary so that any income tax consequences were minimized and deferred over a longer period of time while the assets within the inherited account continued to grow income tax-free. This allowed us to protect the beneficiary from withdrawing too much and wasting the funds.
However, the Secure Act has changed everything on January 1, 2020 concerning stretching an inherited retirement account, including a Roth. There are no longer tax breaks for taking monies from a traditional account; the payments will be taxed at the beneficiary’s income tax bracket. The Secure Act has ended the stretch IRA. All of the plans to date, should now be reviewed, if not revised to take into account the maximum 10-year payout for beneficiaries. Why is this important for a beneficiary? The Secure Act has ended required minimum distributions for a named beneficiary. Rather, the named beneficiary(ies) has 10 years to deplete the inherited account. This is significant, especially if the beneficiary is in a high tax bracket or on the verge of being increased into a higher bracket, or in their 40s or 50s which is typically an individual’s peak earning years. Because required minimum distributions are gone, the beneficiary does have some flexibility with the amount she takes as income in any of the 10 years.
Clients often ask to name their trust as the beneficiary to overcome this 10-year hurdle. The issue there is that if the trust does not qualify as an eligible designated beneficiary (EBD), then the entire plan still has to be paid out by the 10th anniversary of the plan holder’s death.
In order to qualify as an EDB, you must fall into one of the following: if the IRA owner died prior to the law change, their account is grandfathered in. If a beneficiary is the surviving spouse, a minor child, disabled or chronically ill under the IRS rules, or not more than 10 years younger than the IRA owner, then the “old” rules still apply.
What to do? It’s not quite as easy as converting your IRA to a Roth since this will force you to incur income tax now. You should reach out to the planning professionals involved to determine if your wishes will still be met after you pass. Failing to do so could result in excessively taxed assets, or limited access to those assets.