Estate Planning

On December 20, 2019, the SECURE Act was signed into law. In addition to making other changes to retirement plans and IRAs, the SECURE Act changed the rules on distributions from defined contribution plans, including IRAs, for deaths that occur after December 31, 2019.

In light of these new rules, it is imperative that our clients review their estate plan as it relates to distributions from IRAs or other defined contribution plans, such as profit sharing plans or 401(k) plans. The analysis can be complicated in that many of the old rule concepts remain in place, requiring that the new rules be applied in tandem with some old rule principles.

Stretch IRA Eliminated

Under the old rules, with proper planning, the life expectancy of the IRA beneficiary could generally be utilized to determine the minimum distribution requirements. So, for example, if the Beneficiary of an IRA is age 35, under the old rules, distributions from the IRA could be taken out annually over 34.2 years. This dynamic distribution option has often been referred to as “Stretch IRAs.”

The SECURE Act has changed these rules for deaths occurring after December 31, 2019. Essentially, the Stretch IRA rules are replaced with a rule requiring that the IRA be distributed out in its entirety to the designated beneficiary by the end of the tenth (10^th) year following the year of death of the IRA owner (“10-year rule”).

Even with the new rules, it is necessary to determine that the beneficiary be a “designated beneficiary.” Like the old rules, if the beneficiary of an IRA does not qualify as a “designated beneficiary” then the Stretch IRA rules (under the old rules) and the 10-year rule (under the new rules) may not apply, requiring that distributions be made on an even more accelerated basis. For example, the IRA owner’s estate or a charity would not qualify as a “designated beneficiary.” This determination can be quite challenging when a Trust is named as the beneficiary, and there are contingent beneficiaries that do not qualify as “designated beneficiaries.”

Exception to the New Rules

There are five (5) classes of beneficiaries that give rise to an exception to the 10-year rule. These five (5) classes are referred to in the SECURE Act as “eligible designated beneficiaries.”

If the IRA is payable to an eligible designated beneficiary, then generally the old rules and the life expectancy opportunities are still available. Eligible designated beneficiaries include surviving spouses, children of the IRA owner who have not reached majority (children meaning the actual children of the IRA owner as opposed to, say, grandchildren), disabled individuals, the chronically ill, and beneficiaries that are not more than ten (10) years younger than the IRA owner.

Estate Planning Problems

In light of these new rules, a client’s current plan that maximizes estate and income tax savings while attending appropriately to the family dynamics with timely distributions, may have been turned on its head.

Some situations will not require any changes to the estate plan even though the new law will require accelerated distributions from IRAs. Simply put, because the 10-year rule transplants the Stretch IRA rules in many cases, distributions from IRAs will need to be made more rapidly than previously anticipated, and the associated income taxes will need to be paid when distributed. Acknowledging this and planning for this is still necessary even if no changes are actually made to the current estate planning documents and beneficiary designations. For example, it may be appropriate to consider the purchase of life insurance to deal with the accelerated income taxes associated with the accelerated distributions.

On the other hand, the new rules may totally disrupt the current plan. For example, many clients have trusts in place for their younger beneficiaries that have “conduit” provisions. The conduit provisions simply state that any distribution from an IRA must be distributed to the beneficiary. Under the old rules, the beneficiary’s life expectancy governed the minimum distributions, so having the distributions from the IRA be paid to the trust only to be paid to the beneficiary made not only good income tax sense, but also made good people sense.

With the new rules, unless the beneficiary of the trust is a minor child, all of the IRA assets must be distributed to the trust by the end of the tenth year following the death of the IRA owner. And, if the conduit provisions remain in place, then all these monies in turn must be distributed to the very young beneficiary and income taxes (unless a Roth IRA) must be paid on what could be a huge sum of money. Even if the beneficiary of the conduit trust is a minor child (thus being an “eligible designated beneficiary” that can use his or her life expectancy for distribution purposes) once the child attains the age of majority, the 10-year rule kicks in.

The Need to Review

There are too many working parts to these old and new rules to describe them all in detail in this newsletter. Suffice it to say that everyone should revisit their estate plan and beneficiary designations in the context of IRAs and defined contribution plan distributions to make sure that the planning still makes sense. In some scenarios, no changes may be necessary. In other scenarios, changes will obviously be needed. In other scenarios, changes might even be made to make the plan better than it is today.

Although not discussed herein, even for deaths that occurred prior to January 1, 2020, whereby the old rules generally still apply, there are some wrinkles in the law that warrant a look at what might still be done (like timely disclaimers) to make the plan work better.

The Kegler Brown Hill + Ritter team looks forward to the opportunity to work with you in reviewing your estate plan in the context of these new rules.