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The Secure Act – Congress Just Moved the Goalposts

By Patrick D. Owens

The Setting Each Community Up for Retirement Enhancement (SECURE) Act passed Congress on December 20, 2020, effective January 1, 2020[i].  By now most of us are aware of the important terms of the latest federal tax hike/money grab legislation, but here’s a summary of some of the major points to be aware of:

  • Employer Incentives. Adds a $500/per year general business tax credit for employers with no more than 100 employees receiving at least $5,000 in compensation for the preceding year (among other modifications to encourage employers to encourage tax deferred saving)[ii];
  • Employee/Student Incentives. Treats an amount includible in income and paid to the individual to aid in the pursuit of graduate or postdoctoral study or research (fellowship, stipend, or similar amount) as compensation allowing graduate and postdoctoral students use of an IRA[iii];
  • IRA Contributions. Repeals the prohibition on deductible contributions to a traditional IRA at age 70.5 but reduces the qualified charitable distribution (QCD) exclusion by the excess of the allowed IRA deduction[iv];
  • Part-Time Workers. Allows long-term, part-time workers who work for at least 500 hours per year with an employer for at least three consecutive years to participate in their employer’s qualified retirement plans[v];
  • Birth or Adoption Distributions. Provides an exception to the 10% early withdrawal tax for qualified birth or adoption distributions capped at $5,000[vi];
  • Lifetime RMDs. Increased required minimum distribution age to 72[vii];
  • Extra Time for Adoption of Plan. Provides that an employer may elect to treat a qualified retirement plan adopted after the close of a taxable year but before the employer’s tax return is due (including extensions) as having been adopted as of the last day of the taxable year[viii];
  • 529 Distributions for Loan Repayment. Provides that tax-free treatment for higher education expense distributions also applies to expenses for registered apprenticeship program’s required fees, books, supplies and equipment and qualified education loan repayments of up to $10,000[ix];
  • Kiddie Tax. Strikes the TCJA amendment to the tax rates under the kiddie tax (which effectively applied ordinary and capital gains rates of trusts and estates to the net unearned income of a child).  The old kiddie tax rules apply starting in 2020[x].
  • Postmortem RMDs. After death distributions of an IRA or defined contribution plan must be completed within 10 years after the death of the employee/participant.  There is an exception for eligible designated beneficiaries (EDBs) discussed below[xi].

This article focuses on planning for this last point, some of the nuances, and practical ideas for implementation.  While most estate planning attorneys are now trying to grasp the new Illinois Trust Code, we now must also deal with the modified retirement plan rules.

If the beneficiary of a retirement account is more than 10 years younger than the deceased retirement account owner, then all remaining assets must be distributed by December 31st of the year that contains the 10th anniversary of death, unless the beneficiary is the spouse, disabled or chronically ill, or a minor child[xii].  This is huge change in the law that previously allowed designated beneficiaries to withdraw the retirement account over their remaining life expectancies under the IRS tables.  Note that under the new rules, the beneficiary has the option, but does not need to withdraw anything until the end of the 10th year after death which could effectively be 11 tax years.

The SECURE Act keeps the existing statutory framework for required minimum distributions but modifies the general rule for designated beneficiaries (DBs) to a 10-year rule whether the death was before or after the required beginning date.  The limited exception to the general rule where a beneficiary may use his life expectancy applies only to EDBs, however, at the death of the EDB, the 10-year rule then applies.  Let’s first review the general rules and then apply those rules to both designated beneficiaries and nondesignated beneficiaries[xiii].

Designated Beneficiary (DB).  An individual, or individuals, or a trust that qualifies as a see-through trust (i.e. a conduit trust or an accumulation trust) is a DB.  The definition of DBs stayed the same.

Nondesignated Beneficiary (NDB).  The estate, charities, or a trust that does not qualify as a see-through trust is a NDB.  The rules did not change for NDBs so that the existing rules of a 5-year payout requirement for pre-RBD deaths or the remaining life expectancy method of the participant apply for post-RMD deaths.  Note that under the IRS tables and likely new IRS tables, the life expectancy of someone between ages 70 and 80 is longer than 10 years.  This may lead to an odd situation where your client may not want a designated beneficiary (e.g. a trust that qualifies as a see-through trust will have the 10-year distribution while an NDB may use the ghost life expectancy if the death was after age 72).  The IRS will need to clarify this discrepancy.

Eligible Designated Beneficiary (EDBs).  A participant’s spouse, minor child, any disabled or chronically ill individual, or any individual not less than 10 years younger than the participant is an EDB.

  1. Spouses

A surviving spouse is one of the EDBs.  The surviving spouse still has the option to roll over the benefits to his own IRA.  If the surviving spouse does not roll over the benefits, then he must start taking annual RMDs by the later of the year the participant would have reached age 72 or the year after the participant’s death.  As a practical matter, most spouses over age 59.5 will rollover the IRA to their own.  Only spouses under age 59.5 who need to withdraw funds without a penalty would likely set up the IRA as an Inherited IRA.  At the surviving spouse’s death, the 10-year rule applies.

  1. Disabled or Chronically Ill

A DB who is disabled (within the meaning of section 72(m)(7)) is an EDB.  An individual shall be considered to be disabled if he 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.  A DB who is chronically ill (within the meaning of section 7702(b)(c)(2) is also an EDB.  An individual shall be determined to be chronically ill if there is a certification that the period of inability is an indefinite one which is reasonably expected to be lengthy in nature.  For benefits left in trust to these EDBs, each may use their life expectancy if the disabled or chronically ill beneficiary is the sole lifetime beneficiary of the trust.  After the EDB’s death, then the 10-year rule applies.

  1. Minor Children

A child of the participant who has not reached majority is an EDB.  In Illinois, the age of majority is 18, although there is some confusing and unexplained language referencing a regulatory exception for a child who has not completed a specified course of education and is under age 26.  After age of majority, the 10-year rule applies.  For the life expectancy method to be used for a minor child, a conduit trust will likely need to be used.  The conduit trust requires that all RMDs must be distributed to the trust beneficiary[xiv].  Therefore, benefits left to a minor child can be taken out over the minor’s life expectancy until age 18, and thereafter, the 10-year rule applies, so all benefits must be withdrawn by age 28 (until the IRS explains the confusing language).  Note that this exception applies only to a minor child, not a grandchild or other relationship.  Finally, a practical unanswered question is what happens if the benefits are left to a pot trust for the benefit of multiple minor beneficiaries?

  1. Less Than 10-Years Younger Beneficiary

The last EDB is a beneficiary who is not more than 10 years younger than the participant.  As with the other EDBs, at the death of the EDB, the 10-year rule applies.

Practical Considerations and Other Planning Opportunities

Trust as Beneficiary. Do you have to revise all of your trusts named as a DB?  No, each trust will continue to qualify as either a conduit trust or an accumulation trust if drafted properly, however, the tax effect of the distribution will likely need to be reviewed.  The conduit trust will require full distribution of the benefits after the end of the 10-years or 10-years after the age of the majority of a minor.  This potential concern must be weighed against the fact that if an accumulation trust is named, income is taxed at the highest trust income tax rates of 37% after $12,950 in income.  A potential planning idea may be to consider spray trusts that may allow the trustee to distribute to multiple beneficiaries or multiple generations of beneficiaries to spread out the income tax burden, which then raises other practical and fiduciary liability concerns, however, the remainder trust beneficiaries are no longer a concern for calculating the RMDs.

Life Insurance. Consider additional term insurance for clients with minor children.  This should have been a topic discussed before the SECURE Act and maybe becomes a more important topic now.   Also consider additional insurance to cover the expedited income tax payments due now that the life expectancy payouts no longer apply.

Charitable Remainder Trust (CRT). For clients who are already charitably inclined, consider leaving the benefits to a CRT for both income tax deferral benefits and charitable gifting.  There are numerous specific requirements for CRTs and so you must be cautious with this structure which may not work for young beneficiaries[xv].

Conversion to Roth IRA During Life. For certain clients, especially those subject to either federal estate tax or Illinois estate tax, consider the conversion of a Traditional IRA to a Roth IRA.  You will need to run the numbers through various calculators[xvi], but you may find that the 10 years of tax-free growth after death and tax free distributions may work out to your clients’ benefit.

[i] H.R. 1865 – Pub. L. No. 116-94

[ii] IRC §45E

[iii] IRC §219

[iv] IRC §219(d), §408(d)(8)(A)

[v] IRC §401(k), §410

[vi] IRC §72(t), §401 – 403, §408, §457, §3405

[vii] IRC §401(a)(9)

[viii] IRC §401(b)

[ix] IRC §221(d)(1), §529(c)

[x] IRC §1(j), §55(d)(4)

[xi] IRC §401(a)(9)

[xii] IRC §401(a)(9)(B)

[xiii] For more detailed information see Natalie Choate’s website at www.ataxplan.com.

[xiv] See e.g., Treas. Reg. 1.401(a)(9)-5, A-7(c)(3), Ex. 2

[xv] See generally Professor Christopher Hoyt who has written extensively on this subject.

[xvi] See e.g. www.leimbergservices.com/wdev/analyzerssa.cfm

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