In an effort to protect the health of our clients, employees, and communities from potential impacts of COVID-19, we are holding virtual meetings (via telephone) as an alternative to traditional face-to-face meetings. The quarantine does not need to stop you from getting the legal help you need and we are available to help entirely virtually! Feel free to reach out for a Free Virtual Consultation.

In order to express our gratitude and appreciation to all of the healthcare workers and first responders helping our communities, we want to extend a discount to each of them and their families on any estate planning services to help them protect and care for their own loved ones.

New Federal SECURE Act Affects Estate Planning for IRAs & 401(k) Plans

In December 2019, the federal government enacted expansive retirement reforms and related tax law changes that went into effect on January 1, 2020. Among the complex provisions of the SECURE (Setting Every Community Up for Retirement Enhancement) Act are new rules that significantly affect inherited IRAs (Individual Retirement Accounts). The revisions also apply to other defined contribution retirement plans, including 401(k) accounts. As a result, the changes impact estate plans that include assets in an IRA or 401(k) account.

When the legal underpinnings of estate planning change — as they just did — some estate plans will require modification to accommodate the altered rules. Whether that is the case for a particular estate plan depends on a number of factors that must be evaluated on an individual basis.

In the discussion that follows, our BRMM attorneys summarize the key provisions of the SECURE Act that affect estate planning. If you have an IRA or 401(k), you should consult with a knowledgeable estate planning lawyer about how the SECURE Act affects your estate plan provisions for inheritance of those assets.

Lifetime Payout Period Replaced by Mandatory Full Distribution Within 10 Years for Inherited IRAs and 401(k) Plans

Before passage of the SECURE Act, beneficiaries who inherited IRAs and 401(k) accounts could stretch required minimum distributions (RMDs) over their own life expectancy (as determined by the IRS). The prior rule — which still applies to accounts inherited before 2020 — allows the assets to increase tax-free potentially for decades. In many cases, the extended withdrawal period also minimizes the tax impact of the distributions.

For IRAs and 401(k)s that are inherited on or after January 1, 2020, the SECURE Act replaces the previous rule with a new rule that requires mandatory distribution of the full amount in the account within 10 years of the account owner’s death. There are five limited exceptions for certain categories of beneficiaries (discussed below).

Under the new rule, distributions may be spread over the 10-year period or taken entirely at the end of the period. Those distributions are taxed as personal income when the beneficiary receives them. For accounts with substantial assets, the new rule can create significant negative tax implications for a beneficiary who does not fall within one of the exceptions.

In addition to the tax implications, the accelerated distribution often will frustrate the intentions of the IRA or 401(k) plan owner by putting assets into the hands of a beneficiary much sooner than originally contemplated. That can put the assets at risk in a number of different ways.

Exceptions to the 10-Year Distribution Requirement

The SECURE Act includes five categories of beneficiaries who can continue to withdraw from an inherited IRA or 401(k) account over their life expectancy. The law refers to these as “eligible designated beneficiaries” (EDBs).

If a beneficiary qualifies as an EDB, withdrawals are not subject to the 10-year mandatory distribution. However, assets remaining in the account when the EDB passes away will be subject to the 10-year withdrawal period, unless the successor beneficiary qualifies under one of the other exceptions.

The five categories of exempted beneficiaries are as follows:

Surviving Spouse

A surviving spouse still benefits from life-expectancy withdraw from an IRA or 401(k) account, as an exception under the new law. In addition, RMDs for a surviving spouse who inherits in 2020 or later must begin in the year the deceased spouse would have turned 72 (rather than the previous age of 70½).

Minor Children

A minor child of the account owner is also an EDB. However, when the minor reaches the age of majority, the exception ceases to apply, and the account assets must be distributed within 10 years of the child reaching the age of majority.

“Disabled” Beneficiary

A “disabled” beneficiary is eligible for life-expectancy distributions, but the law provides a very limiting definition for a “disabled” beneficiary, as follows:

"[A]n 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. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof in such form and manner as the Secretary may require."

In order to qualify as an EDB under this provision, if a beneficiary is able to engage in “any substantial gainful activity,” the exception does not apply.

“Chronically Ill” Beneficiary

A “chronically ill” beneficiary also is eligible for lifetime distributions, but the law includes a specific and complex definition for this category that is restrictive and limiting.

Beneficiary Not More Than 10 Years Younger

If the account owner names a beneficiary who is not more than 10 years younger than the owner, the beneficiary is exempted from the 10-year requirement.

How the SECURE Act Changes Affect Your Estate Plan

The SECURE Act changes substantially affect estate planning for IRAs and 401(k) plans. The requirement for a beneficiary to withdraw assets fully within a 10-year period significantly accelerates the distribution period. That acceleration runs counter to the intentions and goals underlying many estate plans, which relied on a beneficiary being able to take distributions over a lifetime.

Giving more money to a beneficiary sooner reduces the value of potential tax-deferred growth under the previous rule and exposes the distributed assets to a number of risks. A beneficiary may face a significant increase in personal tax liability due to a higher marginal tax rate on larger distributions, which means that more of the assets end up in the hands of the government rather than the beneficiary. Assets also may be lost due to financial irresponsibility of the beneficiary or asset vulnerability in the event of the beneficiary’s divorce (if the assets are commingled with marital assets).

There are sound strategies and options that can be used to address the issues created by the new rules for inherited IRAs and 401(k) accounts. The best strategy in a particular situation depends entirely on an individual’s financial and family situation and the current structure of the individual’s estate plan. It is essential for anyone who has an estate plan affected by the SECURE Act changes to consult with an experienced estate planning attorney at the earliest opportunity.

In addition, individuals who own IRAs or 401(k) plans but have not created an estate plan in reliance on beneficiary designations are strongly encouraged to talk with a lawyer about creating an estate plan. That advice applies in any case but is particularly critical in light of the SECURE Act provisions relating to inherited IRAs and 401(k) accounts.

Additional Important Changes for IRAs and 401(k) Plans

The SECURE Act includes two other significant changes that affect IRAs and 401(k) plans as of January 1, 2020.

Previously, the law required an account owner to begin taking annual required minimum distributions (RMDs) by April 1st of the year after the owner reached age 70½. The SECURE Act increased the RMD age to 72. Individuals who reach age 70½ in 2020 or later must take their first RMD by April 1st of the year after they reach 72. (The change does not affect people who reached age 70½ in 2019 or earlier.)

The SECURE Act also repealed the previous prohibition on further account contributions beginning in the year that the owner reached age 70½. There is no longer an age limitation on how long individuals can make contributions to an IRA or 401(k) if they continue to work. This change applies for 2020 and subsequent years. It does not apply for the tax year 2019.

Other Significant SECURE Act Provisions

The SECURE Act includes other significant provisions beyond those affecting estate planning for IRAs and 401(k) plans. The changes relate to other aspects of retirement and financial planning as well. For example, the SECURE Act also:

  • Allows new parents to withdraw up to $5,000 penalty-free from a retirement account within a year of the birth or adoption of a child
  • Permits parents to withdraw up to $10,000 penalty-free from a 529 plan to pay down student loans
  • Enables small business owners to receive a tax credit of up to $5,000 for a start-up retirement plan
  • Makes it more attractive for small business owners to open multiple employer plans (MEPs)
  • Allows long-term part-time workers to participate in a 401(k) plan
  • Raises the cap for auto enrollment in employer sponsored plans to 15% of pay

Detailed requirements apply to all of the above provisions. The SECURE Act also includes other revisions to retirement and tax laws.

The law is extremely complex and has numerous different components. The effect on each person and each estate plan will be different, as will the strategies for addressing the changes made by the SECURE Act.

Talk with Our Experienced Troy, Michigan Estate Planning Attorneys

Our attorneys at the law firm of Barron, Rosenberg, Mayoras & Mayoras, P.C. stand ready to assist with your estate plan and other concerns arising because of the new SECURE Act. We have been serving clients in Oakland County and beyond for more than 40 years. Our clients count on our commitment, experience, and credentials when they turn to us for their legal needs.

Call us today at (248) 494-4577 or use our online form to talk with our experienced estate and probate attorneys.

Categories: