Is Your Estate Plan SECURE?
/The SECURE Act became effective on January 1, 2020 and proposes to strengthen retirement savings by making it easier for employees to participate in retirement savings plans and to contribute to these plans for a longer period of time.
Specifically, the SECURE Act:
Repealed the maximum age for traditional IRA contributions (previously 70 ½), provided that the contributor is still working
Increased the age for required minimum distributions from 70 ½ to 72
Allows long-term, part-time workers to participate in 401(k) plans
Offers more options for lifetime income strategies
Raised the cap for auto enrollment contributions in employer-sponsored retirement plans from 10% of pay to 15% of pay – so if your plan at work provides auto enrollment, the amount withheld for your retirement savings could go up every year until you’re contributing 15% of your pay to your retirement savings plan
Allows “lifetime income investment” to be distributed from your workplace retirement plan, i.e., to another 401(k) or IRA
Requires “lifetime income disclosure statements” showing how much money you could potentially receive each month if your total 401(k) balance were used to purchase an annuity
Provides small business owners with incentives for starting retirement plans and makes it easier for them to do so
Permits parents to withdraw up to $5,000 from retirement accounts, penalty-free, within a year of birth or adoption for qualified expenses
Allows parents to withdraw up to $10,000 from 529 plans to repay student loans
While the new law may well succeed in strengthening retirement savings, it also undoes legislation that has long benefited the ultimate beneficiaries of the savings plans – legislation allowing for the “stretch”.
Retirement savings plans are typically distributed upon the death of the saver to those named as plan beneficiaries by the saver. If the beneficiary is the saver’s spouse, then the beneficiary can simply “roll over” the saver’s retirement savings plan into his or her own. And previously, if the beneficiary was someone other than the saver’s spouse – an adult child, for example – the beneficiary was required to take (and pay income tax on) distributions from the retirement savings plan immediately, but could “stretch” the required minimum distributions over his or her projected life expectancy, allowing him or her to limit the income tax due by reason of the savings plan to the lowest amount possible.
However, the SECURE Act eliminates the “stretch” for most beneficiaries (exceptions include assets left to a surviving spouse, a minor child, a disabled or chronically ill beneficiaries and beneficiaries who are less than 10 years younger than the original IRA owner or 401(k) participate) and requires the beneficiaries of a retirement savings plan to withdraw all of the funds within ten years. This is problematic from an estate planning perspective because it thwarts a primary goal of estate planning – tax efficiency – by requiring the beneficiary to incur potentially significant income taxes within a relatively short period of time.
However, there are estate planning strategies that can somewhat counteract the negative effects of the SECURE Act.
Split primary beneficiaries. Assume, for example, that the primary beneficiary of your IRA, valued at $4 million, is your spouse and your contingent beneficiary is your daughter. Upon your death, your spouse “rolls over” your IRA into his/her own IRA, valued at $1 million. When your spouse later dies, having not spent down the combined IRA, your daughter inherits $5 million in retirement savings that she must withdraw over ten years – to the tune of $500,000 per year, all of which is subject to income tax.
However, if your spouse will not need your retirement savings to fund his or her retirement (and that’s a big “if”), consider naming your spouse and your contingent beneficiary as joint primary beneficiaries. In the above example, if you name your spouse and daughter as joint primary beneficiaries, your daughter would inherit $2 million in retirement savings upon your death and would only be required to withdraw and pay income tax on $200,000 per year. When your spouse later dies, your daughter inherits the $3 million balance, but the ten-year clock has been reset and, ideally, there will be no overlap between her $200,000 required minimum distributions from your IRA and her $300,000 required minimum distributions from your spouse’s IRA. In this way, you can construct a “stretch,” albeit not over your daughter’s projected life expectancy.
Use your retirement savings for charitable giving. Many people incorporate charitable giving in their estate plans and, to get the most bang for their charitable-income-tax-deduction-buck, they will earmark assets for charities that would otherwise be subject to income tax. Retirement savings plans are often earmarked for charitable giving – now even more than ever. By naming a charity as the beneficiary of your retirement savings plan you can ensure that the entire amount is passed on without diminishment due to income tax liability. Your heirs can then inherit other assets that are subject to little or no income tax. In this way, the negative tax implications of the SECURE Act can be neutralized.
Convert your IRAs to Roth IRAs. Unlike a traditional IRA, a Roth IRA is a post-tax retirement savings account – meaning that the saver, not the ultimate beneficiary, pays income tax on the funds. If you have retired and find yourself in a low income tax bracket, it may be advisable to convert your traditional IRA to a Roth IRA and pay the income tax now. The result will be that your beneficiary – who may be in a high income tax bracket – can inherit the funds tax free, even if there has been interest growth since the conversion.
In sum, the SECURE Act has changed the game when it comes to estate planning with retirement savings plans. If you have retirement savings, which many of us do, it is important that you consult with your T&E attorney to make sure that you are able to pass these savings on in a tax efficient manner.