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The SECURE Act and How it Effects Beneficiaries

The Setting Every Community Up for Retirement Enhancement Act, or the SECURE Act, was passed in December 2019.  Since being signed into law, the SECURE Act has had a significant impact on Americans’ retirement benefits and long-term retirement savings.  This Act, most importantly, has had a major effect on beneficiaries.  What do you need to know about the SECURE Act and how does it affect your estate planning?

While the SECURE Act changed a variety of retirement account rules, it also preserved much of the current applicable law.  Pre-SECURE Act, there were only two categories of beneficiaries, but under the SECURE Act, there are now three categories of beneficiaries: (1) a non-designated beneficiary; (2) a designated beneficiary; and (3) an eligible designated beneficiary.  First, the non-designated beneficiary category has not changed under the SECURE Act; the 5-year rule is still applicable.  Second, unless “eligible,” a designated beneficiary must withdraw within 10 years of the participant’s death.  Here, all amounts must be distributed before December 31st of the year which contains the 10th anniversary of the participant’s date of death.  In addition, there are no required distributions, so long as the funds are out of the plan by this deadline.

Third, the eligible designated beneficiaries are the exception to the ordinary designated beneficiary as they are still entitled to a modified form of the life expectancy payout method.  The 10-year payout replaces the life expectancy payout method for all except the following five categories of designated beneficiaries:

(1) Surviving Spouse – A surviving spouse may still use the life expectancy payout.  However, when the surviving spouse dies, the exception stops, and the 10-year payout applies.

(2) Minor Child of the Participant – The life expectancy payout applies to all children of the employee who have not reached majority yet.  Once the child reaches majority, the 10-year payout rule begins.  Therefore, when planning for minors, beneficiaries should include a testamentary trust that the minor child must begin taking withdrawals from once they reach the age of majority.

(3) Disabled Beneficiary – A disabled beneficiary may still use the life expectancy payout.  However, upon their death, the exception ceases and the 1-year payout rule kicks in.

(4) Chronically Ill Individual – A life expectancy payout applies to a chronically ill designated beneficiary.  When the chronically ill individual dies, the 10-year payout rule kicks in.

(5) A Beneficiary Less Than Ten Years Younger Than the Participant – A beneficiary who is not more than 10 years younger than the participant may use the life expectancy payout.  Upon their death, the 10-year payout rule begins.

The biggest change from the SECURE Act is that any designated beneficiary of an IRA, whose owner died after 2020, and who does not fall into the new eligible designated beneficiary category, must withdraw distributions over 10 years.  The SECURE Act grandfathered in all retirement accounts of decedents who died prior to January 1, 2020.

How can beneficiaries plan and make their options better?

There are three general options that beneficiaries may use.  First, a beneficiary could vary the amounts in which they withdraw each year or withdraw the entire balance in one year.  Second, a beneficiary could spread the balance out over 10 years and try to manage the tax impact in the given year.  Third, a beneficiary could take various amounts out each year based on the specific tax bracket that year.

There are a few major concerns that the new 10-year period creates.  First, there is a significant tax impact concern.  Because most beneficiaries will need to withdraw the balance within a shortened 10-year period, the income tax accelerates.  This impact could be much larger than the tax impacts for those who were able to withdraw over their lifetime.  Therefore, the tax impact will most likely have changed since pre-SECURE Act.   Along with this concern, beneficiaries will need to set aside enough money to manage the increased tax impact.  Second, some IRA account owners may be concerned about the beneficiary’s ability to withdraw responsibly and not deplete the account too quickly.

An option for IRA account owners who have concerns regarding their beneficiaries, is to leave IRA assets in a trust, rather than to a specific beneficiary.  This is appealing because the language can be direct and clearly state when and how assets can be distributed to the beneficiaries of the trust.  An IRA owner may wish to leave IRA assets in a trust for various reasons, including worry over a beneficiary depleting the assets immediately or not setting aside enough funds for taxes that may be due.  Thus, an IRA owner can leave their assets in a trust, which offer more protection and additional benefits.

 Other major take-aways

An increase in the required minimum distribution age – Prior to the SECURE Act, you were required to begin taking withdrawals from a traditional IRA by April 1st of the year following you turning 70 ½ years old.  These were known as minimum distributions.  Now, you are not required to start taking withdrawals from your traditional IRA until you turn 72 years old.

Elimination of an age limit for IRA Contributions – This is a benefit for older retirees who wish to continue working and contributing to your IRAs.  The SECURE Act eliminated an age limit for contributing to IRAs.  Prior to the Act, workers could only contribute to their own retirement accounts until the age 70 ½.  This is no longer the case.

The Bottom Line

In the light of these changes made by the SECURE Act, you may want to update your estate plans or revisit them.  If you have any questions or concerns with an estate planning issue of your own, please call our experienced estate planning attorneys at (402) 827-7000.

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