The SECURE Act’s Impact on Your Estate Planning

The SECURE Act that took effect at the beginning of 2020 was intended to open up new flexibility for retirement savings, as we discussed here. But in the area of estate planning, its impact is likely to be the opposite. Certain tax and estate planning strategies have been curtailed, and people who had been considering these as a way to minimize their tax impact will now have to look elsewhere.

The most prominent change is the virtual elimination of the "Stretch" IRA for non-spouse beneficiaries, which allowed any individual beneficiary to stretch out their required minimum distributions (RMDs) over their lifetimes, reducing the size of each yearly payment, and avoiding income tax bunching. According to the new law, those RMDs must now be taken within 10 years of the original account holder's death.

This might seem like a small change, but the tax implications can be huge. If a 30-year-old who expected to live to age 80 were to inherit an IRA worth $2 million, the first-year distribution under the old rules would be $37,524. Under the new rules, the whole amount would have to be distributed within 10 years after the year of death, which, if paid out proportionately each year, comes to $200,000 per year.

Review Your Beneficiaries

If you're looking to use your retirement savings as an estate planning vehicle rather than simply to fund your own retirement, it’s important to handle those assets as efficiently as possible. Even if you hadn’t been considering a Stretch IRA Stretch, this is a good time to review the options regarding the beneficiaries of all your retirement accounts.

Since a surviving spouse is exempt from the 10-year rule, it may be prudent to ensure that your spouse is the primary beneficiary on your retirement account. The whole rationale for the Stretch IRA in the first place was the expectation that your children would have a longer life expectancy than your spouse, but now that’s flipped on its head: A spouse who expects to live for more than 10 years would get a more favorable tax treatment than that 30-year-old child.

Another option: name multiple beneficiaries for the account. That eases the tax burden for any one individual recipient.

Take a Second Look at Roth IRAs

Roth IRAs are also subject to a 10-year rule under the SECURE Act, but in this case, it isn't as detrimental, since distributions from a Roth IRA are not subject to income tax.  The time in which the assets can grow income tax free is substantially abridged, but no income tax bunching issue is created.

Converting a traditional IRA to a Roth is fairly simple, and you can do it at any time over the course of your lifetime. You probably want to do so when your tax rates are relatively low, because when you convert to a Roth, you will have to pay income tax, at ordinary federal and state rates, on the funds in the IRA at the time of the conversion.

Change the Trust

Many people name trusts as their IRA beneficiaries in order to maintain control of the assets even after their deaths. This done to ensure that the eventual recipients of the money don't squander it or lose it through lawsuits or mismanagement.

But things have gotten trickier now. The type of IRA trust known as a conduit or pass-through trust has become much less attractive with the passage of the SECURE Act. A conduit trust requires that the entire account be distributed from the trust to the beneficiary upon each RMD distribution as it was with the stretch, but since you could stretch over the beneficiary's lifetime, the RMD to the beneficiary was much smaller. It’s not as beneficial to put the assets in trust if they are only protected for 10 years.

Trusts can be very complicated vehicles; consult with your Baird Financial Advisor and legal counsel for guidance on any of these trusts.

The passage of these new rules should serve as a reminder that it’s helpful to periodically revisit the beneficiary designations for all your retirement accounts. Whether the law changes or your life changes, it’s important that your financial plans keep up with your situation. For all your estate and retirement planning needs, your Baird Financial Advisor can keep you up on the current landscape and steer you in the right direction.