The SECURE Act: How retirement planning has changed for every taxpayer
Paul Dinzeo, CPA, JD, CFP, MBT | April 2020 Footnote
Editor's note: Updated April 1, 2020
Sometimes new laws don’t always benefit the greater good.
By way of the new SECURE Act, Uncle Sam has significantly shortened the deferral of inherited retirement benefits, forcing Joe Taxpayer to pay tax sooner than they would otherwise be able to defer.
The SECURE Act was signed into law by President Donald Trump on Dec. 20, 2019, as part of the appropriations bill that calls for more than $1.7 trillion of spending. While the appropriations law covers a wide array of changes, the SECURE Act focuses on retirement accounts, specifically for seniors.
The acceleration of distributions from tax-deferred retirement accounts under the SECURE Act, an acronym for “Setting Every Community Up for Retirement Enhancement,” provides a revenue offset to this massive spending bill.
Let’s take a closer look at some of the provisions included in the new act.
Lifetime changes
RMDs change from 70 ½ to 72
One of the pro-taxpayer changes in the SECURE Act is the modest delay of when the required minimum distribution (RMD) rules begin, moving from 70 ½ to 72. In general, for individuals born after June 30, 1949, the required beginning date is April 1 of the year following the year the individual turns 72.
For example, Amy was born on July 1, 1949. Her required beginning date will not be until April 1, 2022, the year after she turns 72. For those born prior to July 1, 1949, their RMD would continue to be determined at age 70 ½.
Age cap eliminated
Beginning in 2020, the age cap restriction to contribute to traditional IRAs has been lifted. So, any individual with earned income can contribute to a traditional IRA regardless of age.
Qualified charitable distributions (QCDs) impact
The trigger date remains 70 ½ for QCD purposes even though RMD rules were modified to age 72. However, due to the elimination of the age cap, as discussed above, the CPA must be aware of certain adjustments when a client contributes to their traditional IRA and contributes via a QCD.
As an example, a 70 ½-year-old client who is not a participant in an employer retirement plan makes a tax-deductible contribution of $7,000 to their traditional IRA and transfers $100,000 from one of their traditional IRAs to a qualified charity. Based on the new QCD rules, your client can only exclude $93,000 of the $100,000 of the QCD from income in that tax year.
Further, if a client makes a tax-deductible contribution(s) to their traditional IRA after age 70 ½, they must track those amounts for any future QCD years. For instance, a taxpayer makes a tax-deductible contribution of $7,000 to their traditional IRA in 2020 after age 70 ½ but doesn’t make a QCD in that same tax year. Five years later, the taxpayer makes a charitable contribution of $100,000 via a QCD. They would need to reduce the amount excluded from income by $7,000 related to the IRA contribution in 2020.
Post-lifetime changes
The most significant change under the SECURE Act is the creation of the 10-year rule that eliminates, with certain exceptions, the “stretch” IRA provisions that CPAs have been advising their clients to take advantage of for many years.
The 10-year rule is relatively straightforward: All IRA amounts must be distributed by Dec. 31 of the year that contains the 10th anniversary of the date of death. No interim distributions are required so long as the funds are paid out of the plan by the deadline.
There are four exceptions to the 10-year rule that allow a life-expectancy payout method:
- Surviving spouse: The surviving spouse can still use the life expectancy tables to the detriment of their RMD. However, upon their death, the 10-year payout rules must be used (unless another exception applies).
- Minor child: The life expectancy payout applies to a minor child until they reach 18 years old, then the 10-year rule must be followed.
- Disabled/chronically ill beneficiary: Again, the life-expectancy payout applies to a disabled beneficiary (as defined by Section 72(m)(7)) or a chronically ill person (defined under Section 7702B(c)(2)). The 10-year rule is required after that beneficiary’s death.
- Less than 10 years younger beneficiary: If an individual is not more than 10 years younger than the participant, then the life-expectancy payout applies. As an example, if your client leaves his IRA to his younger brother (who is not less than 10 years younger), the brother is able to use his life-expectancy table for RMD purposes.
Estate planning: Action necessary
CPAs who engage in their client’s estate planning need to act. Clients may currently have an estate plan that uses a “conduit trust” or “accumulation trust.” These types of trusts must be reviewed to determine if the 10-year distribution rule still aligns with the client’s goals and intentions.
One typical plan for clients who desire to leave some or all their IRA into a trust when they pass is a conduit trust. This is a trust that ultimately passes through the annual RMD from the IRA to the beneficiary. Generally, the philosophy is that the IRA will “burn off” over a relatively longer period so the beneficiary receives almost an annuity-like payment. However, with the 10-year rule now in place, clients may want to revisit the use of a conduit trust because the payout must be accelerated across a 10-year period (converts from a lifetime payout to a 10-year payout).
The alternative structure for a trust with an IRA is an accumulation trust. This allows the trustee to decide whether they will distribute the RMD annually to the beneficiary or accumulate the RMD inside of the trust (or some combination of the two). The 10-year rule in this case could accelerate ordinary income over a shorter period and in larger amounts, which are subject to the trust’s punitive ordinary income tax brackets.
Planning strategies
Although these are not necessarily new strategies, they can potentially add significantly more value now that the 10-year rule is in place.
It is probably more important than ever to review with clients the benefit of lifetime Roth conversions. In a nutshell, the math on not doing a Roth conversion was greatly helped by the time-value of the stretch provisions. Now that the 10-year rule is in place and the runway for compounding growth has shortened, the math, especially for those with lower tax rates than trusts or their children, can change to becoming Roth conversion positive.
For those clients who are charitable, the use of their IRA to fund philanthropic goals should be reviewed. Although there are more complicated options, such as using a charitable remainder trust, a client may simply want to name a charity(ies) as a beneficiary of their IRA. These types of gifts escape income and estate taxes and can be a very tax efficient way to give to charity.
Life insurance is another tool for clients that have more significant IRAs. The death benefit can be used to “replace” the income and estate tax hit on the IRA asset or, if the client is charitably minded, the full IRA can be given to charity with the life insurance policy (usually held by an irrevocable life insurance trust), replacing the full value of the IRA to the client’s family.
Other than the aforementioned exceptions and proactive planning, income tax on tax-deferred retirement accounts will be significantly accelerated. This is a resounding win for Uncle Sam, but not Joe Taxpayer.
Paul J. Dinzeo, CPA, MBT, JD, CFP is the president of Dougherty Trust Company, a South Dakota trust company. He is an MNCPA member, and has appeared in numerous publications, including The Wall Street Journal and The New York Times. You may reach him at pdinzeo@doughertytrust.com.
