Back to the Future: New SECURE Act Amendments and Regulations Will Create Significant Impacts on Heirs, and Require Re-Thinking Old Planning Strategies. Recently adopted legislation and proposed (but likely to be adopted) rules will significantly change the interpretation and implementation of the SECURE Act of 2019 and will require retirement plan participants to re-think how these assets can be best passed to their descendants and beneficiaries.
New Legislation and New Rules
The biggest change in the SECURE Act of 2019 was the requirement that all inherited IRA funds had to be distributed to most beneficiaries within ten (10) years of the death of the account holder (the “10-Year Rule”). Beneficiaries qualifying as an “Eligible Designated Beneficiary” (EDB) would not be subject to the 10-Year Rule and could continue stretching these payments out further – all other beneficiaries would be subject to the new requirement.
Since its passage in 2020, the prevailing wisdom had been that the 10-Year Rule meant a non-Eligible Designated Beneficiary could delay withdrawing any assets until whenever they wanted, as long as the entire retirement account was emptied by the 10th anniversary of the account holder’s death. Instead, the new proposed rules modify the 10-Year Rule by requiring that annual Required Minimum Distributions (RMDs) for beneficiaries (based on the beneficiary’s life expectancy) be made each year, and still requiring that the entirety of the account be distributed by the 10th anniversary of the account holder’s death.
Another recent change to the SECURE Act is the raising of the Required Beginning Date (“RBD”) from 72 to 73, and eventually to 75 in 2033. Finally, while not specifically related to the SECURE Act, the upcoming sunset of the Tax Cut and Jobs Act will result in higher income taxes applied to any distributions from these inherited retirement plans, and the new Massachusetts “Millionaire” Tax will have additional impacts on large inherited IRAs amounts for Massachusetts residents.
Impacts of These Changes on Beneficiaries and Planning
The net result of these three changes will be significantly higher tax obligations for the recipients of inherited IRAs. Because plan participants will delay their own RMDs until 73 (as of 2023) and 75 (starting in 2033), the beginning balances in these retirement accounts will be higher. Further, by delaying the beginning of RMDs, many plan participants will compress their actual distribution period between the start of RMDs and their eventual death – this means the ending balance in these retirement accounts will also be higher.
Subsequently, when the plan participant dies, the higher ending balances will be passed to the beneficiaries, and any beneficiary that does not qualify as an Eligible Designated Beneficiary will be subject to the revised 10-Year Rule – they’ll have to take RMDs based on their own life expectancy for each year, and make sure that 100% of the inherited funds are distributed by the end of the ten (10) year period. As a result, there will be larger withdrawals each year, and significantly larger withdrawals in some years. Finally, those higher annual withdrawals will then be subject to the higher income taxes ensuing from the 2026 sunset of the Tax Cut and Jobs Act and the 2023 implementation of the new Massachusetts “Millionaires” Tax.
In upcoming posts, we’ll be discussing ways to minimize the impacts of these changes, including (1) timing withdrawal payments and accelerating distributions; (2) the smart use of different measuring lives; (3) shifting income between different years and different beneficiaries, and using the flexibility of a trust to make this easier; (4) using life insurance and life insurance trusts as a way to help take the sting out of the tax obligations; (5) implementing a structured plan for converted traditional IRA accounts into Roth IRAs, which are not subject to the same rules; and (6) the importance of having strong professional support from your attorneys, accountants, and financial advisors and in finding the right trustees. Make sure to follow for more information and register for our September Back to the Future continuing education course.