Breaking News: Congress Overhauls Retirement System and Eliminates Stretch for Inherited IRAs
- The SECURE Act has passed and brings significant changes to the retirement system.
- The elimination of “stretch” from inherited retirement accounts is one of the these changes and brings potential impacts that you may want to consider.
- You should consider other strategies to pass on retirement assets to your beneficiaries, whether it be charities or your children and grandchildren.
Our retirement system has been overhauled with the passing of the Setting Every Community Up for Retirement Act (“SECURE Act”) . It was tacked onto the “must-pass” 2020 spending bill that was signed by the President on Friday. The SECURE Act overhauls our retirement system. With the exception of eliminating the stretch IRA, the act is overall a positive (click here for a full summary).
Notable Provisions of the SECURE Act:
- Elimination of the Stretch IRA: In 2019 and before, beneficiaries who inherit a retirement account can choose to take distributions over their life expectancy (i.e. the Stretch IRA). The SECURE Act eliminates this Stretch IRA option for any plan owner that passes away after December 31, 2019, and replaces it with a requirement that all funds be distributed out of retirement accounts within 10-years, with some limited exceptions for spouses, minors (and others). See further analysis of the wealth transfer impact below.
- Age Limit Removed for IRA Contributions: There is no longer an age cap on contributions to a traditional IRA. Traditional IRAs will now be aligned with Roth IRAs. Before the SECURE Act, there was an age cap for contributing to a traditional IRA (age 70 ½).
- Required Minimum Distribution (RMD) Age Extended to 72: The SECURE Act delays RMDs from retirement accounts until age 72 (up from 70½). This applies to all those who are not currently in RMD status. Anyone who is over 70½ they must continue taking RMDs.
- Penalty-Free Withdrawals for New Parents:The SECURE Act allows new parents to take penalty-free distributions from their retirement plans within a year of the birth of a child or adoption to cover related expenses, up to $5,000. The traditional 10% penalty would not apply for these distributions.
- Student Loan Repayment through 529 Savings Plans: Individuals can also withdraw up to $10,000 from 529 savings plans to make student loan payments.
- Convert Retirement Plan Accounts to Lifetime Annuity: Retirement accounts could be converted to a lifetime annuity. The SECURE Act creates a safe harbor for employers to offer annuities in their 401(k). The result is clearer protections for employers to avoid liability if they choose annuity providers who later have financial difficulty.
- Lifetime Income Disclosure for Defined Contribution Plans: Employers are required to disclose to employees the amount of sustainable monthly income their balance could support in their 401(k) statements.
- Increased Access to Retirement Plans for Small Business Employees: The SECURE Act expands the ability for small businesses to offer multiple employer plans. It also allows small business employers to join with other employers to set up and offer 401(k) plans with fewer liability concerns and less cost. Small businesses typically have not offered retirement savings options, so the hope here is that more small business employees will be able to take advantage of employer-sponsored plans.
Stretch for Inherited IRAs Eliminated – What you Need to Know
A key change in the SECURE Act, and viewed by many as negative, is the elimination of “stretch” IRA from inherited retirement accounts. The result is that a beneficiary can no longer stretch the distributions over his or her lifetime. Instead, a 10-year distribution rule will require all retirement assets be distributed out of the account within 10 years of the plan owner’s death. There are some exceptions for a surviving spouse and minor beneficiaries (and some other eligible beneficiaries). This new rule applies to all retirement accounts inherited on or after January 1, 2020.
From an estate planning perspective, the elimination of the stretch presents significant changes. Here are some important considerations:
- Retirement trusts are even more critical than before because they can be structured to protect the distributed assets within the trust, whether they are spread over the 10-year period or taken in a lump sum.
- Many revocable trusts will need to be updated, especially those that are named as beneficiaries of a retirement account, because they likely contain conduit provisions. A conduit provision requires the trust to give all distributed retirement assets outright to the beneficiary. This means the trust cannot retain or accumulate the retirement assets within the trust.
- Combining the new 10-year rule and the effects of the conduit provision could produce unfortunate outcomes, especially if a beneficiary is a spendthrift or if the beneficiary is dealing with certain life events (such as divorce, bankruptcy, bad business deals or other lawsuits). These life events may push the retirement assets out to the beneficiaries, whether they want the assets or not.
The good news is that the stretch still applies to inherited IRAs that were effective in 2019 or before.
Please reach out to your advisor about potential changes that may be needed to your estate plan following the implementation of the SECURE Act.