The Secure Act Explained for Estate Planning

From Our “Ask a Question” Mailbag: “The Secure Act Explained.”

Peter Klenk, Estate Planning Lawyer.

The Secure Act Explained.

Begining in 2020, the Rules regarding your qualified plans (IRAs, 401ks, 403bs, etc.) have changed dramatically.  Everyone should contact their financial planner, accountant, and estate planner for a review. The rules have changed for you during your life. Furthermore, your plan has massive changes as pertains to income taxation after you die. For most people, the method that was perfect on December 31, 2019, is now outdated.

So, the most important thing to take from this article is you must review your plan. If you are one of my clients, I am giving free estate planning reviews. Give me a call, let’s brainstorm!

A Bit of Context

A little history goes a long way in helping you understand these most recent changes. Congress created IRAs decades ago to encourage people to save for their retirement. Initially, congress thought IRAs would be small and help supplement Social Security Payments. But, as they became more widespread, “Big Business” saw an opportunity. Large corporations knew that a pension is expensive. Replacing them with IRAs would reduce costs. Thus 401ks were born.  By replacing pensions with 401ks, employees saved for retirement and expenses shrunk.

But, now, these small pools of money grew. Now, instead of small IRAs for supplementing Social Security, people had large 401ks. These 401ks grew more substantial and more extensive, and more significant.  401ks became more specialized, congress crafted plans for specific industries, like 403bs for educators. For the rest of this article, I will lump them together as “Qualified Plans” or QP.

During this process, one political camp believed these Qualified Plans (QP) should be just a deal between the taxpayer and the government to help save for retirement.  At the tax payer’s death, the transaction was over. Deferred income tax came due. They viewed the QP as a loan of government money during the taxpayer’s lifetime. At death, the loan came due.

But, another political camp believed that as these plans grew larger and larger, the forced liquidation of a QP at death was unfair. It forced children to recognized income tax in a short period and pushed them into a higher tax bracket. The second group wanted to have the recognition time spread out to lessen the tax burden on children. The second group won out, and so for decades a parent could die, name a child as a beneficiary and the child could defer income tax recognition.

The default plan for over 30 years has been to utilize this “stretch IRA” option.  A parent would name the child or a trust for the child the beneficiary and the plan could be “stretched” out over the beneficiary’s projected lifetime.  If the 401k owner named a grandchild as beneficiary, the tax deferral might even exceed 80 years.

Evolution.

This lead to QP owners looking at their plans not only as a retirement plan but as a way to pass wealth to their descendants. QP owners would even convert their QP to a Roth IRA, paying all the income taxes early, so they could leave their child or grandchild an income-tax-free inheritance that spread out over their lifetime.

But, in the background, the group that believed QPs should not be an estate planning tool didn’t go away. And over time, their position and power grew until they were able to make changes. Hence, The Secure Act.  So, with this introduction, here is The Secure Act Explained.

The Secure Act Explained for Estate Planning.

The Secure Act makes changes that improve QPs during your life. These are positive changes. For example, you can defer taking withdrawals now until age 72 rather than 70.5. Talk to your financial advisor about these changes.  Utilizing these improvements can be a huge bonus.

But, these positive changes reduced treasury income, so the authors had to make up for the shortfall. Further, the drafters had the goal of lowering QPs as an estate planning tool. So, the Secure Act takes away the ability for most beneficiaries to defer income tax over their lifetime. Instead of being able to defer tax over a lifetime, they shortened it to 10 years. So, while you are alive, the SECURE ACT makes your life better, but at your death…ouch!

For example, before the SECURE ACT, a grandparent could leave a Roth IRA to a one-year-old grandchild. That grandchild could elect to take small, annual withdrawals (tax-free) over the child’s projected lifespan of nearly 90 years. The money in the Roth would continue to grow, income tax-free. Now, the grandchild has to liquidate the Roth IRA in 10 years.

IRA Trusts Not As Useful

Before the SECURE ACT, it was common to create a trust to hold an inherited IRA. Using the prior paragraph’s example, the trust would own the grandchild’s inherited IRA, and her parent could serve as the trustee. This way, the grandchild could not spend the IRA funds upon reaching age 18. Further, the trust protected the inherited IRA from the grandchild’s creditors. 

Though these trusts are still available, they are now shadows of their former selves. Because of the forced 10-year liquidation of most IRAs, the trust is more work than it is worth. 

A trust still might be an excellent tool for you, depending on the beneficiary.  For example, an IRA trust might be a perfect fit if your recipient is a minor child, a special needs person, or someone with creditor problems.  

The best way to sort out your situation is to talk to your financial planner and estate planner. Let’s brainstorm and see what works best given your specific set of facts.

Special Groups that Still Get Deferral.

The Act still allows a few people to defer the QP’s tax deferral over their lifetime.

• Your Surviving Spouse is one. But remember, if you name your Surviving Spouse as the primary beneficiary and your spouse survives you, this works. But, who is your contingent beneficiary? If you have designated a pre-2020 IRA Trust as a contingent beneficiary, you need to update your plan.
• A Disabled or Chronically Ill Person. But, who is “disabled” and who qualifies as “chronically ill?”  These terms still need to be sorted out, and it may be some time until we know who qualifies.
• Your Minor Child, but only until they become an adult. Then the plan switches to the 10-year rule. And remember, it must be YOUR CHILD. Grandchildren do not count.
• A person who is less than 10-years younger than you. For example, your little brother who is five years younger than yourself.

If your beneficiary fits in one of these categories, you need to speak to your financial advisor, accountant, and estate planning attorney. The rules are new, and IRS regulations have not even come out yet.  Careful planning is required.

In Conclusion: The Secure Act Explained, What Should You Do?

Talk to your financial planner, accountant, and estate planner. I cannot emphasize this enough. Make sure your beneficiary designations reflect your current plan. Craft a program using the new SECURE ACT Rules.

I hope you found this short article helpful addressing the question, The Secure Act Explained.  If you are curious about Probate, Estate Planning, or other various planning techniques, contact us. Let our Estate Planning lawyers help walk you through what can be a confusing process. Feel free to contact our office for a free consultation. 

Wills, Trusts, Probate, and Estate Litigation, It’s All We Do!

It’s What We Do!