February 14, 2020
The Secure Act (“the Act”) was passed by Congress and signed by President Trump at the end 2019. The Act delays and minimizes required distributions for those individuals who saved for retirement through tax-favored retirement accounts such as IRAs or 401(k) plans. If you had not reached age 70½ in 2019, the required commencement date for distributions is delayed by a year or two, depending on the month of your birthday, because it now depends on the year you turn 72. The Act also updated the mortality tables for the longer average life expectancies. These updated tables can be used beginning in 2021, and have the effect of reducing required distributions due to the longer life expectancy averages.
For distributions to beneficiaries after the death of an account owner (that occurs after 2019), the Act generally accelerates the required distributions to the beneficiaries of the account. For this reason, if you currently have a trust named as beneficiary of retirement accounts, the trust should be reviewed to determine whether the trust should be amended or the beneficiary changed.
The Act now eliminates the ability to stretch the minimum required distribution over the beneficiary’s life expectancy unless he or she is an “eligible designated beneficiary.” An eligible designated beneficiary is a surviving spouse, minor child of the decedent, a person who is disabled or chronically ill, or someone who is not more than ten years younger than the decedent. Eligible designated beneficiaries may use life expectancy tables to calculate required distributions.
All other individual beneficiaries, including a child of the decedent once he or she has reached age of majority, are required to fully distribute his or her share of the decedent’s retirement account within 10 years. However, if required distributions had already commenced to the account owner during lifetime, his or her hypothetical remaining life expectancy under the IRS Tables may still be used, which in some cases may be a little longer than 10 years.
In the event the decedent’s beneficiaries are not all individuals, determined on September 30 of the calendar year following death, the retirement account is required to be fully distributed within five years of the owner’s death.
Why does it matter? When an individual saves for retirement by contributing to a traditional retirement plan (for example, not a Roth), his or her earnings are set aside “before income tax,” thereby delaying ordinary income tax until the money is distributed. The recipient of a distribution from a retirement account includes the amount of the distribution in his or her taxable income. The receipt is taxed at ordinary income tax rates. Retirement savers bargain that the savings can be distributed from the retirement account and be taxed at a lower income tax rate than when the pretax earnings were originally contributed.
The retirement account owner can help minimize the income tax liability after death by carefully reducing the taxable balance in the traditional retirement accounts during lifetime. She or he can consider moving a portion each year of a traditional IRA to a Roth IRA during years that taxable income is in a lower bracket than expected for future years. Savings moved from a traditional IRA to a Roth IRA are included in the owner’s taxable income in the year of the conversion. However, unlike traditional IRAs, Roth IRAs do not have required distributions during the owner’s lifetime and accumulate income tax free. In addition, after attaining age 70½, a traditional IRA owner may reduce the account balance with a qualified charitable distribution, limited to $100,000 each year, rather than using other types of assets to satisfy pledges or gifts to charity. Qualified charitable distributions are not included in the owner’s taxable income.
Another strategy is to consider adding beneficiaries, like grandchildren, in order to spread the income tax liability after death among a greater number of beneficiaries with the goal of reducing the effective income tax rate. Consider allocating more of the account to beneficiaries you may expect to be in a lower income tax bracket.
If you have charitable intentions, consider naming a qualified charity as a beneficiary for some or all of your retirement account. The charity pays no income taxes on the distribution received. A charity should be cashed out by September 30 of the year following the owner’s death, so that a five year payout for other individual beneficiaries is not triggered.
On a final note, a charitable remainder trust is an option that allows distributions over a term of years (not to exceed 20) or over the life of an individual beneficiary, with the remainder to charity at the end of the initial term or upon death of the lifetime beneficiary. The charitable remainder trust (“CRT”), is the beneficiary of the retirement account and is tax exempt, so it does not pay income tax when it receives the initial account distribution. The initial individual beneficiary of the CRT receives an income distribution over a term of years or for life that is taxed at ordinary rates, at least until the date of death balance is distributed. There are qualifying rules, and beneficiaries generally need to be in their mid-thirties for some of these rules to be satisfied when a lifetime benefit is used. Certain individuals may find this technique attractive, although it is with its own complexities since there are various ways to and rules in structuring a CRT. A good trustee, likely a corporate fiduciary, is recommended for its administration.
Distribution strategies for retirement accounts can be complex for those individuals determined to minimize the income tax bites on those accounts. This article summarizes general changes in the law and possible strategies to respond to those changes, but should not be viewed as specific tax advice for your situation. If you would like to discuss this topic further and tailored to your specific situation, please let us know.
If you have questions about the information in this Legal Alert, please contact your Rothberg attorney to see if we can assist you.
Cindy A. Wolfer, Associate
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