Year-End Tax Law Changes

Secure Act Changes to IRA/401(k) Distributions

For retirement plan benefits inherited after 2019, a new tax law called the “SECURE ACT” makes major changes to rules concerning post-death payments from qualified retirement accounts like IRAs and 401(k) plans. In the past, IRA stretch payouts were the “go to” plan that enabled tax-deferred payments to go to beneficiaries over their life expectancies. This payout strategy worked well, especially when children or grandchildren were named as beneficiaries.

Beginning in 2020, this stretch pay-out strategy is limited to “eligible designated beneficiaries.” These include: (1) surviving spouse of the participant; (2) minor child of the participant; (3) disabled beneficiary; (4) chronically ill beneficiary or (5) an individual who is not more than ten years younger than the participant.

For purposes of determining who is eligible:

  • A chronically ill person is generally someone who could receive benefits under a long-term care policy.
  • A disabled beneficiary is unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment, which can be expected to result in death or to be of long-continued or indefinite duration and for which the individual can furnish proof such as IRS Schedule R (Credit for Elderly or Disabled) or physician’s certification.
  • A minor child receives a life expectancy pay-out until they reach the age of majority and then the ten-year rule applies, which is more fully explained below.

For those inheriting an account after 2019, who do not qualify as an eligible designated beneficiary, the life expectancy payout is replaced by a maximum ten-year post-death payout. As a practical matter, adult children and grandchildren will no longer be able to receive stretch payouts over their life expectancies. Siblings may be able to if they are less than ten years younger than the participant.

Consider what this means. Let’s say Mom is a widow and plans to leave her IRA to her fifty-year-old son, who has a life expectancy of 34.2 years. Under the prior rules, the son could receive secure financial benefits until he was beyond 80 years old. Now, he must withdraw the entire account within ten years of Mom’s death.

Under the prior rules, the length of the stretch payout sometimes depended on whether the participant had begun receiving benefits. Now it no longer matters. For those who are not “eligible designated beneficiaries,” the ten-year payout cap applies. Again, these rules apply with respect to participants who pass away after 2019. The prior law applies if the participant died prior to 2020.

Under the Secure Act, there are no required minimum distributions during the ten-year period, so you can take it all out on the last day of the tenth year. However, there will be a large tax bill at the end, so timing and payment of distributions must be part of a beneficiary’s income tax planning.

For those whose estate plans have left these benefits in trust, it is essential to review your plan. Life expectancy pay-outs were a good way to protect against a child’s imprudence but may no longer work, even if the IRA benefits are left to a child or grandchild in trust. Charitable remainder trusts holding IRAs will still work but make sure the terms of any these trusts accommodate the payout you intend, now that the ten-year cap may apply to certain beneficiaries.

The ten-year cap also applies to beneficiaries of Roth IRAs. While alive, a participant can take Roth IRA distributions as he or she wishes. However, non-qualified designated beneficiaries must take a full distribution within the ten-year period. Another change of the new law is that required minimum distributions must begin the year the participant turns age 72, not 70 ½.

All estate plans should be reviewed in the wake of the Secure Act, especially those which were planned around life pay-outs for children or grandchildren. People not affected by the new law are those who don’t own retirement benefits or who leave them solely to charity.

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