With the arrival of each new year comes a set of new laws. This article will discuss two new laws for 2020: one that brings significant changes to retirement accounts and the other that makes a minor change to the federal estate tax exemption. Here’s an overview of these alterations and what they may mean for your estate plan.
What is the SECURE Act?
On Dec. 20, 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act, which is commonly referred to as the SECURE Act. The enactment of this law was somewhat surprising. Earlier in 2019, the House of Representatives passed this legislation overwhelmingly by a 417–3 margin, one of the few bills receiving bipartisan support. However, after passage in the House, the legislation stalled in the Senate, and it appeared there was little chance it would pass in 2019. When the bill was added as a rider to the appropriations bill to keep the government open, the legislation passed handily and became law to the surprise of most individuals.
The SECURE Act makes some significant changes to our current retirement laws, especially in connection with withdrawals required by designated beneficiaries of retirement accounts, effective Jan. 1, 2020. This has caused at least one commentator to suggest that the only thing enhanced by the SECURE Act is the tax revenue collected by the IRS.
What has not changed?
Some rules did not change in the SECURE Act. The first rule that did not change pertains to retirement accounts held by married couples: the spousal rollover. In other words, if you are married with a retirement account naming your spouse as the sole beneficiary, your spouse may elect a spousal rollover just like under the prior law. The spousal rollover allows the spouse to stretch out withdrawals from the rollover retirement account over the spouse’s remaining lifetime as set forth in the IRS lifetime expectancy tables. In most instances, this will limit a huge tax hit in any given year.
Secondly, in addition to the surviving spouse, other beneficiaries are allowed to withdraw minimum distributions. Those beneficiaries include disabled individuals, chronically ill individuals, someone who is not more than 10 years younger than the IRA owner (for example, a brother who is two years younger than the IRA owner), and minor children (but not grandchildren). In the case of a minor child, the stretch rules would apply until your child attains the age of majority under state law, or as long as age 26 if the child remains in school per federal law. Once the minor child
reaches either of these applicable ages, the new 10-year rule described below becomes applicable.
Finally, the SECURE Act does not apply to retirement account owners who died prior to Jan. 1, 2020. This means that beneficiaries who have already established stretch IRAs pursuant to the prior law can continue to stretch out withdrawals from that retirement account over the remainder of the beneficiary’s lifetime. In fact, a nonspouse beneficiary can still establish a stretch IRA pursuant to the prior law if the retirement account owner died on or before Dec. 31, 2019. For example, if the retirement account owner died on Dec. 30, 2019, and the nonspouse beneficiary has not yet established a stretch IRA, that nonspouse beneficiary may establish a stretch IRA account after Jan. 1, 2020.
What has changed?
The SECURE Act has made a number of significant changes that will apply to our clients and the beneficiaries designated by our clients’ retirement accounts.
- Under prior law, a retirement account owner had to begin withdrawing required minimum distributions (RMDs) from their retirement account when the retirement owner reached age 70 1/2. These annual RMD withdrawals would be based upon the life expectancy of the retirement account owner in accordance with the tables established by the IRS. The new SECURE Act postpones the beginning date for withdrawing required minimum distributions until the retirement account owner turns 72. However, if you are already withdrawing your RMDs and have not reached age 72, you must continue to withdraw those RMDs under the prior law. In other words, you cannot stop and begin again at age 72.In addition, pursuant to the new law, you may continue to contribute to a retirement account until you reach age 72. Those contributions may be wholly or partially deductible on the income tax return of the contributor if the contributor meets certain income requirements.
- The most sweeping change is the elimination of the stretch IRA benefits for nonspouse beneficiaries. The prior law allowed a nonspouse beneficiary to take minimum distributions over the beneficiary’s lifetime to limit the income tax impact. This not only deferred the income tax consequences but also allowed the nonspouse beneficiary to receive a greater amount of funds over decades since the continued growth in the stretch IRA was tax deferred until withdrawn. It also meant that you could postpone much of the income tax impact to an age where you would
likely be in a lower income tax bracket. For example, if you are a child in your early 50s when your parent dies, you are likely in your peak earning years and would want to postpone as much additional income as possible until you retire.The stretch IRA was a great planning tool to pass wealth to the next generation and limit the income tax impact of that transfer on the designated beneficiaries. In fact, based upon the old law, upon death, the beneficiary could pass the remaining wealth in the stretch IRA to a new designated beneficiary, further postponing the income tax impact. The new rule set forth in the SECURE Act does away with the stretch IRA for nonspouse beneficiaries and replaces it with a simple 10-year rule. There are no minimum required distributions during the 10-year period. Instead, the nonspouse beneficiary must withdraw all of the funds held in the retirement account by the end of the 10th year after the death of the person who established the account. The nonspouse beneficiary could leave all of the funds in the retirement account until the end of the 10th year, which might make sense for a nonspouse beneficiary of a Roth IRA. After all, the funds in the Roth IRA continue to grow tax-free as long as it remains in the Roth IRA. However, all the withdrawals from a traditional IRA, of course, are taxed at the beneficiary’s income tax rate. If the retirement account is significant, it will likely push the nonspouse beneficiary into an even higher income tax bracket. To minimize this income tax hit, the nonspouse beneficiary will likely want to strategize when to make withdrawals after taking into consideration his or her own personal income each year.The unfortunate result of the SECURE Act is that it penalizes savers. People sacrificed current access to their funds over the years by placing that money in a tax deferred account for their retirement with the comfort of knowing that it could grow tax deferred and, if the savings were not exhausted, it could benefit their loved ones upon death. Instead, with the SECURE Act, you may want to enjoy your money during your lifetime. Otherwise, taxes will take a much larger portion when you die than under the prior law. We call that revenue enhancement
Federal Estate Tax Exemption for 2020
The other change for the beginning of 2020 is the increase in the federal estate tax exemption. As you know, a few years ago, the federal estate tax exemption doubled to a base of $11,000,000, subject to annual increase based upon inflation. The exemption is the amount which a decedent may transfer to someone other than a spouse or a recognized charity without paying federal estate tax. For individuals who died in 2019, the federal estate tax exemption was $11,400,000. For individuals who pass away in 2020, the federal estate tax exemption is $11,580,000. Married couples in 2020 may transfer a combined amount of $23,160,000 to children with careful planning. Please remember that the current law will expire on Dec. 31, 2025.