Take-Away: As we begin to digest the new SECURE Act and its various provisions, some of its new rules become clearer. What follows is digging a bit deeper into those new rules.

IRA Contributions Beyond age 70 ½: Beginning in 2020 there is no prohibition on the amount an individual can contribute to an IRA, if he or she has earned income. This will allow an individual over the age 70 ½ to contribute to a traditional IRA if they are still working or their spouse is still working. An individual over age 70 ½ can contribute to a Roth IRA, but there are income limits for eligibility to contribute to a Roth IRA. For those who earn too much to contribute to a Roth IRA, they can make an after-tax contribution to a traditional IRA and then convert that IRA to a Roth IRA- the 2017 Tax Act authorizes backdoor Roth conversions. Accordingly, those over age 70 ½ can still contribute to an IRA if they have earned income.

Required Beginning Date for Required Minimum Distributions Now Age 72: The Act increases the required beginning date (RBD) from age 70 ½ to age 72. This is effective for distributions that are required to be taken after December 31, 2019 with respect to individuals who attain age 70 ½ after that date. Therefore, someone who is born in the first half of the year will have two additional years before having to begin to take distributions. Individuals who reached or will reach age 70 ½ by December 31, 2019 will remain subject to the old required minimum distribution (RMD) rules. This change will benefit some IRA owners who make a Roth conversion up to the top of a particular income tax bracket each year. They will have an additional year or two before they have to take distributions, during which time they may be in a lower income tax bracket than if they had to take distributions. [You will recall that if an employee is still working after attaining age 70 ½ and they own less than 5% of their employer-plan sponsor, and then they do not have to take an RMD until they cease to work.]

Stretch IRA Distribution Rule Eliminated: The SECURE Act generally requires designated beneficiaries to take complete distribution of benefits by the tenth (10th) calendar year that follows the employee or IRA owner’s death. For eases of reference, I will simply refer to inherited IRAs, but note that these rules also apply to a deceased qualified plan participant.

  • Effective Date: This change that eliminates the basic stretch IRA rule is effective for persons who die after December 31, 2019.
  • 10-Year Payout: Unlike the old RMD rules, under the SECURE Act, no distributions will not have to be taken from the inherited IRA until the 10th year after the owner’s death. Therefore, the income generated by the inherited IRA can be deferred up to the tenth year, but all of that accumulated income will then be reported, and taxed, in that tenth year, probably at a much higher marginal income tax bracket.
  • Continued Stretch IRAs: Exceptions exist to this 10-year payout rule for designated beneficiaries who are the IRA owner’s spouse, minor children (not grandchildren or other minors), a disabled or chronically ill person, or a person who is not more than 10 years young than the IRA owner. These special beneficiaries are called eligible designated beneficiaries. An eligible designated beneficiary may take distributions from the inherited IRA over his or her life expectancy. Upon the death of an eligible designated beneficiary, the remaining balance of their inherited IRA must be distributed within 10 years after their death. When a minor child ceases to be an eligible designated beneficiary, e.g. upon attaining the age of majority, any remaining balance of the inherited IRA must be distributed within 10 years from when the minor attained the age of majority. [One article mentions (but no others) that age of majority is actually age 26 if the child is still in school. Therefore, I am not sure what applies- age 18 or age 26 before the 10-year payout rule comes into play.]
  • Special Needs Trusts: Trusts established for a disabled or chronically ill eligible designated beneficiary will qualify for the exception to the mandatory 10-year payout rule. However, in that case, no other person can be a current beneficiary of that trust, until after the death of the disabled or chronically ill trust beneficiary. As such, a special or supplemental needs trust for a eligible designated beneficiary will continue to qualify for the stretch IRA rules.
  • *Grandfathering- I Was Wrong!: Clarifying a mistake made in yesterday’s summary of the SECURE Act, [and I have read a couple of articles that contradict this] it appears that because the effective date for these new rules is for deaths after December 31, 2019, any existing inherited IRAs will remain under the old stretch IRA rule. As such, the stretch IRA rule can continue to be used by the beneficiaries of existing inherited IRAs. This change was a departure from the House version of the Act passed last spring, which suggested that there would be no grandfathering of the stretch IRA rules for existing inherited IRAs. While this is good news, i.e. there is grandfathering of the existing stretch IRA rule, it no doubt will cause confusion for some individuals who will have to contend with two different sets of distribution rules applied to inherited IRAs that a beneficiary might own. Example: Dad dies in 2019- stretch rules will apply to child’s inherited IRA from Dad; Mom dies in 2020, the 10-year payout rule applies to the inherited IRA that child inherits from Mom.
  • See-Through Trusts Affected: A conduit see-through trust will probably no longer work with the elimination of the stretch IRA rule. That is because there will no longer be annual RMDs. The only RMD will be at the end of the 10-year ‘holding’ period, which will cause a 100% RMD in that year. At that time, all of the inherited IRA assets will be released to the trust beneficiaries, thus losing any protection afforded by the trust either from the beneficiary’s spendthrift tendencies or from the beneficiary’s creditors. An accumulation see-through trust will still work under these new ‘RMD rules, but that type of trust will be heavily taxed due to the very high income tax rates imposed on irrevocable trusts that accumulate income. If a conduit see-through trust currently exists, it may be possible to have that trust modified or reformed under the Michigan Trust Code to an accumulation see-through trust, as the initial conduit version of the trust was created in reliance on an income tax treatment that no longer exists, which is one of the statutory bases to either reform or modify the terms of the existing trust.
  • Charitable Remainder Trusts: As has been previously reported (admittedly, on many occasions by me) a charitable remainder trust (CRT) could be a workaround to the elimination of the stretch IRA rule. A CRT is required to distribute a percentage of the trust’s assets to one or more individual beneficiaries either for life or for a term of up to 20 years, with the remainder to the charity, like a donor advised fund. The percentage must be at least 5%. The payment can be fixed based on the value of the CRT at the inception (a CRAT) or the annual payments may vary based on the value of the trust corpus each year (a CRUT.) Since a CRT is tax exempt, it can take a lump sum distribution from the inherited IRA without any adverse tax consequences. Distributions from the CRT to the beneficiary will be taxable as ordinary income, just as the distributions from the inherited IRA would usually be ordinary income to the IRA beneficiary.
  • However, there are trade-offs when the see-through trust is replaced with a CRT. First, the CRT is less flexible than an accumulation trust, since the CRT must pay either an annuity amount or the unitrust amount to the currents beneficiary each year. That payment may not vary from year to year (except based on changes in the value of a CRUT’s assets.) In addition, with a limited exception for special needs beneficiaries, the payments to the current individual beneficiary must be outright, exposing those distributions to the beneficiary’s creditor claims. Lastly, there is an economic cost to the CRT in that the value of the charitable remainder interest of the CRT must be at least 10% of the value of the CRT at its inception. If a CRT is considered as a surrogate for the loss of a conduit see-through trust, factors to consider include: (i) the size of the IRA to be inherited; (ii) the risk of exposure to the beneficiary’s creditors; (iii) the risk of the beneficiary’s divorce; (iv) the likelihood that the beneficiary will apply for Medicaid benefits; (v) the likelihood the beneficiary will have a taxable estate; and (vi) the likelihood the beneficiary will need distributions beyond the annual unitrust or annuity amount.
  • Renewed Roth IRAs and 401(k) Focus: If distributions from an inherited IRA will be taxable at higher income tax rates than before, a Roth IRA conversion of a traditional IRA, or a contribution to a Roth 401(k) account may make more sense going forward if the concern is that the beneficiary’s income tax bracket will be at the highest level upon inheriting the traditional IRA or 401(k) account.
  • Grandchildren: IRAs that are payable to grandchildren in order to exploit the stretch IRA rule will need to be revisited, as they will not be eligible designated beneficiaries.
  • Qualified Charitable Distributions: The initial distributions from an IRA, up to $100,000 a year, can be directed to charities, thus satisfying the IRA owner’s RMD obligation for the year. Those charitable distributions are not reported as taxable income by the IRA owner. With the change in the RBD from age 70 ½ to age 72, there is a window where IRA distributions can qualify as a QCDs, yet the IRA owner is not at an age when he/she must take RMDs. Restated, the QCD rules continue to use age 70 ½ as the age when a QCD can be made, even though the new age for RMDs starts at age 72.

Other Small Changes: The SECURE Act also provides a handful of much smaller changes pertaining to contributions and distributions from IRAs and qualified plan accounts.

  • Birth or Adoption Expenses: If distributions are taken from an IRA for birth or adoption expenses, up to $5,000, that distribution will be exempt from the 10% penalty for early distributions prior to age 59 ½. The distribution must be within one year of the date of the child’s birth or legal adoption. The amount withdrawn can also be repaid at a future date, i.e. re-contributed back into any retirement account. Note, however, that the distribution will still be taxable; it is just the 10% penalty that is avoided.
  • Stipend: Taxable non-tuition fellowship and stipend payments will be treated as compensation, in order to permit the recipient to contribute to a traditional IRA or a Roth IRA.
  • Annuities: An employer-sponsor is provided a safe harbor if it offers an annuity as a plan investment option. Any problems or issues that the plan participant has with the annuity investment option must be taken up with the annuity company, not the plan sponsor. The plan sponsor is only required to perform due diligence in the selection of the annuity provider, and the employer is not required to select the lowest cost annuity contract.
  • Kiddie Tax: The 2017 Tax Act changed the rules for the taxation of a child’s non-earned income, exposing that income to the income tax rates of an irrevocable trust, which were exceptionally high. The SECURE Act repealed that change. We are back to the pre-2018 rules, where a child’s passive income will be taxed at the child’s parent’s highest marginal income tax bracket.
  • Qualified Plans: As mentioned yesterday, there are a series of new provisions designed to encourage small employers to adopt qualified plans for their employees. A larger tax credit is available to small businesses to induce them to adopt a qualified plan. A new tax credit is available to small businesses to adopt an auto-enrollment provision for new plan participants. In addition, there is an increase in the default 401(k) contribution for auto-enrolled plan participants.
  • 529 Accounts: As reported yesterday, up to $10,000 a year can be harvested from a 529 account to pay for home-schooling expenses. $10,000 can also be paid from a 529 account to repay a school loan. In addition, a 529 account can be accessed to pay for apprenticeship programs, as the concept of higher education expenses continues to expand to enable access to tax-free distributions from 529 accounts.

Conclusion: In light of the SECURE Act, some types of IRA trusts, including see-through trusts, do not make much sense with the new 10-year payout distribution rule. A 10-year stretch is still better than nothing, especially for inherited Roth IRAs and Roth 401(k) accounts. The primary frustration with the SECURE Act is that many individuals converted traditional IRAs to Roth IRAs in the belief that, per the existing income tax rules, they would be providing tax-free income to the Roth beneficiary for that beneficiary’s lifetime. That promise that caused those individuals to pay ‘early’ the income taxes on that Roth conversion in exchange for that lifetime tax-free income to their Roth beneficiary, was reneged by Congress. Congress simply cannot keep its word when it comes to retirement account distribution rules. That, in the end, is the danger of all estate planning; we plan to circumvent tax rules that are ever changing.