Congress passed the SECURE Act (Setting Every Community Up for Retirement Enhancement Act) at the end of 2019. The SECURE Act made a number of changes to the process of saving for retirement using IRAs. For instance, the Act raised the age at which one has to take required minimum distributions (RMD) from 70½ to 72 for individuals born on or after July 1, 1949. Additionally, it removed the maximum age for making contributions to a traditional IRA so that individuals over the age of 70½ may continue to make IRA contributions if they have earned income. The Act also had important implications for estate planning in that it removed the option for a “stretch IRA”. A recent article from the Mercury News highlighted this. I’ve linked to the article below.
What is a Stretch IRA?
Prior to the passage of the SECURE Act, when a person (we will use the term “heir” for the purpose of this article) inherited an IRA, the government required heir to begin taking RMDs. These RMDs were calculated based on the heir’s age. Thus, the distributions could be spread out over the heir’s life. As the article notes, a two-year-old who inherited an IRA could spread the distributions out until the heir was eighty years old, and thus, “stretching” the IRA. There were several benefits to this. First, with a traditional IRA, the heir is required to pay taxes on the RMDs. The longer the stretch, the longer these taxes are deferred. A Roth IRA allows funds invested in IRA to grow tax free as long as the funds remain in the Roth. The RMDs from a Roth IRA are tax free. However, once out of the Roth IRA, any further growth of the funds becomes taxable. Therefore, ability to stretch the distribution of the IRA over a long period of time was beneficial.
How Were Stretch IRAs Used in Estate Planning?
Under prior law, an IRA that was distributed to the estate of the deceased owner had to be fully distributed within five years. Likewise, unless carefully drafted, an IRA distributed to a trust would have to be distributed over five years. Thus, generally estate planners advised clients to leave their IRAs directly to the beneficiary instead of to their estate or a trust. Sometimes, however, leaving the IRA to a beneficiary is not practical such as when the beneficiary is a minor or is otherwise someone who might not be able to responsibly handle the entire IRA at once. Enter the “conduit trust”. A conduit trust allowed the inherited IRA to be held by the trust but did not require the distribution of the entire IRA within ten years. The IRA could still be stretched over the lifetime of the trust beneficiary. The law required that the RMDs would pass through the trust directly to the beneficiary as opposed to accumulating in the trust.
Effect of SECURE Act on Stretch IRAs
With certain exceptions, the SECURE Act eliminates the option to stretch IRAs over the life of the heir. Now all IRAs, whether inherited by an individual or distributed through a trust, must be distributed by the end of the tenth calendar year following the IRA owner’s death with the following exceptions: if the heir is the spouse of the owner, if the heir is less than 10 years younger than the owners, or if the heir is a disabled person as defined by the Act. The distribution need not be yearly like an RMD, but nevertheless it must be distributed much sooner than under the stretch provisions. Thus, it appears the utility of the conduit trust is largely eliminated. Individuals with estate plans that include conduit trusts, may want to revisit these with their lawyer to determine if such a trust will continue to be useful or if it should be modified.
The financial world is still absorbing the implications of the SECURE Act and the IRS has not created any regulations implementing the Act as of this time. So, as time goes on individuals may find further adjustments that should be made to their retirement and estate plans as a result of the SECURE Act. This highlights the importance of a regular review of your plans with your financial advisors and your attorney.