Considering the Stretch IRA Rules After the SECURE Act.

As a financial and estate planning technique, the “stretch” IRA allowed the beneficiary of an inherited IRA to take distributions from the IRA over her remaining life expectancy, extending the life and income tax advantages (tax-deferred or tax free growth) of the IRA. For a very young beneficiary, this could have been a virtual lifetime. That all changed with the recent passage of the SECURE (“Setting Every Community Up for Retirement Enhancement”) Act.

The SECURE Act severely curtailed the viability of the “stretch” technique for distributions from inherited IRAs, both traditional and Roth. Under the Act, most non-spouse beneficiaries will have to withdraw all of the funds from an inherited IRA within 10 years of the death of the original account owner. The new rules apply to traditional or Roth IRAs inherited after December 31, 2019.

Beginning January 1, 2020, only an “eligible designated beneficiary” may continue to use the stretch technique for distributions from an inherited IRA. Under the SECURE Act, those beneficiaries eligible to use the stretch technique are: i) surviving spouses; ii) minor children of the account owner – until age of majority (but not grandchildren); iii) disabled individuals; iv) individuals who are chronically ill; and v) beneficiaries not more than 10 years younger than the deceased account owner.

If an individual does not qualify as an eligible designated beneficiary under one of those 5 categories, she must use a new 10 year rule – the entire account balance must be withdrawn by December 31 of the 10th year following the year of the account owner’s death. Note too, that a minor child of a deceased account owner may use the old life-expectancy distributions rules until she reaches the age of majority, and then must switch to the 10 year rule thereafter.

Of course, if an IRA owner died before January 1, 2020, the old stretch IRA distribution rules still apply.

Caveat: While this post focuses on the SECURE Act’s impact on distributions from traditional and Roth IRAs, the new rules affect distributions from all inherited qualified retirement plan accounts, including SEP IRA, SIMPLE IRA, 401(k), and 403(b) accounts.

The SECURE Act adds a thick layer of complexity to an already confusing area of tax law. As with any tax law change, one should review their financial and estate plans to better understand how the SECURE Act may affect those plans.

Do you need help understanding the impact the SECURE Act has on your current planning, or need help determining how best to adapt your financial or estate plan to the new law? Give me a call, I can help.

The SECURE Act Becomes Law – How Will it Affect Your Financial and Estate Planning?

The SECURE Act, which passed the US House of Representatives last summer (2019), had been flying well below most people’s radar as it seemed to lose steam in the Senate, despite bipartisan support. However, quite surprisingly and with little fanfare, it was passed into law just before Christmas, and took effect January 1, 2020.

In brief, the SECURE Act changes the age when one must begin taking distributions from qualified retirement accounts, changes provisions regarding contributions to IRAs and penalty-free withdraws from retirement accounts, as well as beneficiary distribution rules for inherited retirement accounts.

For those individuals who are currently working and saving for retirement, the SECURE Act removes the age limit for contributions to traditional IRAs. Under the old rules, a taxpayer could not contribute to a traditional IRA after reaching age 70½, regardless of whether he was employed. The SECURE Act removed that age limit. Now, you may contribute to an IRA regardless of your age, as long as you are working and have earned income. This change will help boost retirement savings for older taxpayers.

In addition, the SECURE Act raises the age at which one must begin taking distributions from retirement accounts. As of January 1, 2020, the age at which require minimum distributions must begin is 72. So, if you reach age 70½ in 2020, you can relax. You may wait until April 1 following the year in which you turn 72 to begin taking distributions from your retirement accounts. If you reached age in 70½ in 2019, the rules have not changed. You must still take your initial RMD before April 1, 2020, if you did not take it before the end of 2019.

The SECURE Act also eliminates the 10% penalty for early withdrawals from a retirement account in situations involving the birth or adoption of a child. In such cases, up to $5,000 may be withdrawn from a retirement account, penalty free, within a year of a birth or adoption of a child. The withdrawn funds may be re-contributed to the account at a later date.

Likely the most significant changes brought by the SECURE Act involve distributions from retirement accounts after the death of the account owner. Under pre-2020 law, an important planning strategy for retirement accounts was to name a spouse, child, or others as account beneficiary to allow for post-death distributions to be extended, or “stretched,” over the beneficiary’s remaining life expectancy. This had the affect of prolonging the tax deferral of investment gains in a retirement account and reducing the amount a beneficiary was required to withdraw each year.

Under the SECURE Act, the “stretch” is eliminated for most non-spouse beneficiaries. For those affected beneficiaries, all funds in a retirement account will have to be distributed within 10 years of the year of the account owner’s death. This will have the effect of increasing the amount of each year’s distribution from a retirement account and the taxes to be paid on those distributions.

Surviving spouses are excluded under the Act, and still have the option of stretching distributions over their remaining life expectancy. Minor children are also exempt from the new rules until they reach the age of majority. Finally, certain disabled and chronically ill beneficiaries and beneficiaries who are not more than 10 years younger than the account owner are also exempt.

The SECURE Act does not apply to retirement accounts owned by individuals who died before January 1, 2020. The old stretch rules will continue to apply.

Whenever significant law changes occur, it’s important to understand the real or potential impact it may have on your financial and estate planning. You should always work with a qualified, knowledgeable and trusted advisor.

If you have questions regarding the SECURE Act’s possible impact on your planning, give me a call. I can help.

How Will the SECURE Act Affect Your Retirement Savings?

Having passed the US House of Representatives and now moving quickly through the US Senate, the SECURE (Setting Every Community Up for Retirement Enhancement) Act appears to be on its way to soon becoming law. The SECURE Act will make numerous changes to how money is contributed to, and withdrawn from retirement accounts. While many of the Act’s provisions are administrative in nature, that is, they deal with the way retirement plans are administered, several provisions will directly affect retirement savings and withdrawals. Here are some of the more important ways the SECURE Act could affect your retirement savings:

First, the Act pushes back the time when retirement savers must begin taking distributions from their IRAs and other retirement accounts. Under current law, a person is required to begin taking retirement account distributions at age 70½, whether or not he or she wants to. The SECURE Act will push the age when required distributions must begin to age 72. This means that retirement savings may continue to grow untouched and untaxed for another year and a half before distributions must begin.

Next, the SECURE Act eliminates the age restrictions on IRA contributions. Americans are living and working longer. However, under current law a person may not contribute to an IRA after age 70½, even if still working. Under the SECURE Act, a person may continue to contribute to an IRA after age of 70½ if still working.

Finally, the SECURE Act changes the required minimum distribution rules with respect to IRA and other retirement account balances upon the death of the account owner. Under the Act, distributions to individuals other than the surviving spouse of the account owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the account owner, or child of the account owner who has not reached the age of majority, are generally required to be distributed by the end of the tenth calendar year following the year of the account owner’s death.

Under current law, a non-spouse beneficiary of an IRA or defined contribution-type retirement account [such as a 401(k) or 403(b) account] may elect to “stretch” distributions from an inherited retirement account over his or her remaining life expectancy. For younger beneficiaries, this means that the remaining account balance has a longer time to grow tax deferred before being withdrawn, and the amounts withdrawn may be taxed at lower rates. The SECURE Act will accelerate distributions from inherited retirement accounts, reducing the time horizon for tax deferred growth and increasing the taxes that must be paid on the larger withdrawals.

This change will have an impact on beneficiary designations and estate plans, especially those situations in which a trust is named as a beneficiary of a retirement account.

Insofar as the SECURE Act will affect retirement saving and distributions in these and other ways, readers should plan to meet with a qualified legal or financial professional to determine the best way forward under the Act should it become law.

If you don’t have an attorney or financial planner, but would like to work with one, please give me a call. I can help.

UTMA Account Seized in Bankruptcy – What Can We Learn?

Uniform Transfers to Minors Act (UTMA) accounts are a popular tool for gifting assets to minors. They can easily be set up without the services of an attorney or accountant. A contribution to an UTMA account is considered a completed gift for tax purposes, but the minor beneficiary is prohibited from accessing the funds in the account until their 18th (or even 21st) birthday.

The account is managed and controlled by a custodian, who can be the minor beneficiary’s parent, guardian, or some other responsible adult. Once an UTMA account is created, any funds or other property transferred to the account cannot be returned to the person making the gift. When the minor reaches age 18 or 21, depending upon the state in which the account was created, he is entitled to access the funds in the account.

However, UTMA accounts are not without their drawbacks. Like other planning tools, unforseen circumstances can arise that defeat the good intentions of the gift maker.

One such example is illustrated in a recent bankruptcy case out of Rhode Island, In re Marcus Soori-Arachi. In 1998, when Marcus was 15, his father purchased an UTMA annuity for him with Fidelity in Nebraska. Under Nebraska law, the UTMA annuity should have terminated when Marcus turned 19 and the proceeds distributed to him. However, Marcus’s 19th birthday came and went and the account went undisturbed for another 10 years.

In 2017 Marcus, then married and living in Rhode Island, filed a petition for bankruptcy under Chapter 7 of the bankruptcy code. As required by bankruptcy law, the trustee appointed to administer Marcus’s case began the process of gathering and liquidating all of Marcus’s non-exempt assets.

The case trustee notified Fidelity that the UTMA annuity (now worth $105,000) should be turned over to the trustee. Marcus objected in the bankruptcy court, arguing that the UTMA annuity was not part of his bankruptcy estate and could not be liquidated by the trustee. (Marcus did claim a basic exemption protecting about $6,500 from the trustee.)

The bankruptcy court disagreed, finding that the UTMA annuity belonged to Marcus when he turned 19. The court ruled that it did not matter that the annuity was still in the account as of the date Marcus filed bankruptcy. Under Nebraska’s UTMA law, the custodial nature of the account terminated on his 19th birthday. Marcus gained an immediate right of ownership, possession, and control of the annuity, regardless of whether he actually exercised that right. The UTMA annuity could not be sheltered from his creditors in bankruptcy.

While this case interpreted Nebraska law, a bankruptcy court interpreting Michigan law would reach the same conclusion. While Michigan law protects the proceeds of an annuity from the claims of the creditors of a beneficiary, it does not protect the annuity proceeds from the claims of the creditors of the annuity owner, which Marcus became at age 19.

The facts of this case are unusual in that the annuity remained untouched in the UTMA for so long after Marcus reached age 19. When Marcus turned 19, he more than likely didn’t have any debts. But as time went on, he acquired a debt burden that grew to the point that he had to seek bankruptcy court protection, losing about $99,000 in the process.

Still, the case serves as an important reminder for those of you planning your estates. How well do you really know your children or other beneficiaries? Do they have excessive debt? Have they filed bankruptcy in the past? Are they being sued, or is a lawsuit threatened? What about a divorce – is a child’s marriage on the rocks? Knowing the answers to questions like these can help you structure or revise your estate plan, including beneficiary designations, to protect an inheritance from being lost to a beneficiary’s creditors.

The bankruptcy court’s opinion can be accessed here.

Middle Aged Man Dies Leaving Substantial IRA With No Beneficiary – What Happens Next?

A client, “Susan,” contacted me recently to help settle the affairs of her recently deceased son, “Frank.” Frank owned a traditional IRA that has a fairly substantial balance. Unfortunately, Frank did not list a beneficiary for the account. Shelly is Frank’s only living heir. Frank was 57 when he died in 2018. What are Susan’s options with regard to Frank’s IRA?

Because Frank’s IRA had no identifiable beneficiary, by default the IRA is payable to his estate. And since Frank died before age 70½, a special 5-year rule applies to the distribution of his IRA. In general, the entire balance of Frank’s IRA must be distributed by December 31 of the year containing the fifth anniversary of Frank’s death. In this case, the entire balance of Frank’s IRA must be distributed by December 31, 2023.

An estate does not have a life expectancy, so distributions cannot be “stretched” beyond the 5 years. However, the entire account balance does not have to be taken in one distribution, it can be broken up over multiple years to reduce the taxes payable as long as the entire account balance is distributed before the end of the fifth year following the year of the account owner’s death.

(Now, had Frank died after April 1 following the year he attained the age of 70½, Susan would have been able to stretch distributions from Frank’s IRA to the estate over his remaining life expectancy, avoiding the special 5-year distribution rule.)

If the entire account balance is not withdrawn by the end of the fifth year following Frank’s death, then the IRS could impose a penalty equal to 50% of the balance remaining. The penalty could be waived by the IRS if it finds there was a reasonable basis for the error.

Failing to designate a beneficiary of an IRA (or other retirement account for that matter) is one of the costliest mistakes you can make. Two problems are created: First, because distributions cannot be “stretched” beyond 5 years, there is little tax-deferred growth that can be achieved in such a short period of time. Second, since distributions from the account must be accelerated, the larger distributions create larger income tax bills.

It always pays to double check beneficiary designations on your retirement accounts (and life insurance, too). I recommend at least annually. Make sure you have beneficiaries named on all of your accounts, and to make sure those beneficiary designations are up to date. Has a beneficiary died, or is there some other reason to replace a beneficiary? If so, update your beneficiary designations immediately.

Do you have an issue concerning distributions from a retirement account, or planning for distributions from a retirement account? If so, call me, I can help.