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On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act into law. The Act, which took effect January 1st, brings major changes to how traditional IRAs, tax-deferred 401(k)s and other retirement accounts operate. 

The change that requires immediate attention is the rule concerning inherited IRA’s.  Under the old rule, a non-spouse beneficiary had the option to take the inherited IRA in a series of payments stretched out over their lifetime, which provided significant tax benefits. That rule has been greatly curtailed. Under the new law, non-spouse beneficiaries who are more than 10 years younger than the deceased must take the inherited IRA within 10 years after the death of the original account owner. There is no requirement as to how much needs to be withdrawn in each of the 10 years, but the full amount must be withdrawn at the end of that 10-year period.

The major impact of this change is that beneficiaries may be required  to withdraw larger amounts in given years than under the old rule, and therefore, may be pushed into higher tax brackets, resulting in higher income tax payments. 

These changes apply to accounts inherited from any person who dies after January 1, 2020. It does not apply to accounts inherited from owners who died prior to this date.

While these changes are significant, there are several ways you can replicate the ability to spread distributions for beneficiaries over longer periods of time than 10 years, including: 

  1. Conversion to a Roth IRA. Under the new rule, withdrawals from a Roth IRA are still required to be paid out over a period of no more than 10 years; however, they will be tax-free.
  2. Life Insurance. Life insurance proceeds are generally free of income tax. If the policy is owned by a child or other beneficiary, or if it is owned by an irrevocable life insurance trust, the insurance proceeds can also be excluded from estate tax.
  3. Irrevocable Trusts. An irrevocable trust can be used to own a life insurance policy. The retirement account owner can fund premiums by taking IRA distributions and gifting them to the trust to pay the insurance premium.  When the account owner dies, the insurance is paid into the trust and can then be distributed to beneficiaries over as long a period of time as desired by the person creating the trust.
  4. Charitable Remainder Trusts. The proceeds of an IRA can be left to a charitable remainder trust. The trust pays out its income to one or more family members over his or her lifetime, or for a set number of years. At the end of that time, the remaining assets in the trust are paid out to the charity(ies). The family members pay income tax on the payments they receive, but the tax should be much less because the payment period can be longer. The original account owner’s estate can receive a charitable deduction at the time the trust is created.

There are other changes in the Act which make retirement accounts easier to use for retirees. Among these changes are:

  1. There is no longer a maximum age at which an individual can contribute to an IRA (the maximum used to be age 70-1/2).
  2. Account owners do not have to start Required Minimum Distributions until age 72, which is up from 70-1/2.
  3. Account owners can withdraw up to $5,000 to cover expenses related to a birth or adoption. Tax must be paid on the money withdrawn, but the 10 percent penalty for withdrawals before age 59-1/2 will not apply.

As this is a significant change in the law regarding how tax-deferred retirement accounts will be taxed after the death of the account owner, it is important to review the beneficiary designations of all of your retirement accounts in order to coordinate both your intended distribution schemes and the income tax consequences.  

Please contact Reger Rizzo & Darnall’s Estates & Trusts attorneys to discuss how these changes affect you, and what options are available to you for updating your estate plan. We would be happy to assist you in making the necessary changes to ensure that you and your family are properly cared for.