In our summer issue of A Step Ahead, we discussed the differences between two pieces of legislation each of which would, if enacted, have far-reaching affects on retirement accounts: one that had passed in the House of Representatives, the “Setting Every Community Up for Retirement Enhancement Act,” also called the SECURE Act, and the other that was under consideration in the Senate, the “Retirement Enhancement Securities Act” (RESA). On December 20, 2019, the President signed the SECURE Act into law. This new scheme imposes major changes that will, for the most part, be detrimental to beneficiaries of individual retirement accounts (IRAs). It could also impact trusts established to act on behalf of beneficiaries who are immature, incapable or disabled.
There are some positive aspects of the SECURE Act. The age at which required minimum distributions must be taken has increased from the year in which the account holder turns 701/2 to the year in which the account holder turns 72. Also, accounts holders are no longer precluded from making contributions to their traditional IRA after reaching a certain age as the SECURE act repeals the age cap for contributions to traditional IRAs. Finally, withdrawals from an IRA prior to age 591/2 formerly incurred a 10% penalty tax while, under the new legislation, an aggregate of $5,000.00 can be withdrawn from a retirement plan without incurring a penalty if the withdrawal is taken within one year of the birth or adoption of the account holder’s child.
These benefits do not mitigate the detrimental affect which the accelerated distributions from an inherited IRA mandated by the SECURE Act impose. The former rules allowed beneficiaries to extend their withdrawals over their life expectancy. Under the SECURE Act, there are now two types of beneficiaries: eligible designated beneficiaries (EDBs) and designated beneficiaries (DBs). There are four categories of EDBs: a surviving spouse who rolls the account of their deceased spouse into their own account, a disabled beneficiary, a minor beneficiary until the age of majority and a spouse who does not roll the account into their own and who is less than 10 years younger than their deceased spouse. Everyone else is a DB.
The rules for the EDBs are virtually the same as under the prior law – distributions are taken based upon the remaining life expectancy of the EDB. The sole exception relates to a minor child. DBs and minors who have reached the age of majority must exhaust the account within ten years. This can be accomplished by taking a 100% distribution on the first or last day, or in equal or unequal yearly distributions that result in the full depletion of the account by the end of the tenth year.
The impact on DBs will be profound. As we discussed in the earlier article, under the old rules, the life expectancy of a 40 year old beneficiary was 43.6 years. If the account was worth $500,000.00, the minimum distribution in the first year would be approximately 2% or $2,147.00. As the life expectancy of the beneficiary decreases each year, the required minimum distribution increases. Assuming annual growth of 5% in the remaining account assets, it would have taken approximately 26 years, the year the beneficiary reaches the age of 66, before the required minimum distribution equals the 5% growth. By that age, despite the beneficiary’s having taken minimum distributions for 26 years, totaling $615,147.73, the account would still have grown to $818,905.40. Under the SECURE Act, the same beneficiary will be required to withdraw and deplete the account within 10 years over which time she will have withdrawn a total of $660,339.36 and the retirement account will be totally depleted.
The accelerated withdrawal schedule is not the only problem, however. Distributions from a tax deferred retirement account are taxed as ordinary income. As a result, not only will the total distributions be significantly reduced, they will be subject to local, state and federal income taxes which could reduce the amount retained from the accounts by as much as 50%.
There may be options available to you to minimize the impact of the SECURE Act. At Berwitz & DiTata LLP, we’re are available to review your situation and identify and discuss the options that will help you limit the affects of the SECURE Act for a nominal fee. We urge you to contact us at your earliest convenience to take advantage of our review.