The SECURE (Setting Every Community Up for Retirement Enhancement) Act proposes a number of changes to IRA rules and other retirement rules.  The Act passed in the House of Representatives by a 417-3 vote and is expected to be passed in some form by the Senate. Some of the changes appear to be common sense, like broadening access to IRAs and 401(k)s, changing the required minimum distribution (RMD) age from 70½ to 72 and providing different investment options for these programs. However, with these changes come potential limitations with Stretch IRAs.

Forbes asks in its recent article “Are Concerns Over Stretch IRAs And The SECURE Act Justified?” An IRA shelters investments from tax which leaves investors with more money for the same investment performance because usually no tax is usually paid as it grows. Your distributions can also be tax-free if you use a Roth IRA. That’s a good thing if you have an option between paying taxes on your investment income and not paying taxes on it. The SECURE act isn’t changing this fundamental process, but the issue is when you still have an IRA balance at death.

A Stretch IRA can be a great estate planning tool. Here’s how it works: you give the IRA to a young beneficiary in your family. The tax shield of the IRA is then “stretched,” for what can be decades, based on the principle that an IRA is used over the life expectancy of the beneficiary. This is important because the longer the IRA lasts, the more investment gains and income can be protected from taxes which allows the investment to grow tremendously.

Even better, current estate planning techniques allow an investor to leave an IRA to a trust and still get “stretch” treatment.  For more information, see our website.  https://galligan-law.com/life-stages/planning-for-retirement/   Current Treasury Rules permit trusts to receive “stretch” treatment if the beneficiary of the trust is readily identifiable. This enables investors to leave their retirement assets to trusts for their individual beneficiaries and receive the investment advantage of the “stretch” as well as the benefit of the trust, such as tax planning and divorce or creditor protection for the beneficiaries.  One such trust is called a “conduit trust” where only RMD’s are paid out to the identifiable beneficiary based upon his or her life expectancy.

However, the SECURE Act could change that.  The proposed IRA rules and other retirement rules instead require funds to be distributed over a 10 year period instead of the beneficiary’s lifetime. That’s a big change for estate planning and the value of assets passed to the next generation.

There are some exceptions to the 10 year time period, including retirement left to a surviving spouse, minor children and some persons with disabilities or chronic illnesses.  However, aside from the spouse, these beneficiary groups are limited and will be most harmed by this change.  For example, a disabled beneficiary would likely not receive the retirement funds directly because receiving the retirement funds would affect their government benefits.  Instead, the retirement will pay to a special kind of trust, called a Supplemental Needs Trust, that will receive the retirement funds and accumulate them for the beneficiary’s use.  However, that form of a trust will presumably not qualify for the 10 year exception because remainder beneficiaries (those who survive the disabled beneficiary) will be brought into the analysis and likely won’t be minors or disabled beneficiaries to make the trust eligible for a 10 year exception.  For someone in that case, a 10 year payout will accelerate tax and greatly reduce the legacy left to the beneficiary with a disability, and he or she is the one who needs it most.

For a person who uses their own IRA in retirement and uses it up or passes it to their spouse as an inheritance—the  proposed IRA rules and retirement rules under the SECURE Act change almost nothing. For those looking to use their own IRA in retirement, IRAs are slightly improved due to the new ability to continue to contribute after age 70½ and other small improvements. Therefore, most typical IRA holders will be unaffected or benefit to some degree during their lifetimes.  However, for investors with large investment funds to pass to beneficiaries, the proposed IRA rules may greatly reduce the legacy left to their loved ones.

Reference: Forbes (July 16, 2019) “Are Concerns Over Stretch IRAs And The SECURE Act Justified?”