The SECURE Act (i.e. the “Setting Every Community Up for Retirement Enhancement Act”) was passed by Congress and signed into law by the President as part of an end-of-year appropriations bill. It is a significant piece of legislation that will likely impact millions in people who have an estate plan and those who are rapidly approaching retirement age.
Stretch IRA Put Out to Pasture
One of the most consequential, and controversial, provisions within the SECURE Act is the demise of the “stretch” IRA. Congress killed the stretch strategy by mandating payouts of many types of Individual Retirement Accounts in about 10 years after the owner of the account passes away. It is expected this new provision will raise close to $16 Billion for the Treasury (which means it is a defacto tax increase for people who have a stretch IRA).
Overview of the New 10-Year Rule for IRAs
If the beneficiary of an IRA is an individual, then the balance within the IRA will need to be paid out by the tenth anniversary of the account owner’s passing. This is a huge change that will impact many people with estate plans. For years, taxpayers relied on the assumption that the valuable income tax deferral and tax free growth inside IRAs would dissuade an otherwise imprudent beneficiary from burning through the balance of the IRA. Instead, payouts could be “stretched” for years into the future. That strategy is no longer allowed.
Given the horror stories and statistics on how fast many heirs burn through an inheritance, IRA or otherwise, that assumption that a valuable tax benefit would dissuade an heir from taking more than the minimum payment required to be made out of an inherited IRA may not have been reliable in many cases. Perhaps that is the reason that has given rise to so many taxpayers with larger balances relying instead on naming trusts as beneficiaries of their IRAs, rather than the intended heir directly.
New 10-Year Rule Creates Risk of Beneficiary Imprudence and Heightened Exposure to Creditors
The requirement that an IRA balance be paid out in approximately 10 years from the plan holder’s death carries many potential risks and adverse ramifications. For example, this new provision could result in a beneficiary receiving a large lump sum payment thereby creating the risk that the funds in the account could be spent irresponsibly and contrary to what the plan holder wanted, according to a great article published on Forbes.com. A large, lump sum payout could also expose the account funds to being accessed by creditors or by an ex-spouse of a beneficiary.
Other Significant Provisions of the SECURE Act
- The SECURE Act will make it easier for small business owners to set up “safe harbor” retirement plans that are less expensive and easier to administer.
- Many part-time workers will be eligible to participate in an employer retirement plan under the bill.
- The Act will also push back the age at which retirement plan participants need to take required minimum distributions (RMDs), from 70½ to 72.
- The legislation has now passed both houses of Congress and is awaiting President Trump’s signature.