Beneficiary designations can be deceptively simple. But their simplicity is sort of like an iceberg. Danger lurks beneath those tranquil waters, both for the client and the attorney. Designations for IRAs and retirement plans can be particularly complicated, especially after the SECURE Act. This article focuses on the basics of the SECURE Act.
Clients spend lots of time, money, and energy planning their estates. Estate Planning attorneys help them by counseling these clients and preparing various documents to meet the goals of the client, such as a Will or Trust.
An increasing part of American wealth is governed by beneficiary designations. According to Statista, Americans had over $32 trillion in retirement assets alone. That’s trillion with a “t.”
This blog series focuses on beneficiary designations. This blog looks at the basics of the SECURE Act. The next blogs in the series will examine exceptions to the Act and how beneficiary designations done prior to the Act might not work as intended after the Act.
The SECURE Act passed in December 2019. First, the SECURE Act changes the age for lifetime Required Minimum Distributions (“RMDs”) from age 70½ to age 72. This change is generally good for savers since it delays the date at which distributions must be taken from retirement assets. This is helpful in two ways. First, it allows the assets to grow tax-deferred. Second, for that additional 18 months from 70½ to 72, the account holder won’t have the tax liability of the distributions.
Once the owner of the IRA (the “Participant”) reaches that age (their “Required Beginning Date”), generally they must take out distributions under the Uniform Table, which represents the joint life expectancy of someone their age and a fictitious spouse 10 years younger (whether or not they are married). If they have a real spouse who is more than 10 years younger, they’d use a joint life expectancy using the real spouse’s age. Here’s a link to the IRS life expectancy tables, including the Single Life, Joint Life, and Uniform Tables.
The biggest change of the SECURE Act concerns the rules for distributions by those whom the Participant names as the beneficiary to receive the assets after the Participant’s death. Prior to the Act, non-spousal beneficiaries could take distributions based on their own single-life expectancy. So, the younger the beneficiary, the longer the permitted distribution period.
Often, attorneys would advise clients to name the youngest beneficiary possible to get the maximum stretch. For example, if the client/Participant named their newborn grandchild, the distributions could be stretched over more than 82 years!
Generally, it’s better to defer retirement plan distributions as long as possible. Deferring distributions allows the assets to grow tax-deferred (or tax-free in the case of a “Roth” account).
Under the SECURE Act, non-spousal beneficiaries must withdraw all the assets by the end of the year which includes the 10th anniversary of the Participant’s death. Under prior law, the beneficiary could take distributions each year over the beneficiary’s life expectancy. So, this is a much more rapid distribution of the retirement benefits.
Let’s look at an example:
John dies leaving $1 million to his daughter, Beth, who is 25 years old. John dies in February 2021. The SECURE Act applies to the distributions to Beth since John died later than December 31, 2019. The 10th anniversary of John’s death occurs in February 2031. Beth doesn’t need to take any distributions for the first 10 years, but she needs to take everything by December 31, 2031.
As a practical matter, often the beneficiary won’t want to wait until the last possible date to take all the assets. If they waited until the final year, all of the income from the distributions would be taxed in that one year. Often, it’s better to spread the income over several years in order to obtain a lower marginal tax rate.
Beneficiary designations can be deceptively simple. Just beware of the rest of the iceberg. The next blogs in this series on beneficiary designations will examine the exceptions to the SECURE Act’s 10-year rule and how beneficiary designations which might have been ideal before the SECURE Act might now have unintended consequences.