New SECURE Act Will Impact Individual’s Retirement Accounts

In an overwhelming 417-3 vote, the US House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”), which has now been incorporated into a spending bill that was signed by President Trump on December 20, 2019.  While the SECURE Act includes numerous changes to certain qualified retirement plans, there is one notable change that will affect some potential beneficiaries of individual retirement accounts (“IRAs”).

Currently, when an individual reaches age 70 1/2, he or she must start taking a required minimum distribution (“RMD”) based upon his or her remaining life expectancy.  If such individual dies and leaves his or her IRA to an individual beneficiary (other than a spouse, a disabled or chronically ill person, an individual who is no more than 10 years younger than the decedent, or the minor child of the decedent), and that individual beneficiary then rolls the decedent’s IRA over to his or her own IRA (i.e. an “inherited IRA”), the RMD will be calculated on that individual beneficiary’s life expectancy resulting in a “stretch IRA.”  The stretch IRA allows for income tax-deferral and avoids a large income tax bill.

Effective January 1, 2020, under the SECURE Act, the age at which an individual must start taking RMDs is increased to age 72.  However, absent a few exceptions, while a non-spouse individual beneficiary would still be able to roll over the decedent’s IRA to his or her own inherited IRA, instead of calculating the RMD on that individual beneficiary’s life expectancy, the IRA must be distributed within 10 years of the decedent’s death.  This change could force non-spouse individual beneficiaries into higher tax brackets, resulting in higher income taxes on both such beneficiary’s ordinary income, as well as the distributions from such inherited IRA.

As an example, assume a 75 year old decedent left his or her IRA to his or her 40 year old child with a 43 year life expectancy and that the IRA is worth $1,000,000 at the time of his or her death.  Under the current law, the IRA would remain in pay-out status, but would be recalculated to be paid out over such child’s life expectancy.  Using the example, the child would receive approximately $23,256 in the first year from the inherited IRA and gradual increases over the next 42 years.  Under the SECURE Act, the child would not be required to receive any minimum distributions from the inherited IRA, but would be required to receive the entire $1,000,000 within 10 years.  Depending on the child’s income tax bracket and the investments within the IRA, the benefits that the child would have received under current law could have been considerable.

While the SECURE Act will not affect the treatment of spousal inheritance of IRAs, it is still important for all individuals to consider how these changes could impact their estate planning.  We recommend that individuals consult with their tax professionals.