The SECURE ACT was passed at the very end of 2019 and is the most significant change on the interaction of taxes and retirement planning since the 1986 Tax Reform Act. The SECURE ACT affects both individual retirement plans such as IRA's and employee sponsored plans. This Article will focus only on the effects on individual retirement plans.
Changes to the Required Minimum Distribution Rules ("RMD")
An IRA (Not a Roth IRA) has what is called a required minimum distribution rule in that when the owner reaches a certain age, then under the tax law they are required to take out a minimum distribution from their IRA. PRIOR to the SECURE ACT, when an individual turned 70 ½ they had to start taking the required minimum distribution from their IRA. If this distribution amount was not taken, then the individual faced a significant tax penalty. UNDER the SECURE ACT, the required age for the RMD is now 72 instead of 70 ½.
This is important because it allows the individual to maintain for a longer time period his money in a tax deferred investment.
Age Limit Removed on Contributions
PRIOR to the SECURE ACT, an individual count not make a contribution to a Traditional IRA if they were passed the age of 70 ½. The SECURE ACT did away with this age restriction and starting in 2020, an individual can contribute to a Traditional IRA regardless of their age.
Inheriting an IRA
Perhaps the biggest change in the SECURE ACT has to do with the significant changes to what is permissible when an individual inherits an IRA. To determine what options are available upon inheriting an IRA, we first have to determine whether a spouse or non-spouse inherits.
Spouse Inherits an IRA
PRIOR to the SECURE ACT, a spouse who inherits an IRA was able to roll over the IRA into their own IRA and treat the IRA as their own in regards to the RMD. The SECURE ACT did NOT change this, and a surviving spouse still has the option to roll over the inherited IRA.
Non-Spouse Inherits an IRA
PRIOR to the SECURE ACT, a non-spouse who inherits an IRA could roll over the IRA and then take the RMD out over their life expectancy. For example, Tom who is age 40 inherited an IRA worth $100,000 from his mother and he rolls-over the IRA. Tom is required to take the RMD each year. Under the Uniform Life Expectancy Tables Tom would use a factor of 43.6 years. This would result in a required minimum distribution of $2,294.00 ($100,000/43.6). Tom would then have to report this income on his tax return and pay the appropriate tax.
UNDER the SECURE ACT, a non-spouse who inherits an IRA is (except for a few exceptions discussed below) NOT permitted to roll over the IRA and must take the distributions from the IRA out within 10 years. Under the 10 year rule all amounts must be distributed by December 31st of the year containing the 10th anniversary of the date of death and in the interim no distributions are required.
Exceptions To Non-Spouse
Under the SECURE ACT there are several exceptions to this 10-year rule if a non-spouse inherits an IRA.
- If a minor child inherits an IRA, then the ten years does not start until the child reaches the age of 18. If a child is 8 when they inherit an IRA, upon the child turning the age of 18 the 10 years starts and they must distribute out the IRA by the age of 28. This exception for minor children only applies to children of the IRA owner and not to grandchildren.
- If a beneficiary is ‘disabled' under Section 72(m)(7) or is ‘chronically ill' under Section 7702(B)(c)(2), then the 10-year rule does not apply. The life expectancy payout will apply to these two categories of beneficiaries. However upon the passing of these beneficiaries, then the 10-year rule will apply.
- If a beneficiary is less than 10 years younger then IRA owner, then the life expectancy tables will apply when they inherit the IRA.
The SECURE ACT significantly impacts the intersection of estate planning and IRAs. Your average individual has the majority of their wealth tied up in IRAs and it is important to have the proper legal and tax guidance with these assets as it relates to Estate Planning.
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