This May 2019, the SECURE Act was introduced and passed in the House in a matter of days. Then, we were waiting to see what the Senate would do with it. As it turns out, the SECURE Act was merged into Division O of H.R.1865 – Further Consolidated Appropriations Act, 2020 (the 2020 budget bill) which was making its way through the House and Senate starting in late October. Then on December 20, 2019, H.R. 1865, which carried the SECURE Act in it, was signed into law.

What the SECURE Act Changes

Prior to the SECURE Act, when you inherited an IRA and if you didn’t have an exception, you had to distribute the whole balance of the inherited IRA in 5 years. The SECURE Act extended this to 10 years.

Unfortunately, they also added that this 10-year distribution rule “shall apply whether or not distributions of the employee’s interests have begun.” Meaning, even if the decedent was older than 70 1/2, you lose the option of using their divisor and are instead required to distribute the entire balance over 10 years.

It clarifies that the option of utilizing the decedent’s divisor “shall apply only in the case of an eligible designated beneficiary.” Meaning designated beneficiaries still have this exception, although only when they were older than the decedent.

Prior to the SECURE Act, second generation beneficiaries inherited the first designated beneficiary’s divisor. This new proposal strikes this, stating, “If an eligible designated beneficiary dies before the portion of the employee’s interest to which this subparagraph applies is entirely distributed, the exception under clause (iii) shall not apply to any beneficiary of such eligible designated beneficiary and the remainder of such portion shall be distributed within 10 years after the death of such eligible designated beneficiary.” This means that second generation beneficiaries would need to distribute the whole IRA within 10 years.

The last update is the worst update.

The SECURE Act states that the “Exception to the 5-year rule for certain amounts payable over the life of the beneficiary” (which created the inherited divisor stretch provisions) “shall apply only in the case of an eligible designated beneficiary.” Then, they add a definition for the term “eligible designated beneficiary” as only someone who is:

1. the surviving spouse of the employee,
2. subject to clause (iii), a child of the employee who has not reached majority (within the meaning of subparagraph (F)),
3. disabled (within the meaning of section 72(m)(7)),
4. a chronically ill individual (within the meaning of section 7702B(c)(2), except that the requirements of subparagraph (A)(i) thereof shall only be treated as met if there is a certification that, as of such date, the period of inability described in such subparagraph with respect to the individual is an indefinite one which is reasonably expected to be lengthy in nature), or
5. an individual not described in any of the preceding subclauses who is not more than 10 years younger than the employee.

The child exception clause iii states:

Subject to subparagraph (F), an individual described in clause (ii)(II) shall cease to be an eligible designated beneficiary as of the date the individual reaches majority and any remainder of the portion of the individual’s interest to which subparagraph (H)(ii) applies shall be distributed within 10 years after such date.

This means that children are treated as eligible beneficiaries until they are adults, then they need to distribute within 10 years.

Luckily, spouses, in addition to stretch provision options, are still given their spousal rollover.

However, non-nuclear family or friends who are more than 10 years younger than the decedent and in good health are never eligible for stretch provisions. They must distribute the whole balance over 10 years.

Furthermore, children of the decedent are only granted stretch provisions until they are of majority age.

The SECURE Act clarifies, “The determination of whether a designated beneficiary is an eligible designated beneficiary shall be made as of the date of death of the employee.” Which I suppose means if you are disabled or chronically ill at the decedent’s demise but then you get better, you are able to retain your stretch.

This law will only affect people “who die after December 31, 2019.” For no good reason, they also give governmental employees an exception, so that it only applies to government employees who die after December 31, 2021.

What You Can Do In Response

1. Make your spouse your primary beneficiary.

These changes make the spousal rollover even more valuable. It is likely a mistake to not take advantage of it.

2. Leave part your Roth IRA to your minor grandchildren or great-grandchildren.

The stretch provisions remain for beneficiaries under 18 years old. If you want to leave assets to your child, you could consider leaving the assets to their children instead, your grandchildren.

3. Reconsider leaving your IRAs to a Trust.

Both a trust account and a non-eligible beneficiary have the same distribution requirements. For healthy beneficiaries, there is now no downside to having IRA assets held in trust, including a common pot trust or a trust with benefits for charities. If you were previously avoiding trusts because of their poor treatment of IRAs, you may now want to pursue creating a trust to better implement your wishes.

4. Make sure your special needs trust qualifies as a look-through trust.

Disabled beneficiaries receive stretch provisions but are also likely to use special needs trust. If your special needs trust qualifies as a look-through trust, your disabled heir will get the most benefit. Check with your trust documents or estate attorney to make sure the document is crafted just right.

5. Continue to make systematic Roth conversions.

Under these new rules, a large traditional IRA is very costly for heirs. If you have a $1 million IRA, the smallest amount they could distribute annually to distribute the whole thing over the 10 years is $100,000 each year for 10 years. Regardless of what their taxable income is before those distributions, their inherited IRA distributions alone will push them into higher tax brackets. In contrast, you can make smaller conversions over the course of your lifetime and with each one ease the tax burden of your heirs and enhance the value of your estate.

Keeping up with recent tax law changes and evaluating how those changes should affect your financial plan is one part of comprehensive wealth management. The SECURE Act featured several significant changes of which its changes to IRAs are some of the most significant.

Photo by Natalia Valverde on Unsplash