New IRA Distribution Rule

January 20, 2020

As we rang in 2020,  the Setting Every Community Up for Retirement Enhancement Act of 2019, also known as the SECURE Act went into effect, enacting a number of major changes to IRA and 401(k) retirement plans.

From an estate planning perspective, perhaps the most significant change under the SECURE Act is the mandate requiring plan benefits to be distributed to non-spouse beneficiaries (and a few others) in 10 years following the plan participant’s death (10-year payout), rather than over the life expectancy of such beneficiary (life expectancy payout).

Consider the following situation:

John, age 50, unmarried, has a niece, Mary, age 24, who is married. John wants to name Mary as the beneficiary of his $600,000 IRA with the expectation that upon his death, the IRA will make annual “required minimum distributions” (RMDs) to Mary to stretch out the IRA benefits over her life expectancy. Based on a life expectancy of 60 years, the initial distribution would be $10,000, with distributions in subsequent years recalculated, but in similar amounts.

Under the SECURE Act, the IRA will no longer have the option of making RMDs to Mary of (using the foregoing example) $10,000 per year, based on Mary’s life expectancy. Instead, under the 10- year payout rule, the IRA would need to make annual distributions ranging from zero to the entire $600,000. If John were to die on June 30, 2020, the entire $600,000 would have to be distributed by December 31, 2030, when Mary would be age 34.

In effect, the legislation mandates a completely different estate plan for John’s IRA. The SECURE Act might be regarded as insecure from an estate planning perspective, although it will secure for the Treasury, over the next decade, billions of dollars of additional tax revenue.

To maintain John’s estate plan for his IRA, John might create a trust, which he would name as the IRA beneficiary. The trust would buy life insurance on John’s life, the proceeds of which the trust could use to make distributions to Mary (for example, in years when the IRA distribution was zero), and to pay the income tax in, for example, year 10, if the entire $600,000 was then distributed. As well, the trust would provide creditor protection and “separate-assets” treatment, should Mary later get divorced. The trust would contain distributions provisions in accordance with John’s wishes.

Got questions? Schedule a Consultation with an experienced Aprio advisor today.