The New SECURE Act’s 10-Year IRA Stretch

by Prof. Robert Bloink and Prof. William H. Byrnes

Whether clients like it or not, the SECURE Act has fundamentally changed the way we now need to think about leaving retirement account assets to heirs. The generous “life expectancy” rule has been replaced with a ten-year distribution rule that now requires almost all non-spouse beneficiaries to empty inherited accounts within ten years of the original account owner’s death. As a result, every client with an IRA or 401(k) now needs to evaluate their original plan to see if it still works for them. Importantly, retirement account beneficiaries will no longer have the powerful tax saving motivation to keep the funds invested in the account—heightening concerns that a financially irresponsible beneficiary might spend the funds much more quickly than the client intends absent proper planning.

The Ten-Year Rule Specifics

If the beneficiary of the retirement account is not an eligible designated beneficiary, the entire account must be emptied within ten years. Additionally, for clients who established a conduit trust to receive the account, the ten-year rule still applies if the trust beneficiary is not an eligible designated beneficiary. Eligible designated beneficiaries include spouses, disabled and chronically ill beneficiaries, minor children of the account owner and beneficiaries who are less than ten years younger than the owner.

While there is no requirement that the beneficiary take a distribution every year (i.e., the beneficiary can still defer taxes for ten years and take a lump sum at the end of that period), the tax consequences can still be serious. Note that it remains unclear whether the balance must be distributed by the tenth anniversary of the account owner’s death or December 31 of the year that contains the tenth anniversary.

Not only will beneficiaries of large accounts incur substantial tax liability within a relatively short timeframe, but they also will not have any motivation to keep the funds in the account. Realistically, this means that beneficiaries are much more likely to burn through the IRA balance within a short period of time—rather than keeping those funds invested, as the original account owner might have wished.

Planning Implications for the 10-Year Rule

Converting portions of a large IRA balance to a Roth account incrementally over time might help some clients minimize the tax hit that beneficiaries would face during the ten-year window. However, as the outcome of this year’s election remains uncertain and the reduced income tax rates are set to expire after 2025, clients should begin converting a tax-smart portion of the IRA beginning with 2020 if the conversion strategy otherwise makes sense.

Clients who are more concerned with their beneficiaries’ spending the account balance irresponsibly—or who have concerns about creditor protection or divorce—may wish to provide that the account will empty into a trust, with the funds held in that trust for the intended beneficiaries.

The tax deferral value of the stretch IRA will be limited to ten years, but the trust could provide a vehicle to keep the assets intact for responsible future investment and distribution. However, the tax hit would then be compressed into a single year—meaning that clients interested in this strategy will have to choose between losing the ten years of tax deferral by transferring smaller pieces of the IRA to the trust over time or taking a tax hit in the final year.

Clients who want to plan for that tax hit can look to an irrevocable life insurance trust (ILIT) option. The ILIT would hold a life insurance policy on the client’s life and receive the proceeds upon death. Those proceeds could then be used to pay the tax liability generated by depleting the IRA after ten years of tax-deferred growth.

Clients also must be advised of the difference between conduit trusts—which pay out distributions to the beneficiary right away—and accumulation trusts, which will hold the assets. Under prior law, accumulation trusts were undesirable beneficiaries because of the short distribution period requirement. Post-SECURE Act, they might be much more valuable for making sure the client has more control over the beneficiary’s access to the funds.

Other clients may simply wish to modify their estate plans so that their retirement assets will be inherited by an eligible designated beneficiary who can continue to stretch the tax deferral benefits of the account over their own life expectancy.

Conclusion

As more guidance on the SECURE Act is released, planning considerations may continue to evolve. It is especially important to remember that, given the fact that the SECURE Act is only a few weeks old, and much remains to interpret, flexibility may be key for clients. Appointing a trust protector with the ability to change trust terms as we learn more can provide clients with peace of mind that their beneficiaries will be protected.