How Does the SECURE Act Affect My Estate Plan and My Child with Special Needs?

For most families with a loved one with disabilities, much of the assets which will be used for the loved one’s long-term needs are found in pre-tax accounts, such as IRAs.

SECURE Act Means Drastic Changes to Retirement Account Inheritance Rules
Congress recently passed, and the President signed into law, the “SECURE Act” (Setting Every Community Up for Retirement Act of 2019), which drastically changes how inherited retirement accounts are treated.

If you are using a pre-tax retirement account to pass assets on to your heirs, the Act drastically limits their ability to “stretch” withdrawals out over many years.  Stretching – taking only a small amount of funds every year then paying taxes only on the amount of those withdrawals – allows the account to grow larger over time. It results in tax savings and financial growth for your loved one, at the expense of the U.S. Treasury (this is why Congress wanted to change it).

What does this elimination of the “stretch” mean in practical terms?  Most significantly, it means that most beneficiaries of a retirement account will have to withdraw all the money in the account within ten years following the death of the account owner.  This creates a real financial risk for your heirs because the longer they wait to withdraw the funds, the bigger the tax hit they will receive.

For example, if they wanted to delay dipping into the account, they could find themselves in a situation where they’re required to take out all of the funds in a single transaction. For an IRA valued at, say, $600,000, withdrawing that amount in a single move would push them into the top tax rate of 37% (for single filers in 2020), more than $200,000. What’s more, if they don’t take all of the money out of the IRA by Year 10, the IRS can levy penalties on top of taxes owed.

Beneficiaries with Disabilities Can Still Use the Stretch!
Fortunately, Congress and the President kept the status quo in the Act for heirs with disabilities: they are allowed to continue using “the stretch” and to continue making withdrawals beyond ten years.

The Act also allows the disabled beneficiary’s interest to be held in a trust, a common practice that allows a trustee to legally manage and protect the beneficiary’s interest, while also managing tax concerns.

Revisiting Estate Plans in Light of the SECURE Act is a Wise Option
In spite of the additional benefits afforded to disabled heirs, families are making changes to protect their beneficiaries with disabilities and others in light of the SECURE Act. Here are some potential options you may wish to discuss with your financial advisor:

  1. Purchasing life insurance to leave a tax-free benefit to your loved one, rather than in a pre-tax account. The life insurance is inherited tax-free and can also be used to fund required any necessary tax payments that arise due to distributions from a retirement account.
  2. Convert pre-tax accounts to a Roth IRA. By converting assets and paying taxes now, your beneficiaries will not be taxed later at potentially a higher rate.
  3. Charitable remainder trusts (CRTs). Naming CRTs as beneficiaries of retirement assets may be an appealing alternative to the “stretch.” Your retirement assets are distributed to the CRT, and the trust then makes annual distributions to your beneficiaries each year for the rest of their lives calculated on a fixed percentage of trust assets. Upon the death of the lifetime trust beneficiaries, the remainder goes to charity.

Need for a Legal Checkup
The bottom line: If your estate plan relies on a pre-tax retirement account and/or a trust to transfer assets to your heirs, you should consult an attorney soon.  Changes in the SECURE Act went into effect on December 31, 2019, which means your current estate planning documents for plans involving pre-tax accounts were written under the old law and are likely to be ineffective.

Posted in Blog, Estate Planning.