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Chapter 7- The Secure Act: The IRS is Coming for Your Retirement Accounts

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Do you remember where you were when you heard the news that President Trump signed the Secure Act into law on December 20, 2019?  As the nation’s estate planning attorneys were busy finalizing their Christmas tree decorations and gift wrapping the latest edition of the Probate Code for their lucky children, they were handed a Holiday shock that none had anticipated.  This was the most radical shake up in the taxation of retirement accounts for over 30 years.  The new law took effect on January 1, 2020.  As dawn broke on New Year’s Day, estate planning attorneys felt confident that the passage of the Secure Act would be the most seismic event to impact the country in 2020.  While that prediction proved somewhat wide of the mark, the Secure Act nevertheless has important implications for the taxation of your retirement accounts.

What was the biggest change brought in by the Secure Act?  The so-called “stretch IRA” was essentially eliminated.  Before the new laws came into effect, you could leave your retirement accounts to your spouse or children and they could choose to leave money in those accounts, growing tax free, for their entire lifetimes.  They could even pass the accounts on to their children (your grandchildren).  As long as your spouse or children or whoever inherited your accounts withdrew fairly nominal sums each year (“required minimum distributions”), the retirement accounts would continue to grow tax free.

The new law reflects a policy change at government level: the tax benefits available to retirement accounts are designed to assist people in their retirement; they are not supposed to be used as a way to create a legacy through successive generations of the account holder’s family.  So the new law is that, with a few exceptions (notably, spouses), most people who inherit a retirement account will have to withdraw all funds in the account within 10 years of the account holder’s death.  So a 35 year old son who inherits his mother’s retirement accounts will have to empty the accounts within 10 years.  Previously, he could potentially have benefited from around 50 years (his life expectancy) of tax free growth.

This is problematic in a number of circumstances.  For those who had been relying on their retirement accounts to provide for future generations, their plans need to be re-examined.  The amount of tax free growth that was being planned for is now no longer going to be available.  Equally, if children inherit retirement accounts in their 30s, 40s or 50s, because the accounts must be emptied within 10 years, they are going to be paying income tax on retirement account distributions at much higher rates than would previously have been the case where withdrawals could be stretched across their lifetime.  For example, a 45 year old on a salary of $150,000 inherits a $1 million IRA.  If he withdraws $100,000 per year to ensure that the account is emptied within 10 years, that is going to trip him into a much higher income tax bracket than would have occurred under the previous regime.

What can be done?  Sometimes buying life insurance is a good way to cover the increased tax bill that will be faced by your beneficiaries.  There are circumstances where converting your retirement accounts into ROTH accounts may be sensible.  That would mean that you would pay the tax now at the time of the ROTH conversion, leaving your children to draw down on the accounts tax free after they inherit them from you.  If you have a trust that is structured as a conduit trust with respect to your retirement accounts, it may be that that should be amended and re-drafted as an accumulation trust.  For those who are charitably inclined, establishing a charitable remainder trust is a way to re-direct to charity the additional amount that would otherwise now be payable to the IRS. 

There are options.  But what’s good for the goose isn’t necessarily good for the gander.  Everyone’s circumstances and objectives are different. Your attorney, CPA and financial advisor, working together, will be able to help you evaluate which options are right for you.

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