On March 29, the House Ways and Means Committee unveiled H.R. 1994, or the SECURE (Setting Every Community Up for Retirement Enhancement) Act. This is a bipartisan bill, co-sponsored by Rep. Ron Kind (D-WI), ranking member Kevin Brady (R-TX) and Mike Kelly (R-PA). On April 1, the Senate, in a similar move, introduced a companion bipartisan bill, RESA (Retirement Enhancement and Savings Act). The House passed the proposal on Thursday, May 23, 2019.
The proposal had bipartisan support when it moved out of committee in April, and President Donald Trump issued an executive order in 2018 to assess expanding workers’ access to multi-employer plans (MEPs) and examine changes to required minimum distributions (RMDs). The SECURE Act also has the support of trade and advocacy organizations like the Securities Industry and Financial Markets Association (SIFMA), the Financial Services Institute (FSI) and the Investment Adviser Association (IAA).
The proposed laws cover many retirement issues, but the most far-reaching is a modification of the ‘Stretch’ IRA rules. Both proposals accelerate IRA distributions and accordingly, taxes on inherited IRAs for non-spouse beneficiaries.
A proposed change contained in the House bill is to increase the RMD age to 72. The Senate bill does not adopt this change.
The current rules allow a spouse to rollover their deceased spouse’s IRA and declare it their own as a “spousal IRA.” This rule remains unchanged in the proposed legislation.
If a person other than a spouse is named as a beneficiary (a usual occurrence), that beneficiary can generally take their IRA distributions over their life expectancy under IRS Table 1. The House version, the SECURE Act, reduces the stretch period to 10 years. The Senate version requires the account balance to be distributed by the end of the 5th calendar year following the year of the account owner’s death but then excepts the first $400,000 (subject to an inflation adjustment) of aggregated IRAs (valued as of the date of death) received by a beneficiary from the new rule, permitting distribution of the $400,000 amount over life expectancy. Both versions allow exceptions for distributions to a surviving spouse, minor children (the 5 year distribution period begins upon attainment of majority), disabled (as defined in Internal Revenue Code §72(m)(7)) or chronically-ill (as defined in Internal Revenue Code §7702(b)(2)) beneficiaries, or beneficiaries not more than 10 years younger than the deceased IRA owner. The $400,000 exception applies on a per beneficiary basis; thus, in the case of a distribution of an $800,000 account to two beneficiaries, each beneficiary will be entitled to a stretch IRA valued at $400,000. So, the more beneficiaries the better the outcome.
Both versions would apply to inherited IRAs for deaths after 12/31/2019.
The inherited IRA RMD rules apply to Roth IRAs so the five or 10-year payout will apply to inherited Roth IRAs as well as traditional IRAs (and qualified plan benefits).
Last-minute changes to the House retirement savings bill would result in the entire legislation costing roughly $389 million over the next decade, rather than raising revenue as under the initial proposal, according to a Joint Committee on Taxation (JCT) estimate released Wednesday.
The largest cost included in the manager’s amendment to H.R. 1994, the SECURE Act, is a repeal of changes under the 2017 federal tax overhaul that inadvertently imposed a tax on certain payments, including military survivor benefits for children. The Joint Committee on Taxation estimated that provision would cost just over $500 million over the next decade. The initial bill would have raised $9 million over 10 years, JCT found.
The amendment also removed a provision from the original bill that would have broadened college savings plans organized under Internal Revenue Code §529 to be able to pay for homeschooling, private tuition and other education expenses.
From a planning perspective, the most significant issue will be to address the effect on the new distribution rules on Conduit Trusts, trusts which mandate the immediate distribution of the annual RMDs from an IRA or Qualified Plan to a specific beneficiary. Generally, Conduit Trusts were established on the assumption that benefit distributions would be stretched-out over the lifetime of the specified beneficiary, often 30+ years. The new law would compress the distribution period to no more than 10 years (potentially forcing distributions of large amounts of money into the hands of relatively immature beneficiaries) and accelerate the inclusion of distributions in the income of beneficiaries, generally at much higher marginal rates.
Conduit Trust provisions should be reviewed and modified if possible and the distribution patterns re-studied and re-planned.
Currently, best practices suggest that if the new law is adopted, IRA or Qualified Plan distributions should be made annually over the 10 year distribution period in an effort to average the tax impact rather than by deferring distribution until the end of the 10th year following the owner’s death.
Alternative suggested planning techniques include (a) using multi-generational trusts as IRA beneficiaries, (b) using partial spousal disclaimers of IRA benefits (the balance would remain part of the spousal IRA) with the disclaimed portion distributed to beneficiaries other than the surviving spouse over the 10 year distribution period, (c) distributions to fund a Charitable Remainder Trust for the benefit of the spouse and beneficiaries, (d) direct distributions of IRA benefits to charities for those clients accustomed to making significant charitable gifts, (e) for those subject to federal estate tax, early periodic distributions used, net of income tax, to fund an Irrevocable Life Insurance Trust to provide funds with which to satisfy the owner’s tax obligation preserving other assets for the benefit of the surviving spouse or descendants. It is not clear at this time whether pre-death Roth IRA conversions will be more or less beneficial in as much as Roth IRAs must be distributed within the 10 year distribution period, thereby adding significant taxable values to the estates of the designated beneficiaries.
Jerrold L. Goldstein
Weston Hurd LLP