How Secure Are You Under the SECURE Act?

By Matthew D. Faulk - November 19, 2019

Earlier this year, nearly the entire House of Representatives passed the “Setting Every Community Up for Retirement Enhancement Act,” more commonly known the SECURE Act. One of the goals of the SECURE Act is to encourage and make it easier for more Americans to set aside personal savings, particularly through employer-established 401(k) accounts. These accounts are great because they allow growth on investments while deferring payment of otherwise required taxes for as long as possible. As lofty as this goal is, and though there are some positive provisions included in this bill (i.e., pushing back the age at which owners of retirement accounts must start taking required minimum distributions [RMDs] from 70.5 to 72), there is one provision in particular that will severely hamper your ability to leave such accounts to further generations in a tax-efficient manner.

Under current law (IRC Sec. 401[a][9]) non-spousal beneficiaries of individual retirement accounts and retirement plans are permitted to take out RMDs over their life expectancy.  Allowing distributions to take place over the beneficiary’s life, thereby deferring any taxes owed, permit the transferred wealth to “stretch,” accumulate, and appreciate.  However, the SECURE Act, as currently drafted, would require the total outright distribution of the plan’s assets within 10 years of the participant’s death. Certain non-spousal beneficiaries, such as minor children, those with disabilities, and those who are not more than 10 years older than the plan owner, are exempt from this 10-year rule. 

For example, let’s imagine a retired 71-year-old owner (“Owner”) of a traditional IRA.  Since Owner is older than 70.5, he is taking RMDs and has a life expectancy of 26.5 years, per IRS Life Expectancy Tables. However, when Owner passes away at 91 years of age, the value of his traditional IRA is $1 million.  The sole beneficiary is a 45-year-old surviving Daughter (“Daughter”), who enjoys a remaining life expectancy of 38.8 years.

Assuming a 5% annual rate of interest and that Daughter lives her full life expectancy, and notwithstanding the payout of RMDs during Owner’s life, the IRA, which had a date-of-death value of $1 million, would have provided nearly an additional $1.5 million to Daughter over her lifetime.  Under the SECURE Act, that IRA would be reduced to $0 after ten years from Owner’s death.  Notice the huge disparity in outcome under the current law and the SECURE Act?  The Senate has its own bill, known as the Retirement Enhancement and Savings Act (RESA), which would instead require a full distribution after FIVE years from the date of Owner’s death, rather than 10 years.  Such payouts, aside from a gross acceleration of tax payments, could also frustrate any potential asset protection designs Owner provided for Daughter in his estate plan, as it related to his retirement account.

Many commentators believe the “stretch IRA” concept is on its way out the door. If the SECURE Act, RESA, or some version of either bill ever become law, it will be of vital importance for participants in such tax deferral plans to coordinate accordingly with their estate attorney, financial advisors, and accountants.