How the SECURE Act Affects Your Estate Planning

 

On December 20, 2019, the Setting Every Community Up For Retirement Enhancement (SECURE) Act was signed into law. The law became effective on January 1, 2020 and created sweeping changes to the landscape of retirement and estate planning.

Pre-SECURE Act Rules for Beneficiaries

Before the SECURE Act death beneficiaries of retirement plans were generally lumped into three categories: (1) Non-Designated Beneficiary, (2) Designated Beneficiary, and (3) surviving spouse. Non-Designated Beneficiaries included a participant’s estate (default beneficiary in most circumstances where no beneficiary is named), a charity, or certain non-qualified trusts. These types of beneficiaries were required to withdraw the entire plan benefit within 5 years of the participant’s death. Designated Beneficiaries included all named beneficiaries except for the participant’s surviving spouse. These individuals were required to take required minimum distributions (RMDs) annually. The amount of the RMD was based on the beneficiary’s life expectancy as determined by the IRS. Surviving spouses were required to withdraw RMDs beginning at the latest of their lifetime, the year the participant would have reached age 70 ½, or the year after the participant’s death.

Post-SECURE Act Rules for Beneficiaries

  • The SECURE Act doesn’t change the definition of a Non-Designated Beneficiary but changes the distribution period from 5 years to 10.
  • Designated beneficiaries now must withdraw all plan benefits by the end of the 10 year after the participants death. These amounts can be taken in any year, and don’t have to be equal.
  • Eligible Designated Beneficiaries: The act created a new category of beneficiaries called “Eligible Designated Beneficiaries.” The categories of individuals listed below are considered Eligible Designated Beneficiaries and are still entitled to take a life expectancy payout of retirement benefits.
      1. Surviving spouse of participant
      2. Minor child of participant (upon reaching age 18, the 10-year rule kicks in)
      3. Disabled beneficiary (must meet IRS definition of disabled)
      4. Chronically ill individual (must meet IRS definition of chronically ill)
      5. A beneficiary who is 10 years or younger than the participant.

Key Rule Changes for Plan Participants

The SECURE Act made two key changes for plan participants. First, it pushed out the age participants are required to start withdrawing benefits from 70 ½ to 72 years old. Second, the act allows participants to continue to the plan indefinitely, whereas under the prior law participants could not contribute to their retirement past age 70 ½.

SECURE Act and 529 College Savings Plans

529 College Savings Plans are a great way to save for your child’s higher education tax. The plans don’t have to be set up by parents alone, they can be set up or funded by parents, grandparents, aunts/uncles, and even friends. Money invested in the plan accumulates tax-free and can be withdrawn for qualifying post-secondary expenses tax free. Before the SECURE act, qualifying post-secondary expenses included things like tuition, books, some room and board costs, and costs for things incidental to schooling such as computers and/or computer software.

The SECURE act has expanded the definition of qualifying expenses to include the repayment of student loans. However, this is currently capped at an aggregate lifetime limit of $10,000 per plan beneficiary. The new rules also allow for an additional $10,000 to be withdrawn by each sibling of the beneficiary to pay student loan debt.

Generally, distributions from plans are treated as un-taxed student income, which is reported on a student’s FAFSA application and can reduce financial aid benefits. With the new rules allowing deferring distributions until after graduation, some students may opt to not take a distribution from their 529 plan until January 1 of their sophomore year or after graduation when the distributions from the 529 plan will no longer affect their financial aid.

In addition, the SECURE Act expands the use of 529 plan funds to cover certain costs associated with elementary and secondary schools (those already covered by Coverdell Education Savings Accounts) including homeschooling expenses.

SECURE Act and Your Estate Plan

Overall, the SECURE act’s major effect on estate planning is the inability for children and grandchildren to take stretched-out distributions over their lifetime. If you have a substantial portion of your estate held in retirement accounts, and your estate plan centers on your beneficiaries being able to take distributions over a long-term payout scheme, you will want to consult with an estate planning attorney to discuss whether this strategy is still appropriate.

If a retirement plan is left to children, it is important to consider that those individuals will have to pay taxes a lot sooner than previously. In addition, because the distributions occur in a drastically shorter time period, the distributions could bump the children into a much higher income tax bracket, resulting in higher taxes. One way to reduce the burden of the additional tax bill would be to purchase life insurance to specifically cover the expected taxes owed.

By identifying the additional tax burden, the plan participant can take steps during their lifetime to avoid unintended consequences. If you have questions about how the SECURE Act affects your particular estate plan please call our office at (503) 206-6401, or click HERE to schedule your free consultation.

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