How the SECURE Act Changed Estate and Long Term Care Planning – Part 2
In last week’s post I reviewed the stretch provision of the tax laws that apply to retirement accounts such as IRAs and 401ks. These laws allowed tax deferred accounts to remain tax deferred for a longer period of time by allowing certain beneficiaries to “stretch out” the time within which they must withdraw funds and pay tax on the growth in these accounts.
As I stated last week, as long as a beneficiary was a designated beneficiary (ie.an individual) the stretch provisions could be utilized. The SECURE Act which became law on January 1, 2020 changed all that. Stretch provisions were severely limited to a small group of individual beneficiaries. For all other formerly designated beneficiaries, a 10 year rule now applies.
The 10 year rule says that for most designated beneficiaries distributions from an inherited retirement account must be made no later than the end of the calendar year which is 10 years after the death of the account owner. Failure to empty the account by that deadline carries a pretty stiff penalty – 50% of the amount that was supposed to be distributed but wasn’t. There is no minimum withdrawal requirement each year. You must simply “zero” out the account by the 10 year deadline.
The SECURE Act also has introduced us to a new term in the language of tax deferred retirement accounts – “eligible designated beneficiary”. EDBs are the individual beneficiaries who may still utilize the old stretch provisions. Now only a surviving spouse, minor child, disabled individual, chronically ill individual and a person who is less than 10 years younger than the account owner qualifies as an EDB and thus is eligible to stretch the IRA out over his or her life expectancy. Minor children, however, are only temporarily considered EDBs. Once they reach the age of majority they are subject to the 10 year rule.
This rule change is significant in that it will severely limit the ability of many families to pass on their retirement accounts and further defer the taxes to be paid on the growth in these accounts. I should also point out that this rule change also applies to Roth IRAs, although the withdrawals from these accounts won’t cause income tax liability to the beneficiaries.
While the elimination of “stretch” provisions certainly is not a positive development, for many of our clients who are concerned about long term care asset protection, the change does make some decisions a bit easier. I’ll explain that next week.