New Rules for Retirement Plan Distributions
The Setting Every Community Up for Retirement (or SECURE) Act, which became effective on January 1, 2020, made two fundamental changes in the rules regarding the mandatory distribution of retirement plan assets.
The first change relates to the age at which you must begin taking “required minimum distributions” (RMDs). RMDs are the way in which the federal government forces you to withdraw funds from your retirement plan and, as a result, forces you to pay income tax. Under the prior rules, RMDs begin in the year in which you reach age 70½. Under the new rules, that age has been pushed out to 72 – or later if you continue to work past that age (and are not a 5% or more owner of the business sponsoring the retirement plan).
The first change is good news. It gives you a bit more time to delay paying income tax on your accumulated retirement assets, and even more time if you continue working. Once you start taking RMDs the rules remain the same – the RMD in any given year is based on your age and is calculated by reference to a table that is based on your life expectancy.
The second change is not good news. The SECURE Act eliminated your ability to pass retirement assets to a beneficiary while maintaining the ability to stretch out RMDs over that beneficiary’s lifetime. The old rules allowed a beneficiary (in most cases a child) to use his or her life expectancy to determine RMDs from an inherited retirement plan. This allowed the beneficiary to slow down the RMDs and thereby slow down the payment of income tax.
The new rule is that the beneficiary must withdraw all of the retirement plan assets within ten (10) years of your death. This greatly accelerates the RMDs and the associated tax. It also makes planning for the distribution of retirement assets more difficult where young beneficiaries are involved – because you may want to defer their receipt of the RMDs. [Note: this new rule does not apply to a surviving spouse. Generally, a surviving spouse may treat the inherited retirement plan as his or her own (subject to the same RMD rules as the owner).]
So, what can you do to mitigate the effects of this 10 year rule? There are a few strategies that could help offset the cost of accelerating the income tax on your retirement assets. One strategy would be to convert, during your life, some of these assets to a Roth IRA. Depending on the timing and amount involved, a Roth conversion can result in overall income tax savings to your family. Another strategy is to employ a charitable remainder trust. The trust would be set up to make distributions to your beneficiaries for a certain period of time – essentially stretching out the distributions and taxation, with the remainder flowing to charity. If used properly, a charitable remainder trust could help reduce the income tax burden imposed by this new rule.
Planning in this area is tricky. If your estate is composed of retirement assets you should revisit the way in which they are distributed in the event of your death under these new rules.