SECURE Act Targets Minimum Distribution Rules

On Dec. 20, 2019, President Donald Trump signed the Further Consolidated Appropriations Act into law. This new law authorizes $1.7 trillion of federal spending, some of which is to be paid for, apparently, from our clients' retirement accounts.

Most of the new law's provisions dealing with retirement plans (nicknamed "SECURE") aim to increase retirement plan contributions (by adding new sign-up methods for employer plans and removing the age cap on traditional IRA contributions) and to facilitate drawing retirement income from such plans (by allowing more annuity options in 401(k) plans). But from the individual's planning perspective, the major impact of SECURE is its changes to the minimum distribution rules of Internal Revenue Code section 401(a)(9).

The lifetime minimum distribution rules are pretty much left alone. The only change is a delay in the starting point for required minimum distributions. For any individual born after June 30, 1949, the required beginning date is April 1 of the year after the year in which such individual reaches age 72 (or, in the case of certain plans, if he or she is still working, after the year in which he or she retires if later). Previously, the trigger age was 70½.

As a result of this change, no IRA owner will have a required beginning date in 2021.

Examples: John was born June 30, 1949. He reached age 70½ on Dec. 30, 2019. Because he turned 70½ before 2020, he is still governed by the old rule. The required beginning date for his IRA is still April 1, 2020.

Meanwhile, Jane was born a day after John, on July 1, 1949. She will reach age 70½ a day later, too, on Jan. 1, 2020--so she is governed by the new rule. Her required beginning date will not be until April 1, 2022, the year after the year (2021) in which she turns age 72.

SECURE's substantial changes to the post-death minimum distribution rules are more complicated and less benign.

Pre-SECURE, we had two classes of beneficiaries, each with its own set of minimum distribution rules: designated beneficiaries and other beneficiaries (let's call them nondesignated beneficiaries). A designated beneficiary was an individual designated as beneficiary, or a trust (so designated) that qualified as a "see-through trust" under the IRS' minimum distribution trust rules. To oversimplify a bit, the respective payout rules were: For a designated beneficiary, the minimum payout schedule was annual distributions over the life expectancy of the designated beneficiary (or the oldest trust beneficiary in case of a trust). For nondesignated beneficiaries (namely, the participant's estate or a trust that did not qualify as a "see-through"), the required payout period was five years after the participant's death (in case of death prior to the required beginning date), otherwise the remaining life expectancy of the deceased participant.

The new law does not change the payout period for a nondesignated beneficiary. If a participant dies leaving his IRA to his estate or to a non-see-through trust, the payout period will apparently still be either the five-year rule or what would have been the remaining life expectancy of the deceased participant.

But for designated beneficiaries, the rules change radically effective for deaths after 2019. Designated beneficiaries are now subdivided into two classes: "eligible designated beneficiaries" and "designated beneficiaries."

For designated beneficiaries, there is a new 10-year rule. It applies just like the old five-year rule, meaning that annual distributions are not required. Instead, "the entire interest of the employee will be distributed within 10 years after the death of such employee." And it applies regardless of whether the participant died before, on, or after her required beginning date.

Examples: Mark dies Dec. 31, 2019, leaving his IRA to his daughter, Mary, who turns age 57 in 2020. Mary is required to withdraw the IRA in annual installments over her life expectancy of 27.9 years (or more rapidly, if she chooses).

Meanwhile, Mike dies Jan. 1, 2020, leaving his IRA to his daughter, Melany, who also turns age 57 in 2020. Melany must withdraw the entire balance of the IRA within 10 years. She can withdraw it gradually over the 11 calendar years 2020–30, or she can wait until the last day and take it all out then, or anything in between, as long as the money is all distributed within the 10-year period. And as is true under the old law, if Mike was past his required beginning date, Melany must withdraw the balance of his year-of-death RMD to the extent he didn't take it himself.

As the Mary/Melany contrast shows, for most adult nondisabled beneficiaries, the new law imposes a drastically accelerated distribution schedule compared with the life expectancy payout regime that has been with us since the 1980s. The settled regime of over 30 years has been obliterated by the stroke of a pen. The "best middle-class tax shelter" has been turned into a "worst middle-class tax trap."

The harsh new 10-year rule does not apply to everybody. Five groups, called "eligible designated beneficiaries," will still be able to use a modified version of the life expectancy payout. These are: the surviving spouse of the participant; a minor child of the participant (however, the minor's life expectancy payout flips to the 10-year rule when the minor reaches majority); a disabled individual; a chronically ill individual; and an individual who is not more than 10 years younger than the participant. A conduit trust for an "eligible designated beneficiary" would presumably be entitled to the same treatment, and certain "accumulation trusts" for disabled or chronically ill beneficiaries can also qualify.

But even for pre-2020 deaths and eligible designated beneficiaries, the rules are not as generous as the pre-2020 rules were: Upon the post-2019 death of an eligible designated beneficiary (or of a designated beneficiary of a pre-2020-death participant), the 10-year rule will kick in.

Much needs to be sorted out about exactly how SECURE will apply--especially in the cases of deaths of eligible designated beneficiaries; deaths of the designated beneficiaries of pre-2020 decedents; and trusts for multiple beneficiaries some or all of whom are eligible designated beneficiaries.

Planners have their work cut out for them for 2020.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website, www.ataxplan.com, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.