By Ariel Marin, JD, LL.M., CFP®, CLU®
The retirement planning landscape could soon undergo a major overhaul. The Setting Every Community Up for Retirement Enhancement Bill of 2019 (HR 1994), also known as the SECURE Act (the Act), is a bill passed by the House of Representatives on May 23, 2019, which has the potential to be the first major retirement related legislation passed since the Pension Protection Act of 2006.
A parallel Senate bill introduced in April known as the Retirement Enhancement Securities Act (RESA) means that the final product will likely represent a merger of the two bills along with parts modified through Congressional or committee action.
The passage of the bills into law has stalled in the Senate after objections from a few Senators, including Ted Cruz (R-Texas). Nonetheless, most believe that the Act will become law. Below is an early look at some of the key proposals and planning considerations.
Proposed SECURE Act changes pre-mortem
CHANGES FOR EMPLOYER-SPONSORS
Multiple employer plans. Employer-sponsors of retirement plans have a fiduciary responsibility to provide a quality low-cost plan as laid out in the federal Employee Retirement Income Security Act of 1974 (ERISA).
This responsibility results in considerable administration costs, which among other costs, are passed on to the participants. Smaller plans cannot access the scale to spread the administration costs that the large plans can.
Enter the multiple employer plan, a retirement plan maintained by two or more employers not "related" under the IRS's rules for controlled groups. Under the current regime, multiple employer plans are only available to employers in a common industry. The idea behind multiple employer plans is to reduce the burden of retirement plans on small employers by sharing "scaling" administration costs and theoretically reducing fiduciary liability for the employer-sponsors.
However, employer-sponsors cannot ultimately avoid fiduciary responsibility and they risk breaching that responsibility if another employer who is part of the multiple employer plan was to breach theirs.
Under the Act, multiple employer plans would be available to businesses that are in unrelated industries, and employers are better protected from the breach of another party's duty.
Tax credits. Under the Act, a tax credit for start-up costs of $5,000 may be available to employers-sponsors with an additional $500 for three years if the plan offers automatic enrollment.
Plan participation rules. Under the current regime, if an employee worked less than 1,000 hours per year, she could be excluded from a plan. The new bill reduces that number to 500 hours.
CHANGES FOR EMPLOYEES-SAVERS
Required minimum distribution age. The SECURE Act and RESA both would delay required minimum distributions (RMDs) until age 72. Currently, employees-savers typically begin taking distributions at age 70½.
Age limitations for IRA contributions. The Act would permit contributions to an IRA at any age. Under the current regime, contributions to an IRA cannot be made after age 70½.
Annuities and lifetime income options. Currently, many plans do not offer an annuity option because of fiduciary concerns regarding selection of an annuity provider. The Act would ease these concerns by providing safe harbor provisions to plan sponsors.
Proposed SECURE Act changes post-mortem
Elimination of the "stretch IRA." A "stretch IRA" is a strategy which involves optimizing the growth of the assets inside of a traditional IRA by preserving a beneficiary's ability to defer the income tax payable on distributions to the maximum extent possible. The idea is that the longer the assets inside the IRA can grow tax deferred, the more those assets will ultimately grow. A stretch IRA therefore involves minimizing distributions.
RMDs are meant to be taken out over the account owner's life expectancy. When the account owner dies, required distributions will typically apply based on the successor account owner's life expectancy (depending on the identity of the beneficiary, and the age of the account owner at death). The stretch is maximized when distributions will pass according to the beneficiary's life expectancy.
Under the Act, the RMDs for the account owner and his/her spouse (as successor owner) would remain unchanged. However, on the occasion that assets pass to a non-spouse beneficiary (typically upon the death of the second spouse to die), those assets would have to be distributed over a new 10-year period instead of his/her life expectancy. Under RESA, the payout period would be five years. Thus, the stretch will be potentially reduced by decades. The 10-year period under the SECURE Act would not apply to spousal beneficiaries, disabled persons, minors, and those not more than 10 years younger than the original account owner.
Planning in the new environment
Planning with IRAs involves bracket management, deferral, charitable planning, and the conversion of ordinary income to tax-free income or capital gains.
A small boon for the ordinary retiree. For most people, the new rules would provide a benefit to retirement savings because they can continue to contribute to their retirement account after age 70½, and assets can remain in the IRA, tax deferred, until later years when the required distribution rules will come into effect. For this group, the elimination of the stretch IRA has less significance.
Roth IRAs and Roth 401(k)s. Overall these types of accounts would be unaffected by the proposed legislation. However, many account owners may consider Roth contributions, and especially Roth conversions.
Although the benefits of Roth conversions are reduced with the elimination of the stretch IRA, Roth conversions under the Act would still enable the account owner to engage in some tax planning. For example, converting a traditional IRA over a 20- to 30-year period, while utilizing a bracket management strategy, could save taxes in the long run, thus transfering more wealth to the beneficiaries who will be forced to receive an entire traditional IRA and its embedded taxes over a shorter 10-year period with less bracket management flexibility, and at potentially higher income tax rates (when Tax Cuts and Jobs Act of 2017 sunsets).
Life insurance. Life insurance proceeds can be used to pay for the embedded tax liability of an inherited IRA. Also, similar to the Roth conversion strategy described above, it may be worth considering having an IRA owner relocate IRA money from her account to fund the premiums of a life insurance policy, thereby absorbing the tax liability during her life in order to provide a tax-free inheritance to her heirs. Furthermore, depending on the type of policy, the lifetime benefits of the policy also could provide her with a tax-free source of funds through withdrawals and policy loans of the policy's cash values.
Review trust documents. For those who name their revocable trust as the beneficiary of their retirement account, the proposed changes under both the SECURE Act and RESA could have a profound impact on their estate plans.
There are essentially two types of trusts for IRAs, conduit trusts and accumulation trusts. As the names suggest, conduit trusts are designed to pass all RMDs to the trust beneficiary, while accumulation trusts allow the trustee to accumulate distributions from the account and pass them to the beneficiary according the trust's language.
The existence of a conduit trust may now have cataclysmic consequences. Instead of the trustee making distributions to the beneficiary over his life expectancy, the entire IRA must now be distributed to him in a 10-year span. This can be catastrophic for a beneficiary with creditor or addiction issues, or one who is poorly skilled with the management of wealth.
Therefore, the switch to an accumulation type of trust may be advisable in situations such as these.
Charitable Remainder Trust (CRT). Naming a CRT as the beneficiary of an IRA may be an acceptable alternative to simulate the stretch IRA. A CRT is a type of irrevocable trust which often names a family member as the current income beneficiary and a charity as the remainder beneficiary. If a CRT is named as the beneficiary of an IRA, retirement assets will be distributed to the trust, and the trust will then make annual distributions to the current beneficiary for the rest of the beneficiary's life, based on a fixed percentage of trust assets. The trust will owe no income taxes on the distribution of the IRA to the trust and once the proceeds are invested, the assets inside the trust will grow tax deferred. Once distributions are made to the beneficiary, she will be taxed on the distributions. However, a CRT strategy has the added benefit of converting some of the ordinary income from the IRA account to capital gains after a certain amount of distributions are made.
The SECURE Act and RESA represent a significant transformation of the rules for retirement plans. Most notably for high net worth persons with significant retirement assets, is their impact on the stratum where retirement planning and estate planning intersect, particularly with the elimination of the stretch IRA.
However, the two bills also are an opportunity for many to visit with their advisors to discuss tactics like the ones discussed above, so that they can pivot and still achieve their retirement planning, estate planning, and charitable planning objectives.
Ariel A. Marin, JD, LL.M., CFP®, CLU®,received his law degree from the City University of New York, and his LL.M. in taxation with a certificate in estate planning from Villanova Law School, Graduate Tax Program. He received his bachelor's degree in arts from The George Washington University. Prior to joining Nautilus, Ari worked with a family office developing customized, comprehensive wealth plans for high net worth clients; prior to that he worked as a trust and estate associate for a large national trust company. He is licensed to practice law in Pennsylvania, and currently holds FINRA series 7 and 66 licenses.
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