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Client Alert SECURE Act The SECURE Act is changing retirement Here are the most important things to know. Januar y 2020

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OVERVIEW 01.Overview Signed into law December 20, 2019 and effective January 1, 2020 the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”) is the most significant Retirement Plan legislation since 1981. The purpose of the SECURE Act is to assist Americans with saving for retirement. It does this by making is easier for small employers to set up Retirement Plans, allowing long-term part-time employees to participate in Retirement Plans, allowing annuities as a 401k option, etc. The SECURE Act dramatically changes how your family will inherit your IRA, 401K or other Retirement Plan. Estate plans created before 2020 may no longer be effective. Without additional estate planning, Inherited IRAs are less valuable as a tool to transfer wealth to your children and other family members

You MUST revisit the beneficiar y designations on your IRA, 401K or other Retirement Plan. •

Get a copy of the beneficiary designations of all IRA, 401K or other Retirement Plan.

•

Identify the balance of each plan.

•

If a trust is named as the beneficiary, obtain a copy of the document creating the trust.

•

Schedule a consultation call (complimentary to clients)

Summary • SECURE Ac t effe c ti ve J an ua ry 1, 2020 • Req u i red mi n i mu m d i str i b u t i ons to a ccount ow ne rs ca n be de layed to age 72 • Empl oyees can co nti n u e to cont ri bute to I RA a nd 4 0 1( k) a fte r ag e 70 1 /2 • End of the I n h e r i te d I RA St retc h – m ost non- spouse be nefi c i a r ies must w i thd raw al l Reti re ment P l a n a ssets w i t hi n 10 yea rs of t he a cco u nt ho l d e r ’s d ate of d eat h • ACTION - U p d ate estate p l a ns w he re a t rusts i s t he be nefi c i a ry of yo u r Retire me nt Pl an o r I RA • ACTION - New p l an n i n g i d ea s

CHANGES 02. Changes New Provisions in Addition to the end of the “Stretch” for Inherited IRAs and Retirement Plans: For individuals, a few new provisions to remember: •

Individuals working can continue to contribute to Retirement Plans, eliminating the prior bar to contributions after age 70 1/2.

•

The age to take Required Minimum Distributions (“RMD”) increases to 72

•

Parents can make penalty-free withdrawals up to $5,000 from Retirement Plans for the birth or adoption of a child

Changes to Inherited IRAs – End of the IRA Stretch Since IRAs are Individual Retirement Accounts, and a deceased person is by definition no longer retired, Congress has deemed that IRAs inherited by persons other than your spouse are no longer eligible for the tax deferral benefits under the pre-2020 law1. This change in the payment of inherited IRAs is estimated to raise $15.7 billion in new tax revenue as the accelerated distributions from inherited IRAs are included in the beneficiaries’ taxable income. At a Glance – How SECURE Act Changes Estate Planning for IRAs: •

Pre-2020 law – Non-spouse beneficiaries can withdraw inherited IRA over their life expectancy (stretch the IRA distributions)

•

SECURE Act – Most non-spouse beneficiaries must withdraw the entire IRA, and pay income tax on the withdrawal, within 10 years

To be clear, the SECURE Act does not change your planning where your spouse is your primary beneficiary. Your spouse will continue to have to option roll over your Retirement Plan to their IRA, defer RMD until they are 72, and then take out over RMD over their life expectancy. The SECURE Act is a game changer when (1) your spouse is not your primary beneficiary, (2) non-spouse contingent beneficiaries inherit your IRA or Retirement Plan, or (3) a trust is a beneficiary of your IRA or Retirement Plan.

The end of tax deferral applies to traditional IRA’s, not Roth IRA’s where qualified distributions are tax-

free. 2

PRE-2020 03. Pre-2020 Pre-2020 Law – Stretch IRA Under Pre-2020 law a person inheriting an IRA could “stretch” the payment of the IRA over their life expectancy. Since (1) growth in an IRA is tax free, and (2) distributions from an IRA are subject to income tax, a foundational strategy to estate planning with IRAs was to maximize the “stretch”. In the example below, a 45 year old child inherits a $1 million IRA. Even taking RMD each year, at the end of 10 years at 7% the IRA balance has grown to over $1.5 million.

Year

Age

1 2/31 Ba la n ce

LE Fa c tor

RMD

7% G row th

20 19

1 ,0 0 0,0 0 0

38 . 8

25 ,7 73

1 ,0 42 , 42 3

2020

1 ,0 42 , 42 3

37.9

27, 5 05

1 ,0 85 ,9 62

202 1

1 ,0 85 ,9 62

29, 35 0

1 ,130, 575

2022

1 ,130, 575

3 1 , 4 05

1 ,1 76 ,1 12

2023

1 ,1 76 ,1 12

35 .1

3 3 , 5 07

1 , 222 , 5 87

2024

1 , 222 , 5 87

34.2

35 ,74 8

1 , 269,9 1 7

2025

1 , 269,9 1 7

33.3

38 ,136

1 , 3 1 8 ,0 0 6

2026

1 , 3 1 8 ,0 0 6

31.4

41 ,9 75

1 , 365 , 35 4

2027

1 , 365 , 35 4

30. 5

4 4 ,76 6

1 , 413 ,029

2028

1 , 413 ,029

29. 6

47,737

1 , 4 6 0, 8 62

2029

1 , 4 6 0, 8 62

28 .7

5 0,9 0 1

1 , 5 0 8 , 65 8

POST-2020 04.Post-2020 Post-2020 Law – SECURE Act 10 Year Rule Default Under the SECURE Act, unless one of the limited exceptions applies, a person inheriting an IRA must withdraw the entire IRA balance within 10 years of the original account holder’s death. Some or all of the IRA balance may be distributed each year; but the entire IRA balance must be distributed in 10 years. Unless the IRA is a Roth IRA, all distributions are subject to state and federal income tax. In the example below, the same 45 year old child inherits a $1 million IRA. The chart illustrates the estimated income tax cost of withdrawing 100% of the IRA in each of the 10 years after the account holder’s death. Even if the child waits until the latest date to withdraw the IRA to maximize the tax-free growth of the IRA, at a 7% growth rate the wealth the child will have at the end of 10 years from the IRA is only approximately $1.1 million after tax.

Yea r

Ag e

12/31 Balance

7% G row th

Fed Ta x @37%

N J Sta te Ta x @ 8 .97%

Tota l Ta x

201 9

1 ,0 0 0,0 0 0

1 ,070,0 0 0

395 ,9 0 0

95 ,9 79

49 1 , 879

2020

1 ,070,0 0 0

1 ,14 4 ,9 0 0

42 3 , 613

1 02 , 698

526 , 3 1 1

202 1

1 ,14 4 ,9 0 0

1 , 225 ,0 4 3

45 3 , 26 6

1 0 9, 8 8 6

5 6 3 ,1 52

2022

1 , 225 ,0 4 3

1 , 3 1 0,79 6

4 8 4 ,9 95

1 1 7, 578

6 02 , 573

2023

1 , 3 1 0,79 6

1 , 4 02 , 552

5 1 8 ,9 4 4

125 , 8 0 9

6 4 4 ,75 3

2024

1 , 4 02 , 552

1 , 5 0 0,730

555 , 270

1 3 4 , 616

6 89, 8 8 6

2025

1 , 5 0 0,730

1 , 6 05 ,78 1

59 4 ,1 39

14 4 ,039

738 ,1 78

2026

1 , 6 05 ,78 1

1 ,7 1 8 ,1 8 6

6 35 ,729

1 5 4 ,12 1

789, 85 0

2027

1 ,7 1 8 ,1 8 6

1 , 8 38 , 459

6 8 0, 2 30

16 4 ,9 1 0

8 45 ,14 0

2028

1 , 8 38 , 459

1 ,9 67,1 5 1

727, 8 4 6

1 76 , 45 3

9 0 4 , 29 9

2029

1 ,9 67,151

2 ,1 0 4 , 852

7 78 ,795

1 8 8 , 8 05

9 67, 6 0 0

EXCEPTIONS 05.EXCEPTIONS Surviving spouse – can do a rollover or continue to distribute the IRA over their life expectancy.

Minor child – can withdraw the IRA over their life expectancy, until they reach the age of majority; they then must withdraw within 10 years from that date.

Disabled individual – can continue to withdraw the IRA over their life expectancy. A specially designed trust should be the beneficiary of the IRA so the Inherited IRA does not become a “countable asset” that will eliminate the person’s ability to qualify for public benefits.

Chronically ill individuals who cannot perform at least 2 activities of daily living - can continue to withdraw the IRA over their life expectancy. A specially designed trust should be the beneficiary of the IRA so the Inherited IRA does not become a “countable asset” that will eliminate the person’s ability to qualify for public benefits.

Individual not over 10 years younger than the account holder.

ACTIONS 06.Actions Change Estate Plans where Trusts are IRA Beneficiaries Your current estate plan may name a trust for your spouse, children or other family members. This could be a trust created in your Will or in a Revocable Trust. There is nothing wrong with the planning idea. However, without review and modification it will not work as originally expected under the new post-2020 law.

Meet with your estate planning attorney to: • Review the current terms of the trust that is a beneficiary of an IRA or retirement account • Revisit the purpose of the trust within your estate plan • Consider how the trust needs to be modified, given (1) SECURE Act, and (2) the purpose of the trust • Modify your estate plan accordingly

New Estate Planning Ideas for Inherited IRA’s around the SECURE Act Even though Congress just slashed the value of your Retirement Account to your beneficiaries, you can engage in planning to continue to maximize the wealth you are transferring to your family members.

Consider the ideas below: • • • • •

Multi-generational sprinkle trust Roth Conversions Charitable Remainder Trust to emulate the “stretch” Life Insurance to replace income taxes State income tax planning to a trust in a no state income tax jurisdiction • Income tax bracket planning with a trust where the beneficiary is the taxpayer • Combo plan • Schedule an appointment with your estate planning attorney to consider how these ideas can be incorporated into your estate plan 6

CONSIDER 07. Consider Multi-Generational Sprinkle Trust (replacing Conduit Trust) There are myriad good reasons to design an estate plan where wealth is inherited in a trust – chief among them protection from divorce and future creditors, and creating a structure that passes investment knowledge and value with money. These goals can still be achieved under the SECURE Act, but the terms of the trust that is the beneficiary of the IRA or Retirement Plan MUST change. Two types of trusts can be beneficiaries of an IRA or Retirement Plan: •

Conduit Trust – Any distribution from the IRA to the trust each year must immediately be distributed to the trust beneficiaries.

•

Accumulation Trust - Distributions from the IRA to the trust can be invested in the trust or distributed to the beneficiaries in the discretion of the Trustee.

For reasons that made a lot of sense pre-2020 most estate plans that established trusts to hold IRA or Retirement Plan assets have been designed with Conduit Trusts – which are no longer effective under the SECURE Act. Post-2020 when the Conduit Trust takes the final distribution from the IRA within 10 years, the terms of the Conduit Trust dictate that the entire distribution be flipped to the beneficiary. This defeats an estate plan with a goal of asset protection. Your asset protection goals can still be achieved in your estate plan under the SECURE Act, but the terms that is the beneficiary of the IRA or Retirement Plan MUST change to be an Accumulation Trust. Additionally, an Accumulation Trust may have income tax benefits in the SECURE Act era. If the trust has beneficiaries of different generations (a child and their children for example) the Trustee can look at the income tax bracket of the beneficiaries and decide if (1) the trust pays income tax on a distribution from the IRA or Retirement Plan, or (2) if the IRA or Retirement Plan distribution is then flipped to the trust beneficiaries, who will pay the income tax on the distribution on their lower tax rate.

CONSIDER 07. Consider Roth Conversion Unlike traditional IRAs, no income tax is paid when beneficiaries take a distribution from the Roth IRA. Instead, the income tax is paid by the account holder (1) on the funds contributed to a Roth IRA or 401(k), or (2) when the account holder converts from a traditional IRA to a Roth IRA. Roth Conversions mitigate income tax costs by account holder paying some income tax now at a lower income tax rate so future distributions are not subject to income tax under the 10 year rule. The math of the Roth conversions is complicated and depends on a variety of factors including assumptions about present v. future income tax brackets, availability of “outside funds” to pay the income tax liability, your need for the IRA to support your lifestyle, etc. However, under the right circumstances the conversion can increase the wealth passing to your family from your Retirement

IRA to Charitable Remainder Trust (“CRT”) to Emulate “Stretch” A Charitable Remainder Trust (“CRT”) is a “split-interest” trust where an individual receives a stream of payments from the CRT, and at the end of the term of the payment stream the remaining balance of the CRT’s assets pass to one or more charities. The individual can receive either (1) a percentage of the value of the CRT each year (a Charitable Remainder Unitrust or “CRUT”), or (2) a fixed amount each year (a Charitable Remainder Annuity Trust or “CRAT”). If an IRA or Retirement Plan is distributed to a Charitable Remainder Trust (“CRT”), the CRT does not pay federal income tax on (1) the IRA distribution, or (2) the growth of assets in the CRT. When distributions are made to the individual the individual will have to pay income tax on those distributions, as they would on distributions from a traditional IRA. By combining these factors, having an IRA payable to a CRT can emulate the

CONSIDER 07. Consider “stretch IRA” which allowed for (1) tax-free growth in the IRA, and (2) payments to the beneficiary over their lifetime or a 20 year timeframe. In the example below, a 45 year old child is a beneficiary of a CRT funded with a $1 million IRA when their parent died. The IRA is paid tax-free to the CRT and the investments will grow tax-free within the CRT. The child receives a percent of the assets of the CRT each year for their lifetime. At the child’s death any balance passes to the charity.

CONSIDER 07. Consider IRA to Charitable Remainder Trust (“CRT”) to Emulate “Stretch” Life insurance is paid to a beneficiary income tax-free. In the SECURE Act example above a 45 year old child inherited a $1 million IRA. If the child left the money to grow tax-free in the IRA for the maximum 10 years at 7%, in year 10 the child will have to withdraw the appreciated balance of $2,104,852 and pay a whopping $967,600 income taxes ($778,795 federal, $188,805 New Jersey if child is a New Jersey resident). That is one heck of a tax bite. If the account holder either purchased a new $750,000 life insurance policy, or repurposed an existing policy, and named the child as the beneficiary, then at the 10 year mark there would be more than sufficient money to replace the dollars eaten away from the inheritance with the income tax bite.

Create Trust Located in State Income Tax Free Jurisdiction New Jersey taxes a New Jersey resident or a New Jersey resident trust at income tax rates up to 10.75%. Many states impose 0% income tax on a trust’s income (Alaska, Delaware if no trust beneficiary resides in DE, Florida, Nevada, New Hampshire, South Dakota, Texas, Washington, Wyoming). If your beneficiary lived in such a state then when the IRA or Retirement Plan was distributed to them, then they would avoid New Jersey state income tax ($188,805 in our 45 year old child example). Since you have no control over where your beneficiaries might reside following your death, consider designing a trust resident in a tax-free state to increase the wealth passing to your children.

CONSIDER 07. Consider Create Trust where the Beneficiary is the Taxpayer It is possible to create a trust where the beneficiary of the trust, after the death of the Grantor, is treated as the taxpayer of the trust. Income to a trust hits the maximum 37% federal income tax rate at a mere $12,950 of income. In comparison, a married couple does not hit the 37% income tax bracket until they have $622,050 of income. With a trust where the beneficiary is designed to be the taxpayer on the trust income the impact of the trust income tax brackets is minimized.

Combo Plan No ideas are either / or. For individuals with a significant amount of their family wealth in Retirement Plans or IRAs a comprehensive estate plan for their Retirement Plans or IRA might include: • • • •

Multi-Generational sprinkle trust Trust located in Florida Plan of Roth conversions during retirement when the account holder is in a lower income tax bracket Life insurance to replace income tax dollars owned by the Florida trust

Next Steps Co ntact your estate pl an n i n g atto rn ey abo u t wh at chang es you n e e d to m ake to yo u r E state P lan a nd IRA and Ret i re m e nt P l an Be n efi c i ar y Des i gn at i o n s.