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Qualified Retirement Accounts and the SECURE Act
The Impact of the Secure Act Concerning Qualified Retirement
Accounts and Its Special Implications for Families with Disabled Children.
The Secure Act, which went into effect on January 1, 2020, effected broad change to the laws regulating Qualified Retirement Accounts, such as 401(k)s and IRAs, in the United States. These changes apply to the holders of every Qualified Retirement Account and the beneficiaries who may inherit such accounts. Account beneficiaries with disabilities or chronic illnesses receive favorable treatment under the new law compared to other beneficiaries. But, such beneficiaries who have trusts to help them manage their financial affairs could lose their favorable tax treatment if their trusts do not comply with complex new legal requirements.
Here is a summary of the main changes in the law implemented under the Secure Act:
1. Required minimum distributions (RMDs) now begin at age 72. Americans are working longer and are no longer being required to withdraw assets from IRAs and 401(k)s at age 70½. RMDs now begin at age 72 for individuals who turned 70½ after 2020. Anyone who turned age 70½ before that time should have begun taking RMDs and should continue doing so.
2. Individuals are now allowed to make IRA contributions beyond age 70½. As Americans live longer, an increasing number are continuing to work past their traditional retirement age. Under the Secure Act, one can continue to contribute to his or her traditional IRA past age 70½, or even age 72, so long as he or she is still working. This change means the rules for traditional IRAs will align more closely with 401(k) plans and Roth IRAs.
3. Small-business owners can receive a tax credit for starting a retirement plan, up to $5,000. They will also find it easier to join with other small business owners to offer defined contribution retirement plans to employees.
4. Individuals can withdraw up to $5,000 per parent, penalty-free, from their retirement plans upon the birth or adoption of a child. The new law permits an individual to take a "qualified birth or adoption distribution" of up to $5,000 from an applicable defined contribution plan, such as a 401(k) or an IRA. The 10% early withdrawal penalty will not apply to these withdrawals, and they can be “repaid” in the same manner that rollover contributions are made to applicable eligible defined contribution plans or IRAs.
5. 529 funds can now be used to pay down student loan debt, up to $10,000. In some cases, families have money remaining in their college savings plans after their student graduates. Now, they can use a 529 savings account to pay up to $10,000 in student debt over the course of the student's lifetime. Under the new law, a 529 plan may also be used to pay for certain apprenticeship programs.
6. Inherited IRA distributions generally must now be taken within 10 years. Previously, it was possible for a person who inherited an IRA or 401(k) to "stretch" his or her distributions and tax payments out over the beneficiary’s individual life expectancy. Under the previous law, many people, including those with disabilities, have used "stretch" IRAs and 401(k)s that they inherited as reliable income sources, even into their own senior years.
Under the new law, for retirement accounts inherited from owners who passed away on or after January 1, 2020, the general rule is that those beneficiaries must withdraw ALL assets from that inherited IRA or 401(k) plan within 10 years, and possibly even 5 years, following the death of the account holder. There are narrow exceptions to this harsh distribution rule, such as for surviving spouses, minor children, disabled or chronically ill beneficiaries, and beneficiaries who are less than 10 years younger than the original IRA owner or 401(k) participant.
What account holders who want to allow beneficiaries with disabilities and chronic illnesses need to know now that the SECURE Act has been put into law:
As originally proposed, the SECURE Act contained no “exception” to the elimination of the valuable “stretch” provisions for beneficiaries with disabilities or chronic illness. The National Academy of Elder Law Attorneys (NAELA), the national affiliate of the Virginia Academy of Elder Law Attorneys (VAELA), successfully lobbied Congress to add provisions to the law that would preserve the “stretch” for chronically ill or disabled individuals who are beneficiaries of a Qualified Retirement Account.
But, many individuals with disabilities or chronic illnesses have trusts in place that allow a loved one, or a professional, to handle financial matters for them. It is common for trusts to benefit multiple beneficiaries, like all of an account-holder’s children, as a group. Since the old law allowed all children to benefit from the “stretch,” a trust with multiple beneficiaries did not present a significant tax problem. But under the new law, a tax problem arises if some beneficiaries of a trust can “stretch” while others cannot.
As a consequence, in order to protect the “stretch” that a disabled or chronically ill individual may be entitled to, it is important that any trust used to manage retirement plan distributions for that person be set up for that individual’s sole benefit (often referred to as “sole-benefit trust”). Because this requires that the appropriate planning be done before the death of retirement account holder, beneficiaries with disabilities or chronic illnesses are at risk of losing a very significant tax benefit if the trust plan does not comply with the new complex requirements established by the SECURE Act. A knowledgeable elder law attorney will be able to help customize a solution that provides for the support and assistance that a beneficiary may need while simultaneously maximizing the tax advantages available to an intended beneficiary with disabilities or chronic illness.