The recently enacted Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act) makes significant changes to individual retirement accounts and individual retirement annuities (IRAs). These important changes generally start in 2020 and touch just about every IRA provider and IRA owner. These changes will have significant effects on retirement, estate, and tax plans that use IRAs.
Age Limit for Annual Traditional IRA Contributions Eliminated With Related Qualified Charitable Distribution Reduction
Beginning with the 2020 tax year, the SECURE Act eliminates the 70½ age limit for making annual contributions to Traditional IRAs. However, beginning with contributions and distributions made or taken in 2020, the SECURE Act reduces the IRA qualified charitable distributions to coordinate with the new post-age 70½ annual contributions.
This is good news for older people who continue to work past age 70½ and want to continue saving for retirement on a tax-deferred basis. The impact of the additional retirement savings is negated somewhat by the related reduction in IRA charitable distributions because eligible IRA charitable distributions are excluded from income.
Deadline for Beginning Mandatory Distributions Delayed
The SECURE Act raises the age when IRA owners are required to begin taking required minimum distributions (RMDs) from age 70½ to 72. This change applies to distributions required to be made in 2020 or later for IRA owners who turn age 70½ in 2020 or later. IRA owners who turned age 70½ in 2019 or earlier must continue to take their RMDs.
This is really good news for people who turn age 70½ in 2020 or later and do not plan to take distributions from their IRAs. This change allows IRA owners to take advantage of the IRA’s tax-deferred nature for a longer period, but see the limitations on “stretch” IRAs below.
Penalty-Free Childbirth and Adoption Distributions
The SECURE Act expands the exceptions to the 10% early distribution tax penalty for IRAs and other eligible retirement plans by adding an exception for “qualified birth or adoption distributions” of up to $5,000. A “qualified birth or adoption distribution” is any withdrawal from an IRA or other eligible retirement plan made during the one-year period beginning on the date the IRA owner’s or plan participant’s child is born or eligible adoptee’s legal adoption is finalized. The IRA owner or plan participant may repay the distribution and the repayment will be treated as a rollover. This change applies to distributions made in 2020 and later.
This change is good news for IRA owners who need to take distributions from their IRAs to cover the costs and expenses of their child’s birth or adoption.
Annual Traditional IRA Nondeductible Contribution Limit Expanded for Foster Parents
For nondeductible annual IRA contributions made after December 20, 2019 (the date of the SECURE Act’s enactment), a foster parent may elect to increase the nondeductible annual Traditional IRA contribution limit by a certain amount of foster care “difficulty of care” payments that are excluded from income, if the individual’s taxable compensation is less than the deductible limit.
This is good news for foster care parents who want to start saving or increase their savings for retirement.
Note: It appears from the terms of the SECURE Act that this change applies to annual IRA contributions for 2019, if made after December 20. Hopefully, this will be confirmed by the Internal Revenue Service (IRS) soon for foster parents to make contributions for the 2019 tax year by their 2019 tax return deadline.
Compensation Expanded for Annual Traditional and Roth IRA Contribution Limit
The SECURE Act expands the definition of compensation for purposes of the annual IRA contribution limit for a small group of people. Beginning with 2020 deductible annual IRA contributions, compensation will include taxable non-tuition fellowship and stipend payments for graduate and postdoctoral study.
This is good news for graduate and postdoctoral students who want to start saving or increase their savings for retirement.
The SECURE Act enables participants in certain qualified plans to avoid termination penalties, surrender charges, and other fees upon liquidation if the plan sponsor eliminates a lifetime income investment option from the investment lineup. Under the new SECURE Act rules, if the qualified plan so permits, these participants will be able to make a direct trustee-to-trustee transfer of the lifetime income investment to an IRA or another employer-sponsored qualified retirement plan or take a distribution in the form of a qualified plan distribution annuity contract.
This is good news for qualified plan participants with an investment option designed to provide lifetime income because it provides them with the flexibility to continue the option in an IRA willing to accept it, if the option is eliminated from the plan.
Severe Restrictions on ‘Stretch’ IRAs
The SECURE Act severely restricts the use of the “stretch” IRA to a limited group of IRA beneficiaries for IRA owners who pass away in 2020 or later. The stretch IRA, without restrictions, is still available for otherwise eligible IRA beneficiaries of IRA owners who passed away before 2020. The stretch IRA is also still available for certain annuity contracts held under an IRA that were in effect on December 20, the date the SECURE Act was enacted, even if the IRA owner passes away in 2020 or later, if certain requirements are met. These requirements are discussed below.
Before the SECURE Act restrictions, a stretch IRA permitted any IRA beneficiary who is an individual or a “see-through” trust to take minimum distributions from an inherited IRA over the beneficiary’s life expectancy under a very complicated set of rules. This flexibility allowed eligible beneficiaries to “stretch” payments from the inherited IRA over many years and potentially pass on the inherited IRA to their beneficiaries. The stretch IRA became a popular estate planning tool for IRA owners with sufficient wealth to pass on to next generations.
For IRA owners who pass away in 2020 or later, the SECURE Act restricts use of the stretch IRA to an IRA beneficiary who is an individual and who is either the IRA owner’s surviving spouse or minor child, or an individual who is disabled, chronically ill, or not more than 10 years younger than the IRA owner. When a minor child reaches the age of majority, the child must take any remaining amounts in the IRA within 10 years. Presumably, these same exceptions would apply to a beneficiary of a see-through trust and multiple beneficiaries of a see-through trust if all of the beneficiaries were eligible for the stretch IRA. Except in the case of a see-through trust for a disabled or chronically ill individual, however, it is not clear how see-through trusts fare if there is more than one trust beneficiary and not all of the trust beneficiaries are eligible for the “stretch” IRA. In the case of a disabled or chronically ill individual, the SECURE Act provides that the stretch IRA is available only for the disabled and/or chronically ill trust beneficiaries of a see-through trust with multiple beneficiaries. Hopefully, guidance will be issued soon on this and other open issues.
For IRA owners who pass away in 2020 or later, the stretch IRA is not available for an IRA beneficiary who is an individual or a see-through trust, unless the beneficiary fits in one of the groups of eligible beneficiaries described above. If an IRA beneficiary does not fit into one of the groups eligible for the stretch IRA, the beneficiary must take a complete distribution of the IRA within 10 years after the IRA owner passes away. If the IRA owner passed away after beginning minimum distributions required during the IRA owner’s lifetime, the IRA beneficiary may take minimum distributions based on the IRA owner’s remaining life expectancy.
The minimum distribution rules for non-individual IRA beneficiaries that were not eligible for the stretch IRA before the SECURE Act restrictions (such as estates, charities, and trusts that are not see-through trusts) have not changed. This group of non-individual beneficiaries were and still are required to take minimum distributions within five years after an IRA owner dies, or over the remaining life expectancy of the IRA owner, if the IRA owner passed away after beginning minimum distributions required during the IRA owner’s lifetime.
The SECURE Act restrictions on the stretch IRA are not good news for IRA owners with estate plans based on the stretch IRA, unless the IRA beneficiaries fit within one of the groups still eligible for the stretch IRA or their IRAs fall under the annuity contract exception discussed in the next section. IRA owners should review their estate plans with their estate planners to determine the impact of the new restrictions.
Challenges for IRA Annuity Providers
Individual retirement annuities funded by annuity contracts face some special challenges in implementing the SECURE Act restrictions on stretch IRAs. Generally, annuity contracts offer a limited number of specific annuity alternatives to IRA owners. If the annuity contract is not excepted from the SECURE Act restrictions and only offers life annuities or payments over longer than 10 years that do not reflect the new restrictions, the annuity contract may not be able to comply with the new restrictions. The exception that permits minor IRA beneficiaries to take distributions over their life expectancy under the “old” stretch IRA rules until they reach the age of majority and then requires them to take complete distribution of their inherited IRA within 10 years may be particularly difficult to reflect in an annuity contract. Amending existing annuity contracts or developing new annuity products to offer annuity alternatives that comply with the new restrictions may not be a simple process and generally requires that the amended annuity contract be submitted for approval by applicable state insurance departments before use. In addition, if the IRA is in the form of a prototype endorsement to the annuity contract, the endorsement and annuity contract may need to be submitted and approved by the IRA before use.
Although the new law provides a helpful exception for certain existing annuity contracts, the exception is limited in scope. For the exception to apply, the annuity contracts must be binding and in effect on December 20, 2019, the date the SECURE Act was enacted, and at all times afterwards. In addition, for the exception to apply, the IRA owner must have made an irrevocable election before December 20, 2019, as to the method and amount of annuity payments to the IRA owner or any IRA beneficiary who is an individual or “see-through” trust.
Insurance companies with individual retirement annuity products should review their annuity contracts as soon as possible to determine the impact of the SECURE Act restrictions on stretch IRAs. Hopefully, guidance will be issued quickly that offers some relief.
IRA providers should consider taking the following steps in light of the SECURE Act changes:
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Craig A. Bitman