2024 Year-End Estate Planning: Retirement Planning

The Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act), was originally signed into law on December 20, 2019. Intended to assist and encourage Americans in saving and investing for retirement, the SECURE Act incentivizes retirement planning by providing Americans with more choices for retirement saving, as well as increasing access to tax-advantaged savings plans. On December 29, 2022, the SECURE Act 2.0 (SECURE 2.0) was signed into law as part of the Consolidated Appropriations Act, 23, with SECURE 2.0 intended to build upon the original SECURE Act. SECURE 2.0 brings major changes to the administration of IRAs, both during the lifetime of the IRA account holder and after the account holder's death. The IRS released the final regulations for SECURE 2.0 on July 19, 2024.

SECURE 2.0 and the final regulations create a new structure for individual retirement accounts (IRA) required minimum distribution (RMDs) for all IRA owners and the IRA owner's designated beneficiaries. With SECURE 2.0, the required beginning date (RBD) for the start of RMDs is delayed as follows to April 1 of the year following the year in which the individual turns: (i) age 72 for an individual who was born in calendar year 1950 or earlier (note that the RBD is still age 70 1/2 for those who attained age 70 1/2 prior to December 31, 2019); (ii) age 73 for an individual who was born on or after January 1, 1951 and before December 31, 1959; and (iii) age 75 for individuals who were born in calendar year 1960 or later. Further, 2.0's finalized regulation clarified that the RBD for individuals born in calendar year 1959 will be age 73 (as individuals born in 1959 previously had two RBDs, age 73 and age 75).

The finalized SECURE 2.0 regulations formalized a new "10-year rule" pertaining to RMDs by beneficiaries of inherited IRAs. Designated beneficiaries of inherited IRAs are classified as either "Eligible Beneficiaries" or "Non-Eligible Beneficiaries." Individual Eligible Beneficiaries include surviving spouses, disabled and chronically ill persons, minor children of the original IRA owner or persons not more than 10 years younger than the original owner. Individual Non-Eligible Beneficiaries encompass a broader class of beneficiaries and include most non-spouse beneficiaries.

The 10-year rule requires that an individual Non-Eligible Designated Beneficiary who inherits an IRA from an account owner who died prior to the original account owner's RBD fully distribute the inherited IRA on or before the end of the 10th anniversary of the original account owner's death. During the 10-year period, Non-Eligible Beneficiaries are required to take, at a minimum, stretch-style distributions each year until year-end of the calendar year that includes such 10th anniversary, at which year-end the IRA must be fully distributed. With respect to a Non-Eligible Beneficiary who inherits from an IRA owner who has already begun taking distributions, the remaining interest in the IRA must be distributed at least as rapidly (the ALAR Rule) as the original account holder was taking distributions as of his or her date of death. This means that an inherited IRA can be subject to both the 10-year rule and the ALAR Rule.

Eligible Designated Beneficiaries are not subject to the 10-year rule and may choose between traditional stretch distributions and the 10-year rule (although the plan administrator can restrict options). The surviving spouse of a deceased account holder will be able to elect to have the inherited account treated as their own. However, the finalized regulations do require a surviving spouse to take "hypothetical RMDs" if the 10-year rule treatment is not elected. If a surviving spouse initially elects 10-year rule treatment on the inherited IRA but subsequently elects a spousal rollover of said account, the surviving spouse will be required to take make-up payments of the hypothetical RMDs to the current date.

For purposes of determining whether an Eligible Designated Beneficiary is a minor under a 10-year rule analysis, an Eligible Designated Beneficiary is a minor until age 21. Upon attaining age 21, the 10-year rule applies to the beneficiary and the beneficiary must take annual stretch-style RMDs during the next 10 years covered by the 10-year rule, just as with an individual Non-Eligible Designated Beneficiary.

Another new feature of SECURE 2.0 and the finalized regulations concerns Roth IRAs. Under SECURE 2.0, if the entire IRA interest is held in a designated Roth account, a Non-Eligible Beneficiary subject to the 10-year rule will not be required to take a distribution in the first nine years after inheriting the IRA but rather can take the entire distribution in year 10. Please note, however, that a Non-Eligible Designated Beneficiary can only elect this treatment if the entire IRA interest must be held in a designated Roth IRA.

SECURE 2.0 has also brought about significant changes to trust beneficiaries of IRAs. SECURE 2.0 classifies most trusts as Non-Eligible Designated Beneficiaries, subjecting most trusts to the 10-year rule and creating complications if a trust is named as a beneficiary of an IRA. However, SECURE 2.0 permits certain trusts to take stretch-style distributions, as discussed below.

Whether a trust beneficiary of an inherited IRA is subject to SECURE 2.0's 10-year rule or can take traditional stretch-style distributions requires an analysis of the trust's underlying beneficiaries. If a trust is classified as a "see-through" trust, the trust's beneficiaries will be deemed to be the ultimate beneficiaries of the inherited IRA. Generally, SECURE 2.0 creates two categories of see-through trusts for RMD purposes. The first such trust is called a "conduit trust," meaning a trust in which all distributions from an IRA are required to be distributed to specific beneficiaries pursuant to the original IRA owner's estate plan. The other type of trust is known as an "accumulation trust," whereby distributions from an IRA are allowed to accumulate in trust, and all trust beneficiaries are treated as beneficiaries of the inherited IRA.

As the 10-year rule applies to most trusts, an analysis of a trust's beneficiaries is required to determine whether such beneficiaries qualify as an Eligible Designated Beneficiary or a Non-Eligible Designated Beneficiary. Just like with individuals who inherit an IRA, most non-spouse beneficiaries of a trust that inherit an IRA will be subject to the 10-year rule and designated as a Non-Eligible Beneficiary. Further, trusts that divide on the original IRA holder's death will require an analysis of each subtrust. By way of example, a trust that divides into five separate subtrusts on the account holder's death will require five separate analyses as to whether each trust is an Eligible Designated Beneficiary or a Non-Eligible Designated Beneficiary. In addition, and as is the case with individuals, the ALAR Rule applies to inherited IRAs where distributions have already started. Traditional stretch-style distributions are generally available to trust beneficiaries who would otherwise qualify as Eligible Designated Beneficiaries.

SECURE 2.0 permits irrevocable trusts benefitting a chronically ill or disabled individual to take traditional stretch-style distributions if such trust is an "applicable multi-beneficiary trust" (AMBT). An AMBT limits distributions to the chronically ill beneficiary during his or her lifetime (and then can subsequently make payments to other beneficiaries). SECURE 2.0 allows a qualified charity to be designated as the remainder beneficiary of an AMBT inheriting an IRA and for the qualified charity to take traditional stretch-style distributions following the death of the trust's initial beneficiary.

SECURE 2.0 and the finalized regulations have also provided new rules regarding the exercise of a power of appointment (POA) for beneficiaries of see-through trusts. SECURE 2.0 permits a beneficiary to hold and exercise POA over his or her trust following the death of the original IRA account holder. SECURE 2.0 permits the powerholder/beneficiary to both exercise their POA by September 30 of the year of the original IRA owner's death or modify their POA to a restricted group of identifiable individuals. Any such exercise or modification by the powerholder/beneficiary will cause the newly named individuals to be considered beneficiaries of the IRA.

In terms of required documentation for plan administrators, SECURE 2.0 requires the trustee of a trust designated as the beneficiary of an IRA to provide the plan administrator either (i) a copy of the trust instrument, or (ii) a list of all beneficiaries of the trust (describing how and when a beneficiary is entitled to a distribution).

With respect to RMDs for years prior to January 1, 2025, IRS Notice 2024-35 provides that the IRS will not impose penalties for failure to take an RMD for years one through nine from an inherited IRA that is otherwise subject to the 10-year rule. Otherwise, the final SECURE 2.0 regulations confirm the prior SECURE 2.0 penalties. Starting January 1, 2025, failure to take an RMD from an inherited IRA will result in a penalty of 25 percent of the RMD amount, reduced to 10 percent if timely corrected.

The SECURE 2.0 provides a few changes to catch-up contributions to certain retirement plans for individuals age 50 or older. High-income employees over age 50 (those who earn more than $145,000, indexed for inflation) must make any "catch-up" contributions into a designated Roth account in such plans. Individuals over age 50 who earn less than $145,000 can continue making any catch-up contributions directly to their regular 401(k) account. Under the SECURE Act 2.0, catch-up contribution levels are now indexed for inflation. Note that the IRS has delayed the effectiveness of these rules until January 1, 2026.

SECURE 2.0 permits a beneficiary of a 529 Plan to make a tax-free rollover of any remaining funds into a Roth IRA (not to exceed the annual Roth IRA contribution limit), provided that the 529 Plan account has been open for at least 15 years and the funds used for the rollover have been in the 529 Plan for at least five years. The lifetime amount a beneficiary can rollover from their 529 Plan to a Roth IRA tax-free is $35,000, and such an amount is not indexed for inflation.

Another feature of SECURE 2.0 is the ability for an account holder to withdraw up to $1,000 from their account for certain emergency expenses (generally defined as an unforeseeable or immediate financial need relating to personal or family expenses) without incurring a 10 percent early withdrawal penalty. There is also an option to repay the distribution within three years. If the withdrawn emergency amounts are not repaid during that three-year window, no additional emergency distributions will be allowed.

SECURE 2.0 has slightly modified the rules governing qualified charitable distributions (QCDs). A QCD is a payment by an IRA account holder directly from the IRA to a qualified charity. Individuals aged 70 1/2 or older can contribute an amount not to exceed $100,000, now indexed for inflation and $105,000 in 2024, to a qualified charity.