New Rules for Required Minimum Distributions

On December 19, 2019, Congress passed a major tax bill that has retirement and estate planning implications for millions of Americans. The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) made several changes to the rules governing company retirement plans, but even more far-reaching changes were made to the rules surrounding IRA and retirement plan Required Minimum Distributions (RMDs).

The first change made to RMDs was to move the required beginning date to your 72nd birthday rather than the previous age of 70.5. Interestingly, you can still make a Qualified Charitable Distribution (QCD) from your IRA beginning at age 70.5.

The SECURE Act also allows for folks older than 70.5 to continue making contributions to Individual Retirement Accounts (IRAs), which had previously been prohibited. There is a catch, though. If you make deductible contributions after age 70.5, they will reduce your future Qualified Charitable Distributions dollar for dollar. As an example, if you contribute $5,000 to your IRA at age 71, then take your first $10,000 Qualified Charitable Distribution at age 72, the excludable (not included in income) amount of your QCD will be $5,000, not $10,000. The other $5,000 of the IRA distribution will be taxable income, and you can take an itemized tax deduction for a $5,000 charitable contribution.

The largest and most far-reaching change, however, was to the provisions surrounding Required Minimum Distributions for people who inherit IRAs. Before the SECURE Act, if you inherited an IRA from your father, required distributions from that IRA were over your remaining life expectancy. Now, you are required to distribute those funds within 10 years from the date of death of the person who originally owned the IRA.

This change does not apply to spouses; if you inherit an IRA from your spouse, you can basically treat it as though it was always yours and continue making RMDs on your own life expectancy schedule. There are also some other complicated exceptions (for minor children and disabled individuals, among others).

This change has major implications for estate planning. Many people (especially in California) simply listed their trust as the beneficiary of their IRAs (or maybe as a contingent beneficiary). Naming a trust as a beneficiary has always come with some complicated rules about required distributions. Generally, a trust must distribute an IRA within 5 years unless it is specially designed to manage IRA distributions and pay out distributions to beneficiaries over their life expectancies. The new 10-year rule interferes with the operation of these trusts and can have some unfortunate results. For example, if the wording of the trust does not force the trustee to take out RMDs every year, the trust might have to wait until the tenth year, and then take everything out at once. Imagine distributing a $1,000,000 IRA in a single year, rather than ‘stretching’ it out over 10 years. That would be a killer tax bill!

But it gets worse. Suppose the trust either allows or requires the trustee to hold that distribution inside the trust (which many do), the Tax Cuts and Jobs Acts of 2017 set trust tax rates at 37% on any income over $12,950 (for 2020). That means that almost every dollar of that IRA distribution would be taxed at the highest possible tax rate in a single year.

Alternatively, many trusts require the trustee to pay out all the income to a beneficiary in the year it is received. This provision usually envisions dividends and interest on stocks, bonds, and real estate, but is not designed to handle a large IRA distribution, which is considered income under the tax code.

If any of your retirement accounts have a trust as the beneficiary, you should review this setup with your advisor (and probably your estate planning attorney, too). It might be time to re-think your distribution strategy.At Blankinship & Foster, we help our clients navigate requirements such as IRA distributions, and to factor such requirements into your long-term plan to meet your retirement goals. Contact us to learn more about how we can help you.

About Rick Brooks

Rick Brooks, CFA®, CFP® is a partner of Blankinship & Foster LLC and is the firm’s Chief Investment Officer. He is a lead advisor, counseling clients on all aspects of personal financial management. Rick serves on several boards. He is the Chairman of the Board of Girl Scouts San Diego, and also chairs the San Diego Foundation’s Professional Advisor Council. Rick and his family live in Mission Hills. Rick enjoys spending time with his family, theater, cooking, skiing, gaming and reading.

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