Congress has passed and President Trump has signed into law significant retirement reform which will go into effect on 1/1/2020. The new law has many provisions which involve expanding and preserving retirement savings, administrative improvements, and revenue provisions.
Listed below are some of the more important reforms of the new law. These provisions will affect retirement planning of both employer-provided defined contribution qualified plans (i.e. 401(k) plans) and IRAs:
- The law repeals the age limit (70 ½) on contributions to a traditional IRA for individuals with earned income. Individuals at any age will be able to make deductible IRA contributions.
- The law encourages qualified Defined Contribution Plans (i.e. 401(k) plans) to offer annuity products (deferred annuities and immediate annuities) as an asset choice within the plan. These products are classified as “lifetime income investments” that offer a “lifetime income feature”.
- The law increases the Required Beginning Date (RBD) from age 70 ½ to age 72 for Required Minimum Distributions (RMD) using the Uniform Lifetime Table.
- The law requires annual benefits statements to be provided to Defined Contribution Plan participants which must include a lifetime income disclosure. The disclosure would illustrate the payments a participant would receive if the total account balance were used to provide lifetime income streams, including a single life annuity and a joint survivor annuity for a participant and spouse.
- The law provides a fiduciary “safe harbor” for selection of lifetime income providers by qualified defined contribution plans. Under the law, fiduciaries are afforded a “safe harbor” to satisfy the ERISA prudence requirement with respect to the selection of insurers for guaranteed retirement income contracts. Fiduciaries are protected from liability for any losses that may result to the participant or beneficiary. Removing ambiguity about the applicable ERISA fiduciary standard eliminates a roadblock to offering lifetime income benefit options under a defined contribution plan.
- The law makes significant changes regarding post-death “inherited” distributions to beneficiaries (aka “stretch” IRAs). The law states that only “eligible designated beneficiaries” will have the option to stretch an inherited distribution over their life expectancy. A surviving spouse is an “eligible designated beneficiary”. With minor exceptions, non-spouse beneficiaries (i.e. adult children and grandchildren) are NOT considered to be an “eligible designated beneficiary”. This means that the “inherited” IRA concept for non-spouses is limited to only 10 years under the new law. The account must be fully distributed within 10 years of the death of the IRA owner. There is a significant penalty tax for “inherited” accounts that have not been fully distributed within 10 years. So, the lifetime “inherited IRA” stretch option for non-spouse beneficiaries that has been available under the law for over 30 years has been repealed. Those non-spouse beneficiaries already receiving stretch IRA payments or eligible to receive stretch IRA payments due to an IRA owner’s death prior to 1/1/2020 may continue to receive lifetime inherited payments if desired. As described above, non-spouse beneficiaries who inherit an IRA from an IRA owner who dies after 12/31/2019 are limited to a 10-year payout only.
Certain alternative planning options may be available due to the much shorter number of years (10) available for post-death distributions to non-spouse beneficiaries. One option may be to take after-tax distributions from a large balance IRA and use the cash as annual premiums for a no-lapse GUL or SGUL life insurance policy. The actuarially leveraged death benefit is income tax-free and may be estate tax-free if owned by an Irrevocable Life Insurance Trust (ILIT). Also, the internal rate of return (IRR) at life expectancy is outstanding when compared to alternative non-guaranteed fixed assets such as money markets, bond funds, and U.S. government securities. This tax-free insurance can make up for and offset the loss of the lifetime inherited IRA distribution option for a non-spouse beneficiary.
Another planning option may be to increase after-tax purchases of non-qualified annuity products which are not affected by the new law. Death distributions under IRC Section 72(s)(2) may still be paid over the life expectancy of an individual non-spouse beneficiary if distributions are started within one year of death. Since non-qualified annuities have a cost basis and there is no stepped-up basis at death, part of post-death inherited distributions will be taxable to the beneficiary and part will be tax-free.
Russell E. Towers JD, CLU, ChFC
Vice President – Business & Estate Planning