Happy “SECURE” New Year!
Security is one of the most basic human needs. According to Maslow’s Hierarchy of needs, it even comes before love and belongingness. The sense of security includes order, law, stability, and protection from the elements. Unfortunately, there are parts of a brand-new tax law titled “Setting Every Community Up For Retirement Enhancement Act” (SECURE Act) that will not fall under Maslow’s definition for many Americans. This major tax law change will become law beginning in 2020.
The law brings with it several changes that can have a significant impact on how planning will need to be done in the future. Some of these changes include:
· No more age limits for making traditional IRA contributions (previously contributions could not be made for the year the IRA owner turned 70-1/2 or later)
· Increases the required date for mandatory distributions (Required Minimum Distributions or RMD) from age 70-1/2 to 72
· Allows penalty free withdrawals from your retirement account for birth or adoption ($5,000 lifetime limit)
· Eliminates the “Stretch IRA” – the Stretch allowed a person who inherited an IRA to take distributions over a longer period of time, perhaps decades
While these changes will have an impact on how we currently plan for retirement and beyond, perhaps the change that will have the biggest impact on you and your family is the elimination of the Stretch. This change is under the radar but could potentially have HUGE consequences for people with SPECIAL NEEDS.
Prior to the SECURE Act, the Stretch IRA was available for all individuals named on the IRA beneficiary forms and for qualifying trusts. This was a tool used in planning to help reduce taxes annually and potentially increase the money you could leave to your loved one with Special Needs. It will now be replaced with a mandatory 10-year payout for all beneficiaries except for 5 “Eligible Designated Beneficiaries.” These exempt beneficiaries are:
· Surviving Spouse
· Minor children (not grandchildren)
· Disabled individuals
· Chronically ill
· Beneficiary not more than 10 years younger than the IRA owner (or plan employee)
Unfortunately, although the law describes “Disabled Individuals” as exempt, the way it is drafted will fail to protect them. When it comes to Special Needs Planning, some people choose to fund a certain type of Trust called the Third-Party Special Needs Trust (a trust funded with assets not owned by the person with special needs). Some people fund it with their IRA or 401K because it is their largest asset; however, Trusts funded with those assets will now need to be revised.
Third-Party Special Needs Trusts are great for people who cannot manage their own affairs, and count on means-tested public benefits. In order to qualify for these benefits, though, the Special Needs Trust must provide the trustee with complete discretion over distributions for the benefit of the beneficiary. To clarify, the individual who is disabled has no authority when it comes to distributions. Because of this, Third Party Special Needs Trust’s almost always require a certain structure that require us to consider not only your loved one with special needs (first-tier beneficiary) but also the contingent, or secondary beneficiaries. This means that UNLESS the beneficiary AND all of the contingent beneficiaries are ALSO disabled, the 10-year exemption will not apply.
This becomes a problem on several levels. Trusts are taxed at a very high rate – any earnings above $12,950 will be taxed at 37% in 2020. The income that is generated but does not get spent on the beneficiary in that year could have the potential to get hit hard when Uncle Sam comes to take his share – and he isn’t even your real uncle! In addition, to qualify for Government benefits that the individual relies on, they must keep their resources below a certain limit. Distributing too much income to try to avoid this tax rate could result in a loss of important Government benefits. The ability to take withdrawals over the disabled beneficiary’s lifetime is important in controlling the amount of taxable income the trust receives each year.
For instance, let’s say you funded your child’s Special Needs Trust with your traditional IRA and 10 years after you passed away it had $100,000 left in it. The retirement account would be required to be fully distributed into the trust and subsequently amounts over $12,950 (for 2020) would be taxed at 37%. This reduces the amount of assets left in the trust for your child’s benefit and treats your child as though they are not the most vulnerable, but rather Bill Gates.
It will be critical for anyone who has named a trust as the beneficiary on their retirement plan to immediately meet with their Special Needs Planning professional to review, and perhaps, revise the trust. Fortunately, there are solutions. If you would like to discuss further, please do not hesitate to reach out to us at Special Needs Advanced Planning Specialists. We are here to help keep the security in your life and the lives of anyone in your life with Special Needs.
This material was created for educational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.