2020 Estate Planning Update
What you need to know: The Setting Every Community Up for Retirement Enhancement (SECURE) Act went into effect on January 1, 2020. The most significant provisions of the SECURE Act involve changes to the withdrawal requirements for inherited retirement assets.
10-Year Withdrawal Requirement: Prior to the SECURE Act, beneficiaries of inherited retirement plans were generally permitted to take distributions over the course of their own lifetimes. As the beneficiaries of tax deferred plans (including 401(k) plans and other defined-contribution plans, defined-benefit pension plans, and traditional IRAs) only paid income tax on the distributions as received, they were potentially able to “stretch out” the income tax-deferral benefits of these retirement plans over a long period of time.
Subject to certain exceptions described below, the beneficiaries of inherited retirement plans will now be required to withdraw all assets from an account within ten years after the death of the account owner. There are, however, no set annual withdrawal requirements. The entire amount can be taken out in the final year, if desired. Note that, although the accelerated withdrawal requirements apply to Roth IRAs, because distributions from Roth IRAs are not subject to income tax, the accelerated income tax consequences are not a concern.
Exceptions to the 10-Year Withdrawal Requirement:
Spousal Beneficiary: A surviving spouse named as an outright beneficiary of a retirement account may still “stretch” the Required Minimum Distribution (“RMDs”) over the spouse’s lifetime (or may roll over inherited benefits into the spouse’s own IRA). The RMDs may also be made over the lifetime of a surviving spouse if a trust for the benefit of the spouse is named as the beneficiary of a retirement account, so long as the trust meets certain requirements (for example, the trust must provide that each year the spouse is to receive at least the greater of all of the trust income or the RMD amount). Note that a Roth IRA left to a surviving spouse may not require any withdrawals during the surviving spouse’s lifetime.
Minor Beneficiaries: The ten-year requirement does not apply to minor children of the deceased IRA owner, but applies once a child reaches the age of majority (as determined by state law), at which point all of the plan assets must be withdrawn within ten years thereafter.
Disabled Beneficiaries and Beneficiaries Who Are Close in Age to the Account Owner: Beneficiaries who are disabled or chronically ill, or who are not more than ten years younger than the deceased account owner (such as a sibling of the account owner), and trusts for such persons (if certain requirements are met) may continue to stretch distributions over the life expectancy of the beneficiary.
Account Owner Died Prior to 2020: If the account owner died prior to January 1, 2020, the above-described changes to the withdrawal requirements do not apply to the account owner’s beneficiary. When that beneficiary subsequently dies (after 2019), distributions of any remaining funds to new beneficiaries will be subject to the SECURE Act.
Surviving spouses of account owners who died in late 2019 may consider disclaiming retirement accounts to contingent beneficiaries in order to take advantage of the life expectancy RMDs still available to such contingent beneficiaries.
Impact on Retirement Assets Payable to Trusts: So-called “conduit trusts” have until now been an effective way of minimizing the income tax effect of RMDs without giving beneficiaries unfettered control over retirement assets. With a conduit trust, all RMDs received by the trust must be distributed to the beneficiary at least annually. Withdrawals in excess of the RMD may be made in the discretion of the Trustees, although any additional amount withdrawn must also be distributed.
The beneficiary is then taxed on the income at his or her individual rate, which may be significantly lower than the trust’s income tax rate. Beneficiaries who are subject to the new ten-year payout rule (e.g., children and grandchildren who do not meet any of the exceptions described above) will now have to realize a significant amount of income over a shorter period of time. Further, conduit trusts for such beneficiaries no longer provide for the long-term control or protection of retirement assets by Trustees who were previously able to determine when, whether, and in what amounts (if any), to make withdrawals in excess of RMDs.
One potential solution is for the account owner to change his or her beneficiary from a conduit trust to an “accumulation trust” while he or she is alive. Although the ten-year payout would still apply with an accumulation trust, RMDs are paid to and held within the trust, and the trust can continue to hold retirement assets even after the retirement account has been terminated by total distribution. The terms of an accumulation trust may provide that the Trustee has complete discretion over distributions to the beneficiary or beneficiaries. Income accumulated in the trust will be taxable at the trust’s income tax rate, which may well be higher than the beneficiaries’ respective tax rates, but any distributions to the beneficiaries will carry out income and be taxed to the beneficiaries, as with a conduit trust.
Other Important SECURE Act Provisions:
Increased Age for Minimum Required Distributions: The SECURE Act increases the age at which an account owner must begin taking RMDs from his or her own retirement plans (including 401(k) plans and traditional IRAs) to 72 for account owners dying on or after January 1, 2020. Unfortunately, if the account owner reached age 70½ on or before December 31, 2019, then he or she remains subject to the prior distribution rules requiring the account owner to begin (or continue) to take RMDs as previously required. Note: There are no required distributions from one’s own Roth IRA.
No Maximum Age for Contributions: Employees with earned income may make tax deductible contributions to their retirement plans regardless of age (previously contributions after age 70½ were not tax deductible).
Expanded 529 Plans: The SECURE Act expands the permitted use of 529 Plan assets by permitting payments for certain apprenticeship programs and by allowing withdrawals of up to $10,000 (lifetime limit) to repay the 529 Plan beneficiary’s qualified student loans. Each of the beneficiary’s siblings may use an additional $10,000 to repay his or her student loans. Note: to the extent 529 Plan assets are applied to pay interest, that interest will not be eligible for a student loan interest deduction.
Changes to the Kiddie Tax Rules: The SECURE Act repeals the unfavorable changes made under the 2017 Tax Cuts and Jobs Act to the “Kiddie Tax” (the tax on unearned income, i.e., dividends, capital gains and interest, of certain children). Going forward, a child’s unearned income will again be taxed at the parents’ marginal rate, rather than at the potentially higher trust and estate tax rates.
What to do: Account owners should carefully review their beneficiary designations to ensure that they continue to meet objectives. In particular, estate plans containing trusts intended to receive retirement assets should be re-examined in response to the SECURE Act.
For questions about the SECURE Act and how these changes may impact your estate planning, please contact a member of Verrill’s Private Clients Group.
Federal and State Tax Update
Federal Gift, Estate, and GST Taxes
IRS issued final regulations addressing clawback concerns: Absent further action from Congress, the unified gift and estate tax exclusion amount is set to be reduced back to approximately $5,000,000 per individual (adjusted upwards for inflation) in 2026. On November 22, 2019, the Internal Revenue Service issued final Regulations to protect taxpayers who make large gifts during the interim period where the higher exclusion amount applies (if it is not renewed or made permanent). In the event of a decrease in the unified exclusion, taxpayers dying in 2026 and beyond will not face a tax liability for lifetime gifts that were exempt from tax when made due to the increased exclusion amount available from 2018-2025. Spouses of decedents who die during the interim period are still able to elect portability to preserve the higher exclusion amount.
Federal unified gift and estate tax exclusion increased to $11,580,000: As of January 1, 2020, an individual may give up to $11,580,000 (increased from $11,400,000 in 2019) during life or at death without incurring any federal gift or estate tax. Married couples may give up to $23,160,000 (increased from $22,800,000 in 2019). State death taxes paid are deductible from the federal gross estate for estate tax purposes. Federal estate and gift tax are assessed at a flat rate of 40%.
Planning Opportunity: Clients may consider making lifetime gifts to lock in use of the current large exemption amount. Gifts may be made outright, to an irrevocable trust, or may take other forms, such as the forgiveness of intra-family loans. Note that gifts of cash or high-basis assets are optimal, because the recipient of a lifetime-gift takes the donor’s cost basis for capital gain purposes, while the recipient of a gift from a decedent’s estate receives a new cost basis equal to fair market value as finally determined for federal estate tax purposes.
GST tax exemption increased to $11,580,000: As of January 1, 2020, an individual may transfer up to $11,580,000 (increased from $11,400,000 in 2019) during life or at death without triggering the generation-skipping transfer (GST) tax. Married couples may give up to $23,160,000 (increased from $22,800,000 in 2019). The GST tax is an additional, flat tax assessed at the highest applicable federal estate tax rate (currently 40%) on transfers to persons two or more generations below the donor (i.e., to grandchildren or more remote descendants). As with the unified gift and estate tax exclusion, the GST tax exemption amount is set to be reduced back to approximately $5,000,000 (adjusted for inflation) in 2026.
Planning Consideration: Clients whose existing estate plans tie distributions upon death to the amount of estate tax or GST tax exemption available at the time of the donor’s death may now wish to review such plans to avoid unintended results. For example, a plan that provides that all GST-exempt property be distributed outright or in trust for grandchildren may result in a larger-than-intended distribution to the donor’s grandchildren (especially prior to 2026), and a smaller-than-intended distribution to the donor’s children.
Gift tax annual exclusion remains at $15,000: In 2020, an individual donor may make annual gifts of up to $15,000 per recipient without incurring gift or GST tax, and without using any of the donor’s federal unified gift and estate tax exclusion or GST tax exemption. Married couples may make annual exclusion gifts in 2020 of up to $30,000 per recipient, treating gifts made to third parties as if one half had been made by each spouse, if the spouses file a federal gift tax return to effect “gift splitting.”
Annual exclusion for gifts to noncitizen spouse increasing to $157,000: The annual exclusion for gifts made in 2020 to a spouse who is not a United States Citizen will be $157,000 (increased from $155,000 in 2019).
Federal Income Taxes
Increase in Standard Deduction: For taxable years beginning in 2020, the standard deduction has been increased to $12,400 for individuals, and $24,800 for married couples filing jointly. Deductions for state and local taxes (SALT) remain capped at $10,000.
Deduction Limit for Cash Charitable Contributions: Taxpayers may deduct the full amount of cash contributions to charity as long as the deduction for charitable contributions does not exceed 60% of adjusted gross income (AGI). Deductions for charitable contributions of appreciated securities to public charities are limited to 30% of AGI (20% for contributions to private foundations). Any charitable contributions exceeding the AGI limits may be carried forward, however, and applied for up to five subsequent years, subject to the same percentage limitations, if the taxpayer is still alive.
IRA Charitable Rollover: Taxpayers who have attained the age of 70 ½ prior to January 1, 2020, and who expect that the charitable deduction will be unavailable to them for the 2020 tax year, either because of the increased standard deduction or because of the AGI deduction limits, may wish to consider making a “qualified charitable distribution” (also known as an IRA Charitable Rollover). The IRA Charitable Rollover permits taxpayers who have attained the age of 70 ½ prior to January 1, 2020 to transfer up to $100,000 annually from their IRAs (less the amount of any pre-tax contributions) directly to public charities without recognizing the distributed amount as taxable income (thereby obviating the need for a deduction). Furthermore, any such charitable distribution will also count against the Required Minimum Distribution for the year. Taxpayers may not carry over their unused qualified charitable distribution allowance to the next calendar year.
Qualified Business Income (QBI) Deduction: Non-corporate taxpayers may be able to claim an income tax deduction for their qualified business income (“QBI”). The deduction is generally 20% of a taxpayer's QBI from a partnership, S corporation, or sole proprietorship. QBI is defined as the net amount of items of income, gain, deduction, and loss with respect to a trade or business. QBI doesn't include certain investment-related items, such as capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). Employee compensation and guaranteed payments to a partner are also excluded. Taxpayers whose taxable income exceeds a certain threshold amount are subject to limitations on the deduction.
State Transfer Taxes
Connecticut increased gift and estate tax exemptions to $5,100,000: The Connecticut gift and estate tax exemption has increased to $5,100,000 for 2020. The exemption will continue to increase gradually to the federal exemption amount over the next three years, rising to $7,100,000 in 2021, $9,100,000 in 2022, and the federal exemption amount in 2023. By conforming Connecticut’s exemption to the federal exemption amount, the Connecticut Legislature created the possibility that the Connecticut exemption will decrease if the federal exemption decreases, which it is scheduled to do under current law on January 1, 2026.
In 2020, the Connecticut estate tax will range from 10% to 12%, with no tax whatsoever on the first $5,100,000. The top rate applies for estates in excess of $10,100,000.
Governor Ned Lamont included a repeal of the Connecticut gift tax in his proposed budget for fiscal years 2020-2021, but the Connecticut General Assembly did not adopt such a repeal in its final budget, and Connecticut remains the only state in the nation that assesses a state gift tax. Connecticut does provide a gift tax annual exclusion similar to the federal annual exclusion. In 2020, an individual donor may make annual gifts of up to $15,000 per recipient without incurring Connecticut gift tax. Married couples may make annual gifts of up to $30,000 per recipient without incurring such tax.
Additionally, of important note, the new Connecticut Uniform Trust Code went into effect on January 1, 2020. The Connecticut Uniform Trust Code adopts major revisions to dynasty trusts, domestic asset protection trusts, directed trusts, and statutory trust rules regarding non-judicial settlement agreements, trust merger and division, modification of irrevocable trusts, and other aspects of trust management. This sweeping trust legislation greatly enhances opportunities for the formation, administration and termination of Connecticut trusts.
Maine estate tax exemption increased to $5,800,000 for 2020: In June 2019, the Maine Legislature tabled two bills that proposed to reduce the Maine estate tax exemption to $2,000,000 and $1,000,000, respectively, for estates of decedents dying on or after January 1, 2020, and eliminate annual adjustments for inflation. Maine’s estate tax rates range from 8% to 12%, with no tax on the first $5,800,000 for 2020 (increased from $5,700,000 in 2019). The top rate applies for estates in excess of $11,800,000.
The new Maine Uniform Probate Code (“MUPC”) went into effect on September 1, 2019. The MUPC was enacted in an effort to modernize statutes regarding wills, intestacy, guardianships and conservatorships, and other probate related areas of the law.
Massachusetts estate tax exclusion remains at $1,000,000: The Massachusetts estate tax system is complex, with an exclusion—not an exemption—of $1,000,000. On estates valued less than $1,000,000, but for all others, tax must be remitted on the full amount, not just the amount over $1,000,000, creating a “tax cliff.”
Massachusetts’s estate tax marginal rates range from 5.6% to 16%. The top rate applies to estates in excess of $10,040,000.
New York estate tax exclusion increased to $5,850,000: The New York estate tax exclusion has increased to $5,850,000 for 2020 (up from $5,740,000 for 2019). For estates valued less than $5,850,000, no tax is owed. For estates valued between $5,850,000 and $6,142,500, New York estate tax is owed on the amount in excess of $5,850,000. Estates exceeding more than 5% of the exclusion amount (i.e., for 2020, estates exceeding $6,142,500) are taxed on the full value of the estate, creating a “tax cliff.”
As part of the New York Fiscal Year 2020 Budget, New York has retroactively reinstated the three-year clawback on lifetime gifts through December 31, 2025. This means that gifts made within three years of death will once again be re-included for purposes of calculating the New York gross estate. There are several exceptions to the clawback rule. Certain gifts are not included in a decedent’s gross estate, such as gifts made between January 1, 2019 and January 15, 2019 (the period prior to the announcement of Governor’s executive budget), gifts made when a decedent was not a New York resident, and gifts of real or tangible personal property located outside of New York.
New York’s estate tax rates range from 3.06% to 16%. The top rate applies to estates in excess of $10,100,000
Please contact a member of Verrill’s Private Clients Group if you have any questions about the SECURE Act, would like to discuss estate planning strategies to plan around your state estate tax exclusion or exemption, or to make use of your federal annual exclusions and lifetime gift, estate and GST tax exemptions, or if you would like to discuss your estate plan generally.