With the SECURE Act now in effect, it’s important for active workers and retirees alike to revisit retirement and estate planning to determine how nuances of this legislation may impact your individual situation. Below for high level reference is an overview of the key elements of the Act. As we continue to dissect this complex topic, our wealth advisors will provide supplemental insights about specific components of the SECURE Act in the coming months with additional suggestions on how the legislation may impact your family.
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Effective January 1, 2020, the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act makes major changes to retirement plans and how certain retirement benefits must be treated by beneficiaries of inherited plans. This new law is designed to help Americans save more towards their retirement and prevent older Americans from outliving their assets.
However, not all provisions in this new law are perceived to be a benefit. One provision, in particular, is expected to accelerate future taxation of inherited accounts. Investors who intend to hand down retirement assets in a will or to a designated IRA beneficiary should be aware of this new tax law change and consult their professional advisors (estate attorney, investment advisor, CPA) regarding implications for their specific situation.
Removal of Inherited “Stretch” Provisions
The single biggest tax revenue generator in the SECURE Act comes from the removal of so-called “stretch” IRA provisions. In the past, a non-spouse beneficiary of an IRA or defined contribution plan like a 401(k) could stretch out required minimum distributions (RMDs) from the plan over their own life expectancy. However, as of January 1st, a non-spouse beneficiary will only have 10 years after the year of death to distribute the entire retirement account. This 10-year rule applies to both traditional (tax-deferred) and Roth (tax-free) accounts. Exempted from the 10-year provisions are Eligible Designated Beneficiaries, which include surviving spouses, minor children up until the age of majority, individuals within 10 years of age of the deceased, the chronically ill and the disabled.
Eliminating the “stretch” IRA severely compromises decades of potential growth (tax-deferred or tax-free) realized by IRA beneficiaries. More importantly, the accelerated distributions subject beneficiaries to higher taxable income (and higher taxes). This will be especially harsh if the beneficiary is currently generating taxable income of their own. If so, the added income from the accelerated withdrawals could be taxed at an even higher rate.
Preparing for the Death of the “Stretch IRA”
The law changes resulting from the SECURE Act are so significant that every plan holder should review how their estate plans may be affected. If the beneficiary of a retirement plan is an individual, then the entire plan balance will have to be paid out by the 10th anniversary of the plan holder’s death. This accelerated 10-year distribution plan may not be in the best interest of the beneficiary. It can result in an individual receiving a large lump sum payment, thereby exposing that payment to an imprudent beneficiary, a divorce, or creditors, and contrary to what the original plan holder wanted.
To this end, plan holders may want to rethink and restructure planning for their retirement accounts. They should review their plan beneficiary designation and consult professional advisors if their situation is complex. IRA owners who have named a conduit trust as beneficiary may consider changing it to an accumulation trust. Doing so may help avoid a large lump sum distribution after 10 years. In other situations, the plan holder might wish the plan assets to pass into a charitable remainder trust (CRT). If an IRA owner had bequeathed their IRAs to grandchildren to maximize the stretch, they might consider leaving the IRA assets to children who will obtain the same 10-year deferral.
Planning Considerations to Avoid Future Taxes on Inherited IRAs – Roth Conversions
Under current tax laws, Roth IRA Conversions are a technique where taxes are paid on the conversion from a traditional IRA to a Roth for the benefit of future tax free growth. In some scenarios, Roth IRA conversions can be an effective strategic planning tool to mitigate the impact of future taxes related to the removal of the stretch IRA. Since there is no income tax consequence to a lump sum distribution in year 10 of an inherited Roth IRA, the tax bite of the 10-year rule might be reduced. Another catalyst for Roth Conversions is the lower marginal tax rates – as well as the potential for higher future rates. It might also be a benefit to stage Roth conversions over several years to avoid the punitive tax impact of a single year lump sum conversion.
Planning Considerations to Avoid Future Taxes on Inherited IRAs – CRT
If the investor is charitably inclined, another option is for the investor to change the designated beneficiary of a traditional IRA to a charitable remainder trust (CRT). On death, the CRT can be the beneficiary of the IRA and payments would be made to the CRT income beneficiary. This approach might meet the plan holder’s intent of stretching payments to beneficiaries over many years. There are more complex CRT variants which might be considered with the help of a professional advisor.
New Required Beginning Date for RMDs at 72
Prior to the SECURE Act, investors were required by law to take annual required minimum distribution (RMDs) from tax-deferred accounts such as traditional IRAs and 401(k)s beginning at age 70½. The new law allows investors to delay RMDs of tax-deferred accounts to age 72. While the investor’s RMD must be satisfied prior to any Roth conversion, this provision of the new law makes it easier for Americans to convert additional tax-deferred assets to Roth IRAs in their senior years.
Removal of Age 70½ IRA Contribution Restriction
The SECURE Act removes the age cap for contributing to traditional IRAs, currently 70½, for individuals with earned income. The new law paves the way for the growing number of Americans staying on the job into their 70s and beyond to continue saving in individual retirement accounts.
The SECURE Act provisions are complex and ramifications are still being reviewed and analyzed. The SECURE Act includes a number of other provisions not addressed here that are also relevant to retirement and estate planning. It is important that investors evaluate options in a holistic manner considering the many ripple effects of both the SECURE Act and any changes to one’s estate planning.