The SECURE Act: Two Changes to Your IRA
On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) was signed into law. This new law impacts 401(k) plans, college 529 plans, and tax extenders. But it is the impact on IRAs that I want to focus on today since that will affect a larger number of families. I will not address every change to IRAs in this article; instead, I will focus on what I think are the two largest planning opportunities.
Death of the Stretch
[I would like to note that the changes regarding stretch IRA rules affect non-spouse beneficiaries (i.e., children, grandchildren, nieces and nephews—anyone except the spouse). If a spouse inherits an IRA, they will not have to follow these rules.]
Before January 1, 2020, a non-spouse beneficiary could take the required minimum distribution (RMD) from the IRA over their life expectancy. If your child or grandchild inherited your IRA, they could have potentially stretched the tax payments out for 30 or 50 years! This was where the name “stretch” came from since one could stretch out the distributions for a long time and keep their tax bill lower each year.
This ability now changes with the SECURE Act. The new law introduces a 10-year requirement for distributions: A non-spouse must now take all the money from an inherited IRA within 10 years of the death of the IRA owner.
There are exceptions to the rule, including for disabled beneficiaries, chronically ill beneficiaries, individuals not more than 10 years younger than the IRA owner, and minor children of the IRA owner. (For minor children, the 10-year clock starts when they reach the age of majority.)
Two Planning Implications
As I have written in the past, people who retire with more than 50% of their assets in IRAs or other defined contribution plans [e.g., 401(k), 403(b)] are setting themselves up for a higher tax bill in retirement because the more they pull from these assets, the higher the tax bill. The trade-off was that, as an inheritance tool, they could leave these accounts to heirs and have them pay lower tax bills over those heirs’ life expectancies (assuming those heirs would be in lower tax brackets). With the new 10-year rule, this becomes more problematic.
The first planning implication moving forward: Roth conversions might become more interesting for these people. If you know that your heirs, due to the 10-year rule, have to take out large distributions that will force them into higher tax brackets than what you currently pay, it might make sense to pay some tax early, at lower rates than your heirs but higher rates than you might have done so before the SECURE Act, via a Roth conversion (or simply a distribution you spend or reinvest).
Keep in mind, however, that you could go overboard here if you took money out at rates that would be higher than your heirs’ rates. To this point, the SECURE Act is kind of a communication tool; more family discussion will be needed about each generation’s circumstances (i.e., tax brackets) if you want to pass assets as efficiently as possible.
The second planning implication moving forward: Review your estate plan. Under the old rules (stretch IRA pre-January 1, 2020), many estate plans had language that said the IRA could continue as an inherited IRA (thus extending tax deferral) if it made RMDs that were passed through the trust to the living beneficiary (and thus taxed at their individual tax rates).
Under the new 10-year rule, the only RMD is in the 10th year (years one through nine are not mandated distribution years even though you could use them for distributions). Thus, under the new rule, a large tax bill could be due in the 10th year versus spreading it out more evenly over 10 years. And if you have a trust that says the distribution must stay in the trust (versus distributing it out to a living beneficiary), you could have an even higher tax bill since trust tax brackets accelerate faster than individual brackets. It is important to contact your attorney sooner, rather than later, to inquire about any changes needed to your estate plan.
RMDs at 72
The second issue facing IRA assets is the change in RMD timing. Under the old rules, RMDs had to start at age 70 ½. Under the SECURE Act, they now start at 72.
You can still delay this first RMD until April 1 of the year following the year you turn 72, although you still would need to pull a second RMD that year for age 73 as well, so be careful of your tax bracket.
Planning Implication of RMDs at 72
This change now allows for extra time where someone can potentially use Roth conversions (or outright distributions) in lower tax brackets. I use the word “potentially” because you will have started taking Social Security at 70 (assuming you deferred until then) along with other income, so you will need to be more careful of which tax brackets you fall in. Additionally, extra income could increase Medicare premiums or affect other tax issues.
Yet, for those with large IRA assets, this extra time could help to deplete the IRA that much more. One rule that was not changed that could help in this is the qualified charitable distribution (QCD). A QCD allows you to give up to $100,000 of an IRA each year, starting after you turn 70 ½, directly to a charity, and it will not be taxable to you (nor is it deductible on your tax return since you are giving away pre-tax assets).
If you have charitable intent, a QCD could help deplete your IRA that much more if you don’t need to rely on it for all your retirement income. Also note, starting at 72, this QCD qualifies as your RMD up to the $100,000 (so if your RMD is over that, you would need to distribute the difference to yourself and pay the taxes attributable to that).
As with all changes to tax law, it is better to get out front on planning issues versus finding out later that you could have done something but now it’s too late. Contact your financial advisor, accountant, and attorney as soon as possible.
Secondly, consider how these changes will affect the next generation of your family. As I noted above, some of these changes affect multi-generational wealth transfer. It is going to be more important to have discussions with children and grandchildren about their situation so that you handle yours efficiently.
If you have questions or would like to learn more, contact Jon Meyer at email@example.com
The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.