Our Congress and President worked together last year to pass into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act, providing sweeping (and mostly beneficial) changes to retirement plans, but without substantial media coverage. The changes are important for anyone who owns retirement assets (think IRA, 401k, Roth, small business plans) or is a beneficiary of retirement assets, so we are highlighting the biggest changes here, and will continue to bring you strategies and opportunities created by the SECURE Act as the nuances of the law unfold.
GOODBYE, STRETCH IRA
If you have never inherited an IRA, you may not have even known about the Stretch IRA, which was a brilliant option for non-spouse beneficiaries (such as children) to withdraw inherited IRAs over their life expectancy. Every dollar that comes out of an IRA is taxable as ordinary income, so if an adult child in the height of their earning years inherits an IRA, all of which is taxable, it can cause a large amount of the IRA to be shuffled off to the government in the form of taxes. Imagine a couple in their 50s who have a combined annual income of $250,000. If they inherit a $1,000,000 IRA and distribute all of it one year, they will be in the highest tax bracket, and 37% of the IRA will go to the IRS. The Stretch IRA allowed the beneficiaries to stretch the distribution over their lifetime (which presumably would have been decades), meaning that they could control the taxation much more effectively. While some of the distributions would have still been in their peak earning years and taxed at a high rate, if their taxable income dropped after retirement, those later withdrawals would be taxed at a lower tax rate. Importantly, the IRA would also continue to grow over their lifetime. As you can imagine, all of this was good for the taxpayer but not for the IRS, which had to wait decades to receive its taxes on the IRA.
Beginning this year, the SECURE Act eliminates the Stretch IRA for many beneficiaries, and instead requires that the beneficiary withdraw the funds by December 31 of the tenth year after the death of the IRA owner. The beneficiary can also choose to withdraw during the ten year period, or can delay it all until the tenth year. Imagine the couple above in their 50s who would have benefitted from using the inherited IRA as part of their income plan once they retired. Now they will be forced to withdraw it all while working, at a high tax bracket. They can certainly reinvest the after-tax dollars, but the pile of money they will have will be about a third smaller due to taxes.
One of the interesting planning tools under the Stretch IRA was the use of a trust to direct your IRA assets after death. Combining a trust and the stretch IRA allowed for both control of the assets after death, and ongoing tax deferral - two things that are commonly at odds with each other during estate planning. With the new ten year requirement, using a trust as an IRA beneficiary may actually cause more problems than it solves for some families. The bottom line is that anyone who lists a trust as a beneficiary of a retirement asset should review other options with their estate attorney and financial advisor. Now that the trust may no longer provide such a clear answer for some families that want to plan well for future generations, options such as Roth IRA conversions and life insurance trusts may become more beneficial.
In the meantime, it is important to note that the Stretch IRA remains an option for the following Eligible Designated Beneficiaries:
- Minor children (but importantly, not grandchildren)
- Those who are disabled (according to IRS guidelines)
- Chronically ill individuals
- Individuals not more than 10 years younger (i.e. a sibling)
We will explore these scenarios in more detail in upcoming blogs.
IRA CONTRIBUTIONS AND DISTRIBUTIONS ARE MORE FLEXIBLE
In a nice acknowledgment of people living and working longer, the options to contribute to and distribute from your IRA have changed. The age limit on making a traditional IRA contribution has been eliminated, where previously you had to stop at age 70 ½. Now you just need to have earned income (i.e. working income from a job, not from Social Security or investments) to make a contribution.
You can also delay your Required Minimum Distribution (RMD) to age 72. Previously you had to start it at age 70 ½, so now you have another 18 months that you can defer paying taxes. If you turn 70 ½ in 2020, you can now delay your RMD until you turn 72.
Interestingly, IRA owners who are now 70 ½ (but under the new law do not yet have to take their RMD until they are 72) can make a Qualified Charitable Distribution (QCD) to their favorite charity, up to the limit of $100,000. The QCD is a tax neutral distribution from your IRA to a nonprofit, which was previously only reserved for those taking RMDs. Instead of taking a taxable distribution, sending a check to a nonprofit, and then using the contribution as a deduction, the distribution is directed to the charity and bypasses taxation all together.
In future blogs we will explore other parts of the SECURE Act, including:
- New retirement plan options for small business owners.
- Updated rules for part-time workers.
- Retirement plan withdrawal options for new parents.
- New ways to use 529 plan funds.
- Opportunities to use your retirement plan for income after you stop working.
Next steps to consider:
Review your retirement account beneficiary listings, and encourage your parents to do the same. If the beneficiary is a trust, please contact your financial advisor and/or estate attorney to determine if it needs to be updated.
Send this blog to friends and family who own retirement assets or are a beneficiary of a retirement asset.
If you have specific questions, please email them to us at email@example.com.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.