March 12, 2020 - In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act, or the SECURE Act, which has far-reaching consequences for Americans at every stage of their financial planning lives. The SECURE Act is one of the largest overhauls of the U.S. retirement system to date, with sweeping changes that could immediately impact investors' short and long-term retirement planning. Considering the potential tax consequences, we thought we could help cut down on confusion by outlining some of the SECURE Act's major provisions for our clients.
Changes to IRA Required Minimum Distribution Age and Contribution Limits
For those in retirement or close to it, the SECURE Act is important when considering IRAs and access to certain tax-advantaged accounts. The Required Minimum Distribution Age (RMD) has been extended from 70 ½ to 72, which allows for continued contributions and growth of IRAs for an extra year and a half. While that may not seem like a lot, if you are an IRA owner, you now have some flexibility, and the additional time should give you an opportunity to grow your tax-deferred assets while taking a deeper look into your tax and estate planning. You may still want to take an early distribution to spread out the tax burden. Ask your financial advisor for guidance.
Another important provision of the SECURE ACT is the elimination of the age cap of 70 ½ for contributions to traditional IRAs; thus, contributions to those accounts can now be made indefinitely. If you or your spouse are still working but stopped contributing to a traditional IRA once you reached 70 ½, you can start again and continue paying into the account(s) for as long as you are working.
Changes to Lifetime "Stretch" Provision IRAs
Probably the most notable change to arise from the SECURE Act will affect one of the most common ways that people traditionally transfer wealth within their families. Previously, one of the more efficient methods of wealth transfer was for investors to leave retirement accounts (e.g. IRAs and 401(k) accounts) to their heirs with the amount of withdrawals allowed based on the beneficiaries' life expectancy.
This let family members, specifically, children or grandchildren, "stretch" distributions from these IRAs over decades without moving into a higher tax bracket, meaning the amount of tax obligation was also spread out over their lifetimes. In stretching out distributions over decades, inherited IRAs also experienced decades of growth.
As of January 1, 2020, the life expectancy rule only applies to spouses. For anyone else, accounts must be completely depleted within 10 years, regardless of tax consequences. The only exceptions made are for recipients who are terminally ill, disabled or minors. Once minors reach the age of majority, which is 21 in most states, however, the 10-year rule applies.
What does this mean for you? Read on for some ways that your financial advisor can assist with some strategic planning and help you minimize the tax burden for your future beneficiaries.
Financial Planning and The Great Wealth Transfer
As we enter what is called the "great wealth transfer," baby boomers are leaving approximately $68 trillion to their heirs. If you are a beneficiary of an estate or a deceased parent or spouse's retirement plan, or, if you have invested significant assets in traditional retirement plans and IRAs that you plan to will to family members, you may want to discuss those plans with your financial advisor. Future non-spouse heirs could be faced with exceptionally high tax bills depending on the circumstances.
Most beneficiaries of the great wealth transfer will be in their 40s or 50s, which are generally known as peak income-earning years for many. Fox example, if you're a middle-aged professional and you inherit an IRA, a 10-year period is thus limiting and could push you into a higher tax bracket. This also means that if your parent left money to one of your children, they could inadvertently be pushed into a much higher tax bracket earlier than anticipated.
Even if you are a beneficiary who has reached the "penalty-free" age for withdrawals, which is 59 ½, the 10-year limit still applies. It may be worth considering taking out as much money as you can for the first nine years while making sure you remain in your current tax bracket, and then taking the remainder in the 10th year. Your financial advisor can guide you through additional workarounds.
Roth IRA Conversion Strategies
Depending on the type of retirement account you have and some other factors, you might want to leave some of your IRAs in non-qualified accounts for your beneficiaries. Although that will generate capital gains, money bequeathed to heirs from non-qualified accounts can be withdrawn more slowly, and likely at a lower tax rate, than under the current SECURE Act's 10-year rule. This is because heirs can take advantage of step-up allowances for inherited assets. Capital gains taxes are also likely lower than income tax rates for many.
Another recommendation might be to convert as much of your 401(k) or IRA income as possible from a traditional IRA to a Roth IRA. While the conversion from a traditional IRA to a Roth is itself a taxable event, the inheritance is income tax-free. Consult with your financial advisor for further details on more ways to work with Roth conversions and Roth Contributory IRAs.
Additional Ways Investors Can Offset the Change in Stretch Provision IRAs
Given that spouses are not affected by the 10-year rule, Insurance News Net says that one way to navigate the SECURE Act change is by leaving an IRA directly to your spouse, who could in turn convert the IRA to their own name and then will it to your intended non-spouse beneficiaries. This allows for a longer withdrawal period; as such, assets can be stretched across your spouse's lifetime and then passed on to children or grandchildren, who would still have 10 years to draw the account down.
Also, if you are older than 70 ½ and have earned income, you may be able to bypass RMDs (Required Minimum Distributions) by contributing to a Roth IRA. Although the account would still have to be liquidated in 10 years upon inheritance by your heirs, there would be no tax penalty once the Roth IRA had been open for five years.
Another consideration could be the purchase of a life insurance plan naming your non-spouse beneficiaries, as life insurance plan proceeds are tax-free, and payment is guaranteed. Some have even suggested that IRA account owners substitute life insurance for an IRA by taking a withdrawal at the RMD age of 70 ½ from the IRA to fund a life insurance plan.
Additional SECURE Act Considerations:
The SECURE Act has 30 different provisions, and while we've outlined the two most well-known points above, there are a few more taxpayer-friendly ideas you may want to consider.
Flexibility With 529 Plans
The SECURE Act has allowed for some flexibility with the use of 529 plans so that parents or grandparents can assist a college graduate with student loans. While the benefit is limited to a lifetime maximum of $10,000 each 529 plan allows for one beneficiary or sibling of the beneficiary, so each child would be allowed to draw $10,000 tax-free to use for student loan payments upon graduating from college. If you're currently saving for children and grandchildren's tuition, this affects you.
Penalty-free Withdrawals: Childbirth or Adoption
Considering adopting a child? Under the SECURE Act, families now have an option should they need additional cash to offset the costs of the birth of a child or an adoption. Parents can take up to $5,000 out of a qualified IRA account penalty-free. The limit is $5,000 per child, and families have within one year of a birth or child adoption to withdraw funds (after, not before the event). It may not be the most tax efficient option, given that the $5,000 will be subject to income tax; however, it remains an option.
Qualified Charitable Distributions
Qualified Charitable Distributions (QCDs) have been indirectly affected under the SECURE Act as well. QCDs still require that anyone who wants to make a contribution be age 70 ½, but now that the RMD age has been raised to 72, you can make charitable contributions prior to taking an RMD.
Those who would like to support a charity can still use non-taxable accounts for Qualified Charitable Distributions, up to $100,000 per year from an IRA to a qualified charity - and it doesn't count as realized income from their distribution, since it's voluntary. In the past, investors used QCDs to reduce the tax obligations for a Required Minimum Distribution because in doing so, they could avoid a large portion of tax ramifications from taking the distribution. Beyond reducing the IRA balance, future RMD amounts will not be affected.
If you have questions about the SECURE Act, your B. Riley Wealth financial advisor has answers. While the ability for beneficiaries to "stretch" payouts from inherited IRA accounts over several years based on life expectancy has now been forced into a 10-year acceleration of payouts, there are still myriad ways you can plan thoughtfully around the willing of your estates and retirement income to your family members and other beneficiaries.
Overall, this legislation has created mechanisms for most investors to save more for their retirement; however, it is recommended that you strategize with your financial advisor about ways the SECURE Act might affect your retirement plans.
Questions? Please do not hesitate to call your financial advisor directly. Learn more at http://www.brileywealth.com
Disclosure: Our firm is not a tax or legal advisor. Although this summary is not intended to replace discussions with your tax and legal advisors, it may help you to comprehend the tax implications of your investments and plan efficiently going forward.