The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019 as part of a broader government spending package. The law includes many provisions designed to make saving for retirement easier and more accessible. However, other changes related to distributions from retirement accounts may not be as favorable. Changes have been made to the rules for various accounts, including 401(k) plans, IRAs, pension plans, and 529 plans. These reforms will undoubtedly impact existing and future financial and estate planning strategies for savers and retirees alike. Of particular note are the significant changes made to the existing rules regarding IRAs, including the elimination of the “Stretch IRA.”
We summarize below the basics of some of the changes, the potential impacts, and possible strategies to address them.
Congress’ Balancing Act
The Act includes changes intended to make retirement and education savings accounts simpler and more cost effective, especially for less-affluent savers. As a result, a number of changes would likely lower tax revenue for Uncle Sam. Under current law, this revenue reduction must be offset by additional changes that would generate more tax revenue. This resulted in the elimination of the Stretch IRA.
On the positive side for taxpayers, the main changes include:
- Eliminating the maximum age of 70 ½ for deducting contributions to a traditional IRA;
- Increasing the required minimum distribution (RMD) starting age from 70 ½ to 72;
- Allowing employers wider safe harbors to offer annuities within a 401(k) plan;
- Allowing small employers to consolidate their interests to sponsor a retirement plan;
- Allowing new parents to take penalty-free withdrawals from retirement plans of up to $5,000; and
- Allowing withdrawals of up to $10,000 from 529 plans to pay student loans.
On the negative side, for those who will eventually inherit an IRA from a non-spouse, is the aforementioned elimination of the Stretch IRA (with some notable exceptions). The good news here is that the change does not affect those who have already inherited an IRA, but rather those who inherit an IRA from someone who dies after December 31, 2019.
Defining the Stretch IRA
Under the previous law, and what is still true for existing inherited IRAs, non-spousal beneficiaries of an IRA were able to “stretch” withdrawals from an IRA over their (presumably) longer life-spans, a valuable tax-planning and estate-planning strategy. Every year, non-spousal beneficiaries were required to take a distribution from the inherited IRA. The amount was calculated based on the IRS factor for their life expectancy and the balance of the account on the last day of the prior year. Their annual required distributions were often smaller than the original IRA owner’s would have been given the ability to use their longer expected life span. These smaller distributions allowed the beneficiary to stretch the IRA over a longer time period and potentially pay less in taxes than the original IRA owner would have.
Planning Implications – Federal Income Tax
The law changed such that beginning on January 1, 2020, when an IRA owner dies, their non-spousal inheritors are required to fully withdraw the IRA within ten years. (There are exceptions to this rule for some who qualify as disabled, chronically ill, or who are fewer than ten years younger than the deceased IRA owner.) In most cases, this will result in a much higher distribution rate than under the prior rules. It’s clear that Uncle Sam is doing the math and has no plans to take in less revenue with this new law. There is some flexibility, in that inheritors are not required to take a distribution every year. It does not matter when and how much is distributed in that period of time, as long as the account is fully distributed by the end of the ten-year period. For example, one could wait until the latter years before taking any distributions if their income will be lower at that time compared to the earlier years.
Some potential ways to soften this impact before the original IRA owner passes away include:
- Re-evaluating a conversion to a Roth IRA;
- Re-evaluating who should inherit a traditional versus a Roth IRA;
- Specifically targeting beneficiaries by age and income so as to minimize marginal tax impact; or
- More aggressive use of charitable gifting strategies, such as charitable remainder trusts benefiting children, funded at the IRA owner’s death.
Planning Implications – Estate Planning
It appears the owners of large IRAs are in the crosshairs of the federal government given the impact of the elimination of the stretch provision. Many owners of larger IRAs often name a trust as the beneficiary so as to control the distributions and maintain the IRA after death. While there are different types of trust provisions that control an IRA’s distribution to the ultimate beneficiaries (e.g. conduit or accumulation trusts), the intention of these estate planning tools is to provide flexibility, asset protection, and ensure the longest distribution period to the beneficiaries. Two key components of these trusts have been, first, reliance on the ability to stretch the distributions, and second, not mandating a complete payout of the trust assets after ten years, as the new law will require. These strategies need to be re-evaluated to determine if they are still appropriate under the new rules.
As this shift in the landscape demonstrates, it’s critical to stay up to date on these changes, and to lean on your team of advisors who can coordinate your financial plan from all angles. As always, we will work hard to ensure the success of our clients as circumstances continue to change in the years ahead. If you have family and friends who could benefit from our advice on this topic or any other, please use this article as a resource and have them contact us for help.
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