Navigating the shifting terrain of retirement, tax, and estate planning can be a complicated and arduous journey. With so many variables and moving pieces, the landscape is constantly evolving. It requires clear and consistent communication between clients and their team of advisors. Like it or not, a third “person” must also be included at the meeting table – Uncle Sam.
We’re discussing Uncle Sam again because the House recently passed H.R. 1994 by an overwhelming majority (417-3). This bill is known as the SECURE Act, or . The bill would make profound changes to the existing rules regarding IRAs, including eliminating the “Stretch IRA.” The bill is not yet law, and now awaits passage in the Senate and presidential approval. Based on our assessment, it appears some form of this bill could become law in late 2019 or 2020.
Congress’ Balancing Act
The bill 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 generated the idea of elimination of the Stretch IRA.
On the positive side for taxpayers, the main changes include:
- Allowing small employers to consolidate their interests to sponsor a retirement plan;
- Eliminating the maximum age of 70 ½ for contributing to a traditional IRA;
- Increasing the RMD (required minimum distribution) age from 70 ½ to 72;
- Allowing employers to offer annuities within a 401(k) plan;
- Allowing withdrawals of up to $10,000 from 529 plans to pay student loans.
On the “negative” side for taxpayers would be the aforementioned elimination of the Stretch IRA.
Defining the Stretch IRA
Under current law, non-spousal beneficiaries of an IRA can “stretch” withdrawals from an IRA over their (presumably) longer life-spans, a valuable tax-planning and estate-planning strategy. Every year, non-spousal beneficiaries are required to take a distribution from the inherited IRA. The amount is 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 are often smaller than the original IRA owner’s would have been given the ability to use their longer expected life span. These smaller distributions allow the beneficiary to stretch the IRA over a longer time period and also pay less in taxes than the original IRA owner would have.
Planning Implications – Federal Income Tax
As noted, the bill proposes that most non-spousal inheritors would now be required to take these distributions over 10 years, emptying the account sooner and potentially resulting in a much higher distribution rate. It isn’t clear yet whether the new bill requires annual distributions over the new 10 year period. But it is clear that Uncle Sam is doing the math and has no plans to take in less revenue with this proposal.
If the bill becomes law, some potential ways to soften this impact before the IRA owner passes away include:
- Re-evaluating a conversion to a Roth IRA, and who should inherit traditional versus Roth IRAs;
- Specifically targeting beneficiaries by age and income to minimize tax impact;
- 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 an IRA trust as the beneficiary so as to control the distributions and maintain the IRA after death. These strategies will need to be re-evaluated if the SECURE Act becomes law as the existing strategies could fail or become unnecessary.
Bottom Line – What We’re Watching
This bill will likely undergo changes as it goes through the Senate (which already has its own version) and goes through the negotiation process before landing on the President’s desk. But given the overwhelming majority of passage in the House and the need for offsetting tax revenue, it appears some version of this bill is likely to become law sometime in the next 12-18 months. Knowing this, it’s critical to have a wealth manager in place who can not only keep up to date on these changes but can also coordinate with professionals from the tax and legal perspective. As this latest shift in the landscape demonstrates, the need for integrated wealth management has never been greater. We will continue to monitor this issue and other developments in the coming months as events unfold.