On December 20, 2019, The SECURE Act became law. The SECURE Act, which is an acronym for “Setting Every Community Up for Retirement Enhancement” is mainly intended to expand opportunities for more individuals to increase their retirement savings.
Here are several major facets of the new law.
The required minimum distribution (RMD) age is changed from age 70 ½ to age 72. RMD owners who turn 70 ½ on January 1, 2020, or later will be required to take RMDs at age 72 rather than age 70 ½. Additionally, the IRS published a recommendation in November to update the life expectancy and distribution period tables to reflect longer lifespans (the table has not been updated in nearly 20 years). Essentially it reflects a 2-year increased lifespan, and RMDs that previously were 4.37% at age 75 declined to 4.07%. RMDs will be required by April 1 following the year at which the recipient turns 72.
Interestingly, the new law does not change the age at which Qualified Charitable Distributions can be made. As a result, there will be a potential two-year window when charitable distributions can be made prior to distributions being required.
There is also no longer a restriction on making traditional IRA contributions after age 70 ½. There must be earned income to make a contribution, but this is beneficial as more workers are staying in the workforce longer.
The “Stretch IRA” is gone and inherited IRAs must be fully liquidated within 10 years of receipt“Stretching” an IRA allows young beneficiaries to benefit from years of tax deferral while taking small required minimum distributions over their lifetime.
Previously, an IRA could be transferred to a much younger beneficiary. The benefit of doing that was that the payments were then “stretched” over the longer lifetime and as a result, the tax benefit of shielding capital gains and income on the investments of the IRA lasted much longer. Most affected by this policy change are those with the largest IRAs who had planned on leaving the accounts to extend over the lives of their children and grandchildren.
This especially includes any clients who named a trust as their IRA beneficiary. These trusts will generally not work well under the new rules and should be re-evaluated, depending on the trust’s language surrounding annual distributions.
Frequently Asked Questions:
Are current stretch IRAs for those who died before 2020 still good? Current inherited IRA recipients are “grandfathered” in and will not be subject to these new rules – only recipients of inherited IRAs for those who died after 2019 will be impacted. Additionally, spouses, disabled individuals, and children will be exempt. However, once the child reaches age 21, the clock will then start ticking on their required 10-year liquidation period.
How do the RMDs work under the 10-year rule? Under the 10-year rule, there are no RMDs during the 10 years. Instead, the entire IRA balance must be emptied by the end of the 10 years. Beneficiaries can withdraw any amounts they wish during the 10-year period, so there is an element of planning flexibility to withdraw funds when it best fits their tax situation during that time.
Do Roth IRAs still qualify for the stretch? No. Inherited Roth IRAs are subject to the same 10-year payout rule, except that the distributions will generally be tax-free. Roth conversions may be able to eliminate potentially large tax bills within 10 years after death.
What planning strategies can be used to avoid the potentially substantial tax impact to beneficiaries?
Evaluate your beneficiaries. Though the Secure Act does away with the stretch for non-spouse heirs, it makes exceptions for a number of beneficiaries: • a surviving spouse• an owner’s child who is still a minor• a beneficiary who is chronically ill or disabled• a beneficiary who is no more than 10 years younger than the IRA ownerBuild “income’ flexibility into the plan
One way to build flexibility into a plan is to treat different beneficiaries in an unequal manner to make things more even from a tax perspective. For example, a low income earning beneficiary could be left a larger traditional IRA and a high-income earner could inherit a smaller Roth IRA. Roth IRA conversions for legacy planning
While Roth conversions have always been a valuable tool, they are now more valuable than ever. They are typically most effective when retirees are in their late 50’s to early ’70s when earned income is modest, and thus the resulting effective tax rate on the conversion is lower. Although the “10-year rule” will apply to Roth IRAs, the distributions will still be tax-free. As a result, the recipient can wait until year 10 to take the full distribution, thus maximizing the tax free growth in their inherited Roth.
Increase use of charitable trusts and gifting
If you are charitably-inclined, donate distributions as early as age 70 ½ to charity or your own donor advised fund. Once the distribution is made as a Qualified Charitable Distribution, the opportunity to convert additional Traditional IRA funds to a Roth may be taken depending on your marginal tax bracket. Note that the new tax law still allows Qualified Charitable Distributions beginning at age 70 ½, which creates an opportunity to make those distributions prior to the onset of required distributions at age 72, subject to IRS clarification.
Since after-tax funds and Roth IRAs receive much more favorable tax treatment, you can potentially take additional IRA distributions in low tax years and gift the funds to your heirs to help them fund their own Roth IRAs. Note that for 2020, individuals can gift up to $15,000 tax-free. You can still gift more than $15,000, but it must be reported to the IRS on Form 709. The lifetime estate/gift tax exemption will be $11.58 million in 2020 — up from $11.4 million in 2019 — so the IRS applies the amount over $15,000 to your lifetime exemption. However, note that the exemption will be cut in half after 2025 and is of course subject to potential changes in tax law.
Other minor changes from the SECURE Act
• Expansion of the use of 529 funds, including allowing them to be used to pay off up to $10,000 of student loan debt and for apprenticeships
• Penalty-free distribution of up to $5,000 from an IRA for a qualified birth or adoption These changes will affect each person differently. However, it is very important to understand the consequences of these changes as it relates to your current investment plan, and even more important to know what the consequences of inaction will be.