The SECURE Act
As 2019 came to a close, the President signed into law a sweeping series of changes that will affect how we save for retirement. Officially entitled the Setting Every Community Up for Retirement Enhancement Act, but more commonly known as the SECURE Act, the new law includes both welcome changes and controversial elements.
The largest number of questions we’ve received, and one we’ll address first, is about the change to the rules that govern inherited IRAs, or so-called stretch IRAs.
Previously, if you inherited an IRA, you were allowed to take distributions from the retirement account over your life expectancy. That is to say, a healthy 40-year-old person who inherited an IRA from his or her mom or grandfather could withdraw the funds over several decades.
While there are exceptions for spouses, minor children (until they reach the age of majority), disabled individuals, the chronically ill, and those within 10 years of age of the decedent, the new law requires that you withdraw the assets within 10 years if the decedent passed away after December 31, 2019. There are no changes to inherited IRA accounts for those who died prior to 2020.
In addition to the initial tax bite and the implications for estate planning, you may lose out on the tax deferred benefits that accrue from sheltering assets in an IRA account over an extended period of time.
Yet, there are ways to reduce the impact. For example, let’s say Tom is 63 years old, plans to retire when he is 68, and inherits an IRA from his uncle valued at $300,000. Recognizing that his income will decline at retirement, Tom may decide to delay withdrawals until he reaches 69, when he expects to be in a lower tax bracket. Conversely, Tom may also decide to make minimal distributions before he retires, but we may want to make sure distributions do not push him into a higher tax bracket. Or consider Cindy, who is 22 years old and inherits an IRA. She may decide to accelerate withdrawals if she expects to be in a lower tax bracket during the front-end years of the ten-year required distribution period.
Trusts as beneficiaries—changes are coming
This may sound a bit confusing and I’ll try to be brief. If you have additional questions, I would be happy to discuss options in more detail and tailor any recommendations. But I would be remiss if I didn’t share some of my thoughts regarding trusts.
For starters, it’s always a good idea to periodically review beneficiaries whether or not the tax laws change.
That said, when it comes to trusts as the beneficiary of an IRA, generally speaking there are two types of trusts: conduit and discretionary (accumulation trusts). With a conduit trust, we may be facing a situation that doesn’t allow the beneficiary to receive a distribution until the tenth year. Needless to say, this would create a very large tax bill when the distribution is received.
With an accumulation trust, the distributions from the inherited IRA are paid to the trust and the trustee has greater discretion as to whether the funds will be held within the trust or paid to the beneficiary. While this provides greater control, it may come at the cost of much higher taxes. As you may already be aware, the tax rate applied to funds in a trust is much steeper than individual tax rates, i.e., income over $12,750 in the trust is taxed at 37%. Of course what I have provided here is simply a broad overview. There may be other options to consider.
For most folks, the death of the stretch IRA is creating some challenges on the estate-planning front. We are happy to discuss alternatives and reduce some of the confusion surrounding the new law.
Long overdue changes
While the law governing stretch IRAs is creating challenges, there are also big, positive changes that we believe are long overdue.
People are living and working longer. In our view, these changes are welcome.
Other changes include:
Let me add one final comment on the ability to make contributions to IRAs past 70½ and QCDs, or qualified charitable distributions. You may continue to directly transfer up to $100,000 per year to a qualified charity from your IRA at 70½. You may also decide to wait until you are 72 to donate via a QCD, which will satisfy the RMD requirement.
Going forward, however, IRA contributions made after age 70½ cannot also be part of a QCD.
This means that if you contribute $6,000 to a traditional IRA after 70½ and later donate $50,000 in a QCD, you will lose the deduction for $6,000 of that QCD. The remaining $44,000 of your donation will still qualify as a QCD.
As always, when it comes to taxes, let me know if you have questions! ~John Davidson
The largest number of questions we’ve received, and one we’ll address first, is about the change to the rules that govern inherited IRAs, or so-called stretch IRAs.
Previously, if you inherited an IRA, you were allowed to take distributions from the retirement account over your life expectancy. That is to say, a healthy 40-year-old person who inherited an IRA from his or her mom or grandfather could withdraw the funds over several decades.
While there are exceptions for spouses, minor children (until they reach the age of majority), disabled individuals, the chronically ill, and those within 10 years of age of the decedent, the new law requires that you withdraw the assets within 10 years if the decedent passed away after December 31, 2019. There are no changes to inherited IRA accounts for those who died prior to 2020.
In addition to the initial tax bite and the implications for estate planning, you may lose out on the tax deferred benefits that accrue from sheltering assets in an IRA account over an extended period of time.
Yet, there are ways to reduce the impact. For example, let’s say Tom is 63 years old, plans to retire when he is 68, and inherits an IRA from his uncle valued at $300,000. Recognizing that his income will decline at retirement, Tom may decide to delay withdrawals until he reaches 69, when he expects to be in a lower tax bracket. Conversely, Tom may also decide to make minimal distributions before he retires, but we may want to make sure distributions do not push him into a higher tax bracket. Or consider Cindy, who is 22 years old and inherits an IRA. She may decide to accelerate withdrawals if she expects to be in a lower tax bracket during the front-end years of the ten-year required distribution period.
Trusts as beneficiaries—changes are coming
This may sound a bit confusing and I’ll try to be brief. If you have additional questions, I would be happy to discuss options in more detail and tailor any recommendations. But I would be remiss if I didn’t share some of my thoughts regarding trusts.
For starters, it’s always a good idea to periodically review beneficiaries whether or not the tax laws change.
That said, when it comes to trusts as the beneficiary of an IRA, generally speaking there are two types of trusts: conduit and discretionary (accumulation trusts). With a conduit trust, we may be facing a situation that doesn’t allow the beneficiary to receive a distribution until the tenth year. Needless to say, this would create a very large tax bill when the distribution is received.
With an accumulation trust, the distributions from the inherited IRA are paid to the trust and the trustee has greater discretion as to whether the funds will be held within the trust or paid to the beneficiary. While this provides greater control, it may come at the cost of much higher taxes. As you may already be aware, the tax rate applied to funds in a trust is much steeper than individual tax rates, i.e., income over $12,750 in the trust is taxed at 37%. Of course what I have provided here is simply a broad overview. There may be other options to consider.
For most folks, the death of the stretch IRA is creating some challenges on the estate-planning front. We are happy to discuss alternatives and reduce some of the confusion surrounding the new law.
Long overdue changes
While the law governing stretch IRAs is creating challenges, there are also big, positive changes that we believe are long overdue.
- If you turned 70½ on January 1, the initial required minimum distribution (RMD) for a traditional IRA is being raised from 70½ to 72.
- You may continue to contribute to a traditional IRA past the age of 70½, as long as you are working and have earned income.
People are living and working longer. In our view, these changes are welcome.
Other changes include:
- Through the first year of an adoption or birth, parents can withdraw up to $5,000 without penalty from a traditional IRA or employer-sponsored retirement plan, such as a 401(k).
- Annuity options improve within a 401(k).
- Part-time employees will receive greater access to 401(k) plans, and several provisions make it easier for small businesses to offer retirement plans.
- Up to $10,000 in assets held in a 529 plan may now be used to repay student loans.
- The new law requires the Department of Labor to propose rules that will illustrate the participant’s projected monthly income in retirement based on current retirement assets.
- A plan participant will no longer be able to access 401(k) funds for loans with a credit card.
Let me add one final comment on the ability to make contributions to IRAs past 70½ and QCDs, or qualified charitable distributions. You may continue to directly transfer up to $100,000 per year to a qualified charity from your IRA at 70½. You may also decide to wait until you are 72 to donate via a QCD, which will satisfy the RMD requirement.
Going forward, however, IRA contributions made after age 70½ cannot also be part of a QCD.
This means that if you contribute $6,000 to a traditional IRA after 70½ and later donate $50,000 in a QCD, you will lose the deduction for $6,000 of that QCD. The remaining $44,000 of your donation will still qualify as a QCD.
As always, when it comes to taxes, let me know if you have questions! ~John Davidson