Since my brief posting about the SECURE Act (Setting Every Community Up for Retirement Enhancement), I’ve probably received more emails and questions about it than any other topic since I started this blog. So, it’s clear there are questions out there. Jeffrey Levine, with Team Kitces, put together the below comprehensive visual of the key provisions of the SECURE Act and other provisions that were included in the total legislation package.
You can click the above image to be taken to Jeffrey Levine’s review of the SECURE Act if you wish. I will be focusing solely on everything in the red box above and the planning implications of those issues as they are the primary issues that will impact those in or nearing retirement. I will also be including some potential strategies you may consider to address these planning issues, particularly as it relates to the loss of the Stretch IRA as we know it.
Goodbye Lifetime Stretch IRA, Hello 10-Year Distribution
Under previous law, a spouse or non-spouse beneficiary and certain qualifying trusts were eligible to “stretch” IRA distributions over their respective lifetime (or in the case of trusts, over the oldest beneficiary’s lifetime).
Note: There are a few parties who will retain the ability to stretch the distributions over their life expectancy.
- Spouses (can also utilize spousal rollovers as well);
- Chronically ill;
- Individuals who are not more than 10 years younger than the decedent;
- Minor children of the original account owner who is a parent. (But only until they reach the age of majority at which point a 10-year clock starts ticking.)
For everyone else, which primarily includes children of the account owner, trusts, and other non-spouse beneficiaries, the stretch IRA will no longer be available.
What is replacing the “stretch IRA” is a requirement to withdraw the entirety of the account by the end of the 10th year following the year of inheritance. Here’s where it gets interesting though and where there may be some planning opportunities:
Planning Opportunities for the 10-Year Inherited IRA Distribution:
If you’re nearing retirement: Though the account will be required to be depleted by the end of the 10th year, there are no interim distributions required. This means an inheritor may not make any distributions whatsoever until the 10th and final year as long as the entire account is liquidated that year.
If you find yourself the beneficiary of an IRA, it may be easiest to think of this 10-year period in much the same way we think about completing potential IRA conversions. It’s all about timing and managing tax brackets.
If you are nearing retirement, you may delay your distributions until retirement to minimize the tax hit assuming you would drop to a significantly lower bracket while potentially delaying Social Security as well.
If you choose to do delay distributions until you stop working and are retired, you will want to pay attention to Medicare IRMAA brackets that will catch up to you two years after these distributions have taken place. (See RFG Medicare Article under subsection “How much does it cost?”) Also, depending on the distribution amounts and your other incomes, also beware that this income could potentially push you into 20% capital gains rates as well.
If you are not within ten years of retirement: You may focus on timing distributions to fill up specific tax brackets each year while ensuring that over the ten year period that the account will be liquidated appropriately. (See tax brackets here.) This can provide tremendous tax savings over the ten year period rather than taking distributions with little forethought.
Other Planning Ideas to Deal With the Loss of the Stretch IRA
If you plan to live on your Required Minimum Distributions or more, feel free to skip down to the next section. Please note: I do not/am not advocating for any of the below options - these are purely personal choices and a significant amount of planning should be done to decide whether any of these strategies are appropriate for you.
#1. Roth conversions. While converting your Traditional IRA to a Roth IRA will not circumvent your beneficiary’s requirement to withdraw all proceeds within the 10-year timeline, it can mitigate the significant tax bill that your heirs may be stuck with. This can be especially helpful for those with heirs in the top tax brackets - but you have to be willing to pay the tax now. Personal choices here for sure.
#2. Life Insurance. For those who do not need their RMDs, you may consider utilizing your after-tax distributions to purchase life insurance. In some cases, a second-to-die policy if you are married and at least one of you is in good health can offer the most bang for your buck. This is one way in which you can reduce the tax burden on your future heirs. Your heirs would receive the funds free of tax and any withdrawal requirements - though it will also be free of any rules of how and when they spend the assets. If this is an issue of concern for you, see #3.
#3 Irrevocable Trusts. Utilizing the same idea as the life insurance example above, the retiree could create an irrevocable trust and have the trust purchase a life insurance policy. The retiree would fund the trust with their after-tax RMD payments to pay the policy premium. The trust could be there to provide for the heirs in a way similar to that of the stretch IRA or however you see fit.
As we gain more clarity around these laws and more casework is done moving forward, invariably, we’ll identify new planning ideas. Long story short, just about everyone exercising care and planning could save thousands on taxes by just making some calculated decisions!
“See-Through Trust” Issues
If you do not utilize a trust as an IRA beneficiary, feel free to skip to the next section. Also note, I am not an attorney or CPA and do not play one on the internet.
For folks who have chosen to make their IRA beneficiary a see-through trust, there may be significant issues at hand thanks to the new law. For those who need reminding, a see-through trust is a vehicle through which individuals may pass retirement assets on to the trust where the sole beneficiaries are living people (not charities) and the Required Minimum Distribution (RMD) would be based on the oldest beneficiary.
For those who have properly done this type of planning, the SECURE Act is likely to cause an issue. Many of these trusts, most notably Conduit Trusts, are generally drafted in a way that only allows for the RMD to be distributed to the trust, then on to the beneficiaries each year. Under the SECURE Act, there are no RMDs until the 10th year, at which point, the entire balance of the IRA could be required to be distributed. This could cause both an income shortfall from what was expected in years one through nine, followed by a tax catastrophe in year ten!
And if you’ve chosen to utilize a Discretionary Trust, the results may be even worse. Discretionary Trusts often retain a significant portion of distributions (as opposed to distributing them to beneficiaries). If that’s the case and the entirety of the IRA is to be distributed within 10 years, any funds retained by the trust could be taxed at trust tax rates. Not a good thing! (See Trust Tax Rates.)
It has yet to be determined exactly how the IRS will deal with the above issues as it is not spelled out in the current law. But it is notable enough to be sure that, if you’ve designated a trust as your IRA beneficiary, it could be vital to discuss this with your attorney and revisit your plan as soon as possible.
Required Minimum Distribution Age Is Movin’ On Up to Age 72
This one is decidedly good news for retirees. Previously, the age at which a retiree was forced to withdraw funds was age 70.5 - which was confusing from time to time especially when you add in the fact that the withdrawal amounts were different based on if you were born in the first half or second half of the year.
From here on out, you will not be forced to make a withdrawal from your Traditional IRA or employer plans until age 72.
This does not impact people who need to make larger withdrawals or earlier withdrawals as age 59.5 to begin withdrawing penalty-free is intact. This change allows for people who do not need their distributions to enjoy 1.5 years more tax-deferred growth.
Another rule that has not changed is your first-year RMD can be delayed until the year following the year in which you turn age 72, but the distribution will need to be completed prior to April 1st of the following year. If you choose to delay your first RMD, you will also need to take a second RMD (for that year) prior to the end of that year.
It’s nice that they’ve offered a little reprieve for folks who do not need to make the distributions or are continuing to work.
Qualified Charitable Distributions Still Allowed at Age 70.5
For those who intend to utilize their IRAs for their charitable endeavors, upon attaining age 70.5, you may still make your Qualified Charitable Distribution (QCD) up to $100,000. While there is no RMD to reduce, this offering allows you to give to charity in a tax-preferred way.
Upon reaching age 72 (the new RMD age), any QCD will be used to reduce the amount of your Required Minimum Distribution for that year.
You May Contribute to a Traditional IRA Beyond Age 70.5
Starting this year (2020), individuals at any age can contribute to a Traditional IRA assuming they have “earned income” - meaning income derived from active employment or self-employment. You may also contribute if you have a spouse who has earned income.
One wrinkle, however, is that your post-age 70.5 Traditional IRA contributions (if any) would be used to offset any Qualified Charitable Distribution in the future until those contributions are zeroed out. Those contributions would be required to be an itemized deduction which may eliminate the taxable benefit given the increased standard deduction for many retirees.
As you can see, the SECURE Act impacts many Americans immediately and changes the way many retirees and soon-to-be retirees should be planning. The key is to do the research to ensure you and your loved ones are making the most of the rules at hand. If you have questions, feel free to reach out!
This post is not advice. Please see additional disclaimers.