With the passing of the new tax law, the SECURE Act of 2019 (Setting Every Community Up for Retirement Enhancement Act), I am reminded of a quote attributed to Benjamin Franklin: “There are two things certain in life, Death and Taxes.”
The main objective for this tax act is to expand an individual’s access to their retirement savings and this will come at a cost to our inherited retirement accounts. It will be especially challenging for those who plan to leave a legacy through IRAs to beneﬁciaries beyond their spouses. Many will rethink the beneﬁciaries of their pre-tax retirement accounts, as well as consider tax planning strategies like Roth conversions and life insurance planning. While there are pros and cons to the new changes, their impact can be signiﬁcant and everyone with a retirement account should review their estate and trust plan.
Here is a summary of the key provisions:
Retirees – Required minimum distributions (RMDs) have changed from 70 ½ to 72 years
of age for mandatory distributions from your IRAs, 401(k), 403(b) and other employer-sponsored retirement plans. This simpliﬁes when to begin your RMDs and can be helpful when you don’t need the additional income. It also allows one to two additional years of tax efficiency planning for those under age 72.
Beneﬁciaries – The SECURE Act marks the end of a popular ﬁnancial and tax planning strategy called the Stretch IRA. This stretch planning technique allowed anyone who inherits an IRA to spread out, or stretch, their required minimum distributions over the younger of the beneﬁciary’s or decedent’s life expectancy. For example, if a grandchild was the beneﬁciary, the stretch of the RMDs over more years would allow for a greater income tax beneﬁt.
After January 1, 2020, IRAs, 401(k)s and other deﬁned contribution retirement plans, which are inherited by most non-spouse beneﬁciaries, will have the requirement of a taxable distribution and depletion of the entire account within 10 years of inheritance. For most, the IRAs will be taxed sooner and at a much higher income tax rate(s) than originally planned by savers. This will be especially challenging if you are in the Retirement RedZone or for those already retired.
There is an exception for non-spouse beneﬁciaries who are disabled, a minor, or chronically ill. Distributions for these exceptions would be over their life expectancy, although the exception for minors would end once they reach the age of majority with the ﬁnal distribution to be taken within 10 years.
If you do not retire after age 72, there is an exception to RMDs. If you continue to work and you are not a 5% owner (or more) in the company, you can postpone your RMDs for that employer’s retirement plan until after you retire.
Spousal beneﬁciaries continue to be able to stretch and delay the inherited account’s required minimum distributions (RMDs) until year end of their 72nd birthday.
Trusts can be considered non-spouse beneﬁciaries and is an area which will require more analysis for the tax impact, as a trust is often used to restrict withdrawals and access for speciﬁc beneﬁciaries who may otherwise be irresponsible and possibly squander their inheritance. The loss of the Stretch IRA provisions has the potential to create income tax at a much higher trust rate. Those with spendthrift concerns for their non-spouse beneﬁciaries should consider the impact on their legacy and tax plan for potential changes in their estate documents and/or beneﬁciary designations.
The loss of the Stretch IRA results in the following challenges:
Employees – Employer-sponsored retirement plans will now allow for the inclusion of annuities and other lifetime income options. With the continued reduction of employer-provided pensions, creating your own personal style pension becomes more important.
There are now penalty-free withdrawals from an IRA for the birth or adoption of a child for individuals under age 59 ½ years of age.
The age restriction of age 70 for contributions to traditional IRAs is now eliminated if you meet the IRS requirements, such as earned income/wages. This will allow those who continue to work the ability to make pre-tax contributions.
Employers – There is a new 3-year tax credit for startup expenses for a new retirement plan. It’s important to note the difference between a tax credit and a tax deduction. The tax credit will reduce your tax liability, dollar for dollar. A tax deduction will reduce your taxable income at your current tax top tax rate which is currently 37% for individuals and 21% for corporations. There is a maximum tax credit of $5,000 annually, for three years. There is also a $500 tax credit for automatic enrollment of employees into the retirement plan.
a. Consider Roth conversions. Recharacterizations of Roth conversions, also known as a do-over, are no longer allowed, so careful tax planning is prudent.
b. Consider taking earlier distributions from your qualiﬁed retirement accounts, such as your IRAs, 401(k)s, and other deﬁned contribution employer retirement plans before your required minimum distribution (RMD) age of 72.
c. Consider moving to a lower taxed state for residency. The average is a 5-7%tax savings annually.
d. Consider qualiﬁed charitable distributions (QCD) directly from your IRAs to an IRS-qualiﬁed charity for additional tax savings. This tax saving strategy is allowable once you reach age 72 or RMD age.
e. Consider whether life insurance could be advantageous as tax free income for your legacy plan and to pay the potential increase in income and estate taxes.
f. If you are still working, be cautious not to continue to overfund your pre-tax accounts.
3. Review your estate and legacy plan for potential revisions which may be necessary for your legal documents such as your Last Will and Testament and Trust(s).
4. Continue to monitor changes of tax laws as the SECURE Act continues to be analyzed, anticipated reform of the life expectancy tables in the near future is ﬁnalized, and the possible tax increases at the expiration of the Tax Cuts and Jobs Act tax reform at the end of 2025. Almost all individual income tax rates and estate taxes expire at that time.
Depending on your objectives and unique situation, a successful retirement plan is one that must be not only created and written, but also revisited annually to account for changes we can and cannot control. Tax reform and new tax laws are beyond our control. However, review your retirement plan and partner with a ﬁduciary to assist with navigating through the impacts it may have on your income plan, tax plan, investment plan, and legacy plan. Taxes can be your largest expense in retirement, but with smart tax planning you can potentially add more to your bottom line and the legacy you desire for loved ones.