The SECURE Act passed in December and will take effect for 2020. I’m glad the government is helping Americans better face the challenge of retirement readiness. Although I work with clients who are often fairly well prepared, the reality is that a majority of Americans are falling behind and need to do more to plan for their retirement income.
It’s highly likely that the SECURE Act will directly impact you and your family. Six of the changes are positive, but there’s one big problem for families with larger retirement accounts: the elimination of the Stretch IRA. We’re going to briefly share the six beneficial new rules, and then take a deeper dive into the impact of eliminating the Stretch IRA.
1. RMDs pushed to age 72. Currently, you have to begin Required Minimum Distributions from your IRA or 401(k) in the year in which you turn 70 1/2. For 2020 and going forward, the age for RMDs is pushed to 72. This is going to be very helpful for people who are working longer or who have other sources of income and who don’t need to take money from their retirement accounts. People are living longer and working for longer, so this is a welcome change.
2. You can contribute to a Traditional IRA after age 70 1/2. Previously, you could no longer make a Traditional IRA contribution once you turned 70 1/2, but this restriction has been eliminated. Good news for people who continue to work into their seventies!
3. The definition of eligible income for an IRA has been broadened to include stipends or fellowships (for students) and home healthcare payments. This will allow more people to fund their retirement accounts, even if they don’t have a traditional job.
4. For 529 College Savings Plans, you can now take $10,000 in qualified distributions to pay student loans or for registered apprenticeship programs.
5. The SECURE Act will help more Americans be covered by 401(k) plans by allowing small companies to join together to form multi-employer plans and by expanding eligible workers to include part-time employees.
6. 401(k) plans will be allowed to offer income annuities and enable retiring participants to create a guaranteed monthly payout from their 401(k).
7. The elimination of the Stretch IRA. This is a problem for a lot of families who have done a good job building their retirement accounts. A spousal beneficiary will still be allowed to roll over an inherited IRA into their own account, however a non-spousal beneficiary (such as a daughter, son, or other person) will be required to withdraw the entire IRA and pay taxes within 10 years.
Existing Beneficiary IRAs (also known as Inherited IRAs or Stretch IRAs) will be grandfathered under the old rules. However, for anyone who passes away in 2020 going forward, their IRA beneficiaries will not be eligible for a Stretch.
If you have a $1 million IRA, your beneficiaries will have to withdraw the full amount within 10 years and count that distribution as ordinary income. If you do inherit a large IRA, try to spread out the distributions over many years, if it will enable you to stay in a lower income tax bracket.
For current IRA owners, there are a number of strategies to consider to plan ahead to reduce this enormous tax liability for your heirs.
Read more: 7 Strategies If The Stretch IRA Is Eliminated
Additionally, if you created a trust to serve as the beneficiary of your IRA, this provision of the SECURE Act might negate the value and efficacy of your trust. See your attorney and financial planner immediately.
The elimination of the Stretch IRA is how Congress is going to pay for the other benefits of the SECURE Act. While I understand there is not a lot of sympathy for people who have to pay taxes on inheriting a $1 million IRA, this is a big tax increase for upper-middle class families. It won’t impact Billionaires at all, but for the average millionaire next door, their retirement account is often their largest asset, and it’s a huge change.
If you want to start to reduce this future tax liability on your beneficiaries, it will require a gradual, multi-year strategy. It may be possible that I could save your family hundreds of thousands of dollars in income taxes by creating an efficient pre and post-inheritance distribution plan. They key will be to start early, though, and not wait.
Otherwise, Uncle Sam will be happy to take 37% of your IRA (plus possible state income taxes, too!). And don’t forget, the top tax rate is set to go back to 39.6% after 2025. That’s why the elimination of the Stretch IRA is so significant – many middle class beneficiaries will suddenly be taxed at the top rate.
From a behavioral perspective, most Stretch IRA beneficiaries limit their withdrawals to just their RMD, and the continually invested inheritance lasts them for decades. I’m afraid that by forcing beneficiaries to withdraw the funds, many will squander the money rather than investing prudently and taking measured distributions. There will be a lot of consequences from the SECURE Act, but we are here to help you unpack these changes and move forward with an informed plan.