By J. Victor Conrad, CPA (inactive), CFP, AIF
The federal Setting Every Community Up for Retirement Enhancement (SECURE) Act contains 29 provisions that encompass many aspects of financial planning and retirement saving. In this blog I address some of what the act entails and who it affects, as well as provide a few suggestions on how to plan for the changes and discuss the matter with clients.
Key SECURE Act Provisions
Many of the provisions adopted into the Internal Revenue Code (IRC) as part of the SECURE Act allow individuals more time for tax-deferred savings and growth before distributions are required.
- Repeal of the prohibition on retirement contributions after the account owner reaches age 70½.
- Delay in the age for required minimum distributions (RMDs) from 70½ to 72.
- Elimination of the lifetime “stretch” IRA option; now requiring nonspouse beneficiaries of IRAs to deplete an inherited IRA balance within 10 years of the decedent’s death.
- Permission for penalty-free withdrawals of up to $5,000 from retirement accounts to help pay for childbirth or adoption expenses.
- Expansion of permitted 529 college savings plan expenses to include apprenticeships, as well as up to $10,000 of qualified student loan repayments for the beneficiary and $10,000 for each of the beneficiary’s siblings (an aggregate lifetime limit, not an annual limit).
- Reinstatement of the “kiddie tax” to rates prior to the Tax Cuts and Jobs Act (TCJA). Excess income will be taxed at the parents’ rate rather than the trust and estate rates.
- Allowance for graduate students to count stipends and nontuition fellowship payments as compensation for IRA contribution purposes.
- Requirement that certain part-time employees are eligible participants in employer-sponsored retirement plans.
The SECURE Act includes requirements designed to account for this loss of revenue by accelerating the withdrawal and taxation of inherited retirement accounts.
Loss of the Lifetime “Stretch”
The provision with the greatest effect (and which may present the biggest and hardest planning challenge) is the elimination of the lifetime “stretch” option for IRAs. Prior to the SECURE Act, nonspouse beneficiaries were entitled to stretch out the withdrawal of their inherited retirement account in accordance with their life expectancy. Now, beneficiaries are required to withdraw their entire inherited retirement account within 10 years of the original owner’s death (with some exceptions).
In most instances, withdrawal over a 10-year period (rather than over the course of the beneficiary’s lifetime) will result in substantially less tax-deferred growth, as well as more taxes due (and more quickly) upon withdrawal from the account (possibly moving the taxpayer into a higher tax bracket). Blindly spreading withdrawals evenly over a 10-year period may not be the most tax-efficient approach. Therefore, knowing the taxpayer’s year-by-year taxable income expectations (bonuses, bad years for business, exercising stock options, anticipated layoffs, projected year of retirement, etc.) will become critical if the goal is to minimize the taxation on the withdrawals.
Here are a few strategies to consider when planning for the loss of the lifetime “stretch” IRA option.
Roth conversions – Tax rates are at historic lows, so it could be a good plan to accelerate Roth conversions so beneficiaries can avoid being taxed rapidly on distributions. This is an especially applicable strategy if the beneficiaries are in a higher tax bracket than the account owner was. However, individuals with legacy priorities (a grandchild, for example) may not be motivated to accelerate Roth conversions under the SECURE Act. That grandchild will not receive the benefit of long term tax-free growth from the inherited Roth because even beneficiary Roth IRAs need to be totally distributed within 10 years.
Qualified charitable distribution (QCD) – This has been one of my favorite strategies, even before the SECURE Act, due to the TCJA’s changes to the standard deduction and state and local tax deduction. If an individual is older than 70½, he or she is entitled to make tax-free gifts of up to $100,000 per year from their IRA payable directly to charity, which they count toward their RMD. QCDs may become more advantageous after the SECURE Act because IRAs will become a less attractive inherited asset. Therefore, tax-free depletion of the IRA may be more beneficial than the dissipation of other nonqualified appreciated assets, which could pass to beneficiaries at a stepped-up basis.
Life insurance – While not a new strategy, it may become more powerful. Taking withdrawals from a retirement account to pay for premiums on a life insurance policy could be more advantageous than leaving a retirement account to a beneficiary. Beneficiaries typically receive life insurance death benefits tax free (and usually inheritance tax-free too). Depending on the insurability of the individual, the total death benefit payable to the beneficiaries may well exceed what they would receive as a beneficiary of an IRA.
General estate planning – It may make sense for account owners to revise their estate plans to take a more specific “asset-by-asset” approach, rather than simply splitting assets by percentage. For example, an account owner might earmark IRA assets to be distributed to minors or individuals in lower tax brackets (or charity) and designate a larger portion of non-IRA assets to those with higher incomes (and benefit from the step-up in basis).
Not Affected by the SECURE Act
Here are a few individuals who are not directly impacted by the SECURE Act:
- Those who turned 70½ prior to Dec. 31, 2019. Individuals who were 70½ or older as of Dec. 31, 2019, will continue with RMDs under the pre-SECURE Act rules.
- Surviving spouses of IRA owners.
- Beneficiaries of IRA owners who died before Dec. 31, 2019.
J. Victor Conrad, CPA (inactive), CFP, AIF, is the founder of PINNACLE Financial Strategies LLC, a wealth management firm in Wexford, Pa. He offers securities and advisory services as a Registered Representative and Investment Adviser Representative of Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at email@example.com.
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