If you’ve turned on CNN, Fox News or MSNBC in the last three months, most of the headlines you’ve seen focused on impeachment, the trade war and Rudy Giuliani. It’s reminiscent of Groundhog Day. What have you not seen? The passage of the “Setting Every Community Up for Retirement Enhancement Act.” Not because of the mouthful it is, but because the SECURE Act was attached to an appropriations bill that was rushed through both houses to prevent another government shutdown.
What’s clear to anyone who has been paying attention is that there are wide-reaching planning implications that will affect different communities in different ways. Also clear: The new law will not “enhance” everyone’s retirement.
Below is advice for retirees and those who are about to retire with what should be enough resources to last through their golden years.
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1. Delay distributions from your IRA, if you can.
Required minimum distributions (RMD) are essentially the tax goalie for the IRS. After decades of deferring taxes on income earned, the Treasury wants its cut. Hence, at age 70½ you are required to distribute 3.65% of pre-tax retirement accounts. That money will show up on Line 4 of your 1040 and be taxed as income. This has long been loathed by affluent investors who don’t need the money but see their tax rate spike at 70, due to these distributions, paired with Social Security income.
Starting on Jan. 1, 2020, the 70½ RMD rule is changing. The SECURE Act delays distributions for everyone born on July 1, 1949, or later, to age 72. If you are not 70½ in 2019, you will fall under the new RMD rules. Why raise the age? People are living longer. The idea behind the RMD tables is that you can take out the required amount annually and not run out of money. This is debatable. People living longer lives is not.
2. Continue to save … but maybe not into an IRA.
Under previous legislation, you could save into a Roth IRA but not a traditional IRA after age 70½. Because there are income limitations on Roth IRAs, it meant that some people could not save into either type once they hit the age limit. Thanks to the SECURE Act, however, age limits are now gone for both traditional and Roth IRAs.
The headlines and previous few sentences would lead you to believe that you should now be saving into a traditional IRA. While it may make sense, you still need earned income and, post-retirement, that often gets reported on a Schedule C: self-employment income. If you are self-employed, the contribution limits are typically much higher for a solo 401(k), so it could be a better choice than an IRA. Essentially, a solo 401(k) is a 401(k) that you are setting up for yourself. You’ll take the deduction on Line 8a of the 1040, just as you did with the IRA — it just may be bigger.
For retirees, this reduces your modified adjusted gross income. That could reduce capital gains, Medicare Part B premiums and, therefore, give your Social Security a boost. Merry Christmas!
3. Consider paying taxes before your kids get your IRA.
Stretching an IRA allowed IRA beneficiaries to spread distributions over their own life expectancy. This resulted in smaller distributions and thus a smaller tax bite. Early in my career, I encountered a 20-year-old who inherited a $1 million IRA. He had a first-year distribution of $15,873. Under the SECURE Act’s new rules, that distribution can only be spread over a maximum of 10 years, which would have meant a $100,000 first-year distribution for that 20-year-old. That would bump him into a 24% marginal federal tax bracket without considering any other income.
One way to “pre-pay” your taxes is to do a partial Roth conversion. This means moving the money from a traditional IRA to a Roth IRA and taking a hit in this year. This typically makes sense if your current rate is lower than your or your kids’ future rate. When you pair the SECURE Act with the Tax Cuts and Jobs Act, that is a more likely scenario.
4. Talk to your financial planner and/or tax adviser.
The SECURE Act is the largest legislative change in retirement rules since the Pension Protection Act of 2006. Theoretically, the people advising you on retirement will be well-informed and can look at your situation individually to tell you what would make the most sense. Given the previous example of Roth conversions, you would have to do forward-looking tax projections to determine if your future rates are likely to go up or down. If you think they are going to go down, the Roth conversion is the last thing you want to do. You would look for any way to minimize current taxes, which would bring you back up to strategy No. 2.
5. Revisit your estate plan.
This one is also tied to the elimination of the “stretch provision” for traditional IRAs. If you can’t spread a tax hit over your non-spouse beneficiaries’ lifetime, you may want to change your beneficiaries.
Generally, married folks will name their spouse as the primary beneficiary and kids or a trust as a contingent. This legislation means it may make sense for the primary to be split between your spouse and kids. Therefore, the kids will start taking smaller distributions at the death of the first parent and then will start the second half at the death of the second parent. As a result, they are stretching their distribution for up to twice as long and will pay less in taxes.
For reasons too complex for the scope of this piece, if you have a trust as the beneficiary of an IRA, you’ll need to talk to your legal adviser. Trusts may need to be rewritten to comply with new rules.
In conclusion, this new law is a big deal. The SECURE Act comes with 29 new provisions or rule changes. It is very unlikely that you won’t have to change anything. The worst thing the professionals you work with can do is sit on their hands as you live through your retirement and they coast toward theirs.
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