Making Your Money Last

5 Ways the SECURE Act Could Harm Retirees

To avoid RMD penalties, tax bills that are (possibly MUCH) higher than necessary and other problems, make sure you understand this groundbreaking new retirement law and take steps to keep your plan on track.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act, mostly went into effect on Jan. 1, 2020. While the SECURE Act passed with a lot of bipartisan support in Congress and fanfare from financial services lobbyists, firms and trade associations, not all of the law’s provisions are encouraging for retirees.

True, there are a lot of positives, such as pushing back the required minimum distribution (RMD) required beginning age from 70.5 until 72, adding lifetime income notices in retirement plans and lowering costs for small-business owners to run retirement plans. However, the new rules could cause tax increases, trust language issues and other retirement challenges if individuals are not engaged in proactive planning.

Let’s look at five major ways the SECURE Act could actually end up hurting retirees and savers.

1. Less Wealth Passed to Heirs (and More Taxes Being Paid)

The most impactful provision from the SECURE Act, at least from a tax perspective, is the removal of the “stretch” provisions for many inherited IRAs and defined contribution plans. Surviving spouses can still take advantage of the popular stretch provisions, but for heirs like children and grandchildren, the stretch provisions are gone, with only a few exceptions. Those include young children under the age of majority, the disabled, the chronically ill and individuals who are younger than the decedent by up to 10 years.

In the past, most beneficiaries could stretch out the RMDs of inherited IRAs and 401(k)s over their own life expectancy. This allowed inherited IRAs and 401(k)s to grow tax advantaged for heirs for many years. Additionally, RMDs were relatively small, since they were based off of their longer life expectancy.

Now, these non-spouse beneficiaries must cash out the entire IRA within 10 years. Because the withdrawals will be larger, they will likely force beneficiaries to pay higher tax rates on taxable distributions, and because the time period is limited, the opportunity for tax-deferred growth is also being shortened. Realistically, the government expects $15.7 billion more in tax revenue over the next 10 years due to this change.

The bottom line: Heirs will receive less true wealth from IRAs and 401(k)s than they could under previous rules.

2. Confusion Leading to Possible Missed RMDs (and Penalties)

One change in the SECURE Act designed to benefit retirees is the push back of the required beginning date for RMDs from age 70.5 to 72. That being said, there is a lot of confusion around this change for those directly around age 70. To clear things up, here’s what to know: The new, later start for RMDs applies only to people who haven’t already reached age 70.5 in 2019 — meaning those born on July, 1, 1949, or later. Individuals who reached age 70.5 prior to the end of 2019 have already hit their required beginning date and must take RMDs under the old rules.

So, if you reached age 70.5 in 2019 — meaning you were born on Jan. 1, 1949, through June 30, 1949 — and own a traditional IRA, even though you’re not 72 yet, you still owe an RMD for 2019. That RMD must come out of the account by April 1, 2020. Your second RMD would be due by Dec. 31, 2020.

There will definitely be those who turned 70.5 in 2019 who see that the rule has changed to move back the RMD age to 72 and then fail to take a RMD for 2019, 2020 or even 2021 on time because they don’t reach age 72 until 2021. By not taking an RMD for 2019 by April 1, 2020, by skipping 2020 and pushing 2021’s RMD to April 1, 2022, they might really be messing up three years of RMDs. This is all because they don’t clearly understand that the new age 72 RMD rule only applies to those who have not yet reached age 70.5 by the end of 2019. Everyone else is still subject to the 70.5 RMD age.

These people could be hit with the 50% penalty for missed RMDs. Consumers need to understand how this rule will impact those nearly age 72, so that they do not miss any RMDs.

To recap:

  • If you were born before July 1, 1948, you were already taking RMDs, and that continues unchanged going forward.
  • If you were born on July 1, 1948, through June 30, 1949, you turned 70.5 in 2019. Your first RMD is due by April 1, 2020. Your second one is due by Dec. 31, 2020. And then you continue to take RMDs by the end of each year going forward.
  • If you were born on July 1, 1949, or later, your first RMD is due by April 1 of the year after which you turn 72. Your second would be due by Dec. 31 of that same year, and then by Dec. 31 of each year thereafter.

3. Conduit or Pass-Through Trust RMD Failure (and a Big Tax Bill If Not Corrected)

In the past, many IRA and 401(k) owners have been encouraged to use conduit or “pass-through” trusts as beneficiaries of their retirement accounts to help qualify for the “stretch” provisions and provide creditor protections for their heirs. However, many of these trusts only gave access to the RMDs each year to the beneficiary of the trust.

With the new 10-year distribution period for many beneficiaries, there is actually no RMD for year one after the year of death of the account owner. In fact, the way the SECURE Act was drafted, the only year that has an RMD is year 10, as the act states all money must be distributed by the end of year 10 after the year of death of the IRA owner.

This means the trust provisions that were drafted prior to the SECURE Act could lock up money for heirs for up to a decade and then cause a full taxable distribution in one tax year for the full retirement account. This has potential for disaster, so trusts need to be reviewed as a consequence of the SECURE Act.

4. More Money Leaking Out of Retirement Accounts

A positive provision was added to the SECURE Act that allows those under the age of 59.5 to take out up to $5,000 from their IRA or 401(k) to cover costs within a year associated with childbirth or adoption and avoid the 10% penalty tax for early withdrawals. If both parents have their own retirement accounts, they could each withdraw $5,000, for a total of $10,000, without a penalty. Of course, they’d have to pay taxes on the money, though.

One issue with these types of additional access points, in regards to retirement money, is that they can encourage leakage — money leaving retirement plans and being used for other needs, instead of retirement.

While it is important to note that this provision actually allows for the individual to repay the amount they take out, there is the possibility of money leaving retirement plans that won’t be put back. In general, many Americans are not saving enough for retirement, and while childcare, the birth of a child and adoption are expensive, it is not always the best idea to use retirement funds for these expenses.

5. Improper Annuity Ownership in Retirement Plans

A new rule in the SECURE Act lessened the standard of care and review that a retirement plan sponsor must use to vet insurance products going into the plan. As such, there will be a large push to add more annuities into 401(k)s. The reality is, more Americans need access to lifetime income options inside of their retirement plans. Because investment advice and help with financial planning in a 401(k) can be hard to receive, many investors are on their own when picking investment allocations within their employer retirement plans.

By adding more annuities into retirement plans, younger investors who do not yet need to be invested in an annuity might end up with large percentages of their wealth in this strategy. The reality is that annuities can add value, but they will not be the right investment option for all participants … and without quality guidance, education and advice, individuals could have improper ownership and investments in these assets.

Lastly, the bill really fails to address the biggest issues in financial and retirement planning. Americans rely heavily on Medicare, Medicaid and Social Security. However, all three government programs need revisions and further funding to secure the retirement of many Americans.

While the SECURE Act has a very exciting and positive sounding name, it does not really address the true issues facing many Americans in regards to retirement planning. Be proactive, save for retirement, invest for the long term, understand how these new rules impact your situation and speak to a qualified professional to ensure your plan is up to date with the new laws.

About the Author

Jamie P. Hopkins, Esq., CFP, RICP

Director of Retirement Research, Carson Wealth

Jamie Hopkins is a well-recognized writer, speaker and thought leader in the area of retirement income planning. He serves as Director of Retirement Research at Carson Group and is a finance professor of practice at Creighton University's Heider College of Business. His most recent book, "Rewirement: Rewiring The Way You Think About Retirement," details the behavioral finance issues that hold people back from a more financially secure retirement.

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