Pros, Cons and Possible Disasters after SECURE Act
Sweeping retirement changes were just signed into law that bring both positives (for savers) and potentially disastrous consequences (for heirs). Here are five important things everyone should do right now.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was attached to a broad appropriations bill at the end of 2019, ushering in the largest retirement planning bill since the Pension Protection Act of 2006.
The SECURE Act has three main areas of impact for Americans:
- To help reduce costs associated with setting up retirement plans for small employers.
- Increase access to lifetime income options (annuities) inside retirement accounts.
- Lastly, and perhaps most importantly, in the short term, the SECURE Act made major required minimum distribution (RMD) rule changes around retirement accounts.
Since the RMD rule changes have the biggest impact on the near term, I put together a short review of what is changing and what you need to do now in order to be prepared.
3 Major RMD Changes
1. Bad News for Inheritors: Removal of Inherited “Stretch” Provisions
As part of the new rules, some taxpayers are about to take a hit. The single biggest tax revenue generator in the SECURE Act comes from the removal of the so-called “stretch” IRA provisions.
In the past, a non-spouse beneficiary of an IRA or defined contribution plan like a 401(k) could stretch out RMDs from the plan over their own life expectancy. However, starting on Jan. 1, 2020, if an owner of IRAs and 401(k)s passes away and leaves the accounts to a beneficiary other than their spouse, the beneficiary will only have 10 years after the year of death to distribute the entire retirement account unless the beneficiary is a qualified eligible beneficiary as defined in the SECURE Act.
Exempted from the 10-year stretch provisions are surviving spouses, minor children up until the age of majority, individuals within 10 years of age of the deceased, the chronically ill and the disabled.
Bottom line: Many beneficiaries will now see higher taxes and a shorter distribution period for inherited retirement accounts under this change.
2. Good News for Savers: Removal of Age 70.5 IRA Contribution Restriction
Under previous law, those working past age 70.5 could not contribute to a traditional IRA. Starting in 2020, the SECURE Act will remove that restriction.
This means that those working past age 70.5 can contribute to an IRA — either deductible or non-deductible — depending on other factors around IRA contributions like income, filing status, earned compensation, and active status in a qualified plan. As such, someone after age 70.5 could now contribute up to $7,000 as a deductible contribution to an IRA and so could a spouse, totaling $14,000 as a couple per year, if they meet certain requirements.
3. Good News for Retirees: New Required Beginning Date for RMDs at 72
In the past, the mandatory beginning date for most retired individuals was age 70.5 to begin taking RMDs from their retirement accounts. If you have not yet reached age 70.5 by the end of 2019, your new required beginning date for RMDs will be age 72. However, if you reach age 70.5 by the end of 2019, your required beginning date is set, and the SECURE Act does not change the requirement for you to begin taking out RMDs at 70.5.
So, what do we do now that the RMD rules have changed?
No matter who you are, take the following five steps to check in on your financial plan.
1. Review Your Beneficiaries
Because the SECURE Act changes the outcome for many inherited retirement accounts to be distributed in a shorter time period, now is the time to review your beneficiary designation. Beneficiary designation on IRAs and 401(k)s determines who the accounts will pass to once the owner dies. Take the time and make sure all your beneficiary designations are in order and that they still match up with your intended goals.
If the goal of the original retirement account owner is to give lifetime income to a child, they might want to reconsider the strategy or the beneficiary designation. As an alternative, a charitable remainder trust could be used as a beneficiary with the child as the lifetime income beneficiary to provide them with a lifetime income.
This is just one example of how changing a beneficiary designation might make sense to better align with your goals after the SECURE Act’s passing.
2. To Avoid Disaster, Take a Close Look at Your Trust
If you were using a trust as a beneficiary of an IRA or 401(k) in order to achieve creditor protections and take advantage of the stretch provisions through a “pass-through” trust, there could be a huge issue with your plan now that the SECURE Act passed. Most of these conduit or pass-through stretch trusts for IRAs were set up to pass through RMDs to the beneficiary.
However, if the trust language states that the beneficiary only has access to the RMD each year, under the new rules, there is no RMD until year 10 after the year of death. This means the IRA money could be held up in the trust for 10 years and then all be distributed as a taxable event on year 10.
This is nothing short of a disaster for trust planning, so review your trust documents if you were using one as an IRA beneficiary.
3. Perform a Tax Review
The RMD rules are expected to be a huge tax revenue generator for the federal government. As such, review your tax situation and how the new rules will impact the true amount of legacy and wealth you are passing over to your children.
In some cases, it might make sense to leave your IRA to a charity and purchase life insurance for your children or a charitable remainder trust to maximize legacy benefits. The SECURE Act should put everyone on notice that the government is looking to raise tax revenue in new ways, so do a tax review of your estate and retirement income plans.
4. Consider Doing Roth Conversions
While Roth IRAs are subject to RMDs when inherited, they typically do not cause a taxable event when distributions are taken by a beneficiary. As such, it can make a lot of sense (with lower tax rates under the Tax Cut and Jobs Act) before the owner of the IRA passes away to strategically do Roth conversions to move money from an IRA to a Roth IRA. The benefits here are threefold, as it can help a retiree:
- Maximize their wealth
- Lower taxes in retirement, and
- Be a huge benefit for heirs under the SECURE Act’s 10-year distribution rule.
5. Execute RMD Planning
Lastly, if you have an IRA or retirement account, you need to get a retirement income plan in place. This means understanding your RMDs, when they will begin, which accounts you need to withdraw from, and how the withdrawals will impact your taxes and other retirement benefits, like Social Security or Medicare.
Prior to retirement, it might make sense to do Roth conversions or to roll money into an IRA to better manage RMDs. Additionally, strategies like Qualified Charitable Contributions — where you give money directly from an IRA to a qualified charity (thus reducing RMDs) — can be powerful planning strategies with the new RMD age of 72.
The SECURE Act’s full impact won’t be felt for decades, but the time to act is now, even if it’s just a review to make sure nothing’s changing for you. Don’t delay and fall into higher taxes because you weren’t proactive around the new retirement law changes.
Because so many of these changes are complex and involve long-term financial and tax planning strategies, it is important to consider how the act will impact your overall plan and to speak with a qualified tax and financial professional about what is best for your situation.
About the Author
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.