The SECURE Act: What It Could Mean for You
There is a bill in Congress that has passed in the House and may be debated in the Senate this fall that could have a big impact on retirees if it becomes law. It is called the SECURE Act (Setting Every Community Up for Retirement Enhancement) and below are a few of the proposed changes:
- The Required Minimum Distribution age will be raised from 70 ½ to 72.
- Traditional IRAs will no longer have age restrictions in regards to contributions.
- 401(k)’s will be available for part-time employees.
- The distribution timeframe of Stretch IRAs will be limited to 10 years.
While the list of proposed changes is much lengthier, one can see that positive steps are being made to promote financial well-being. However, one big area of concern is around the withdrawal limitations on Stretch IRAs as this may cause some strategies in place to be revised.
When one inherits an IRA, they will have to take Required Minimum Distribution (some exceptions apply) and are faced with a few distribution options:
- For surviving spouses only – Rollover the deceased spouse’s IRA into your own. If a spouse, below age 70 ½, inherits an IRA, it is generally advisable to roll over the deceased spouse’s IRA into their own and defer taking RMDs.
- Take a Lump-Sum Distribution and pay ordinary income taxes on it. Generally, this is not good idea from a tax standpoint. It can push you into a higher tax bracket for that year, thus resulting in a higher tax liability.
- Distribute the IRA within a five-year timeframe. If the new IRA holder has not taken RMDs yet, they have the option to delay taking them with the caveat that after a five-year period, the entire IRA must be distributed. This delay can provide some breathing room to do some tax planning in order to minimize the overall tax liability faced with the full distribution of this IRA.
- “Stretch” out the Required Minimum Distributions of the IRA over a lifetime. The IRS provides an age-factor table which one can calculate how much to distribute annually. This is the typical option for most individuals as it minimizes the overall tax liability.
What this new bill proposes is to eliminate option #4. Large IRAs can be affected for a few reasons:
- Larger annual tax liability – Because the distribution period will be restricted, taxes owed on distributions can no longer be stretched out over a lifetime and thus minimized.
- IRA Trusts may no longer be viable – In most cases, when a Trust is named the beneficiary of the IRA, the Trust follows Required Minimum Distribution rules. In this bill proposal, the only RMD, as per the Trust, is at the end of the tenth year. This would cause an enormous tax liability.
There are a few solutions that could circumvent or minimize the potential tax liabilities:
- Beneficiary Management – Directly naming multiple beneficiaries from the IRA can spread out the tax hit. For example, if an IRA is split amongst five beneficiaries, over a ten-year period, the tax impact would occur over 50 ‘tax years’. Assuming all five beneficiaries are in a low tax bracket, the distributed amounts would be spread out and thus minimize tax liabilities.
- Roth IRA Conversions – Before the owner of the IRA passes, Roth conversions can reduce the value in a Traditional IRA once it is inherited, which can minimize the tax liability for beneficiaries.
- Increasing Qualified Charitable Distributions from the IRA – Similar to the previous point, this can reduce the value of the IRA once it is inherited. (Which reduces the future tax burden on beneficiaries.) In addition, the owner of the IRA benefits from a reduced tax obligation on his/her RMD. Note: Qualified Charitable Distributions are only available to taxpayers age 70 ½ years or older.
As advisors, we are on the lookout for ways to maximize our clients’ after-tax returns and it’s important for us and for you to consider alternative strategies in the face of uncertain futures.