The SECURE Act was signed into law in late December 2019 with little public fanfare. The Act was designed to improve the ability of Americans to save for their retirement, which overall it did.
But there is also a taxation change that is projected to raise over $15 billion in new tax revenue in the next decade, according to the Congressional Research Service. And it’s coming out of your pocket and mine, so tax planning is truly imperative now.
On the good side, the SECURE Act raises the Required Minimum Distribution age to 72 from 70 ½. This RMD age is when the IRS steps in and dictates an amount you must withdraw from your pre-tax retirement accounts and pay the associated income tax. Having more flexibility to wait until 72 is a plus for taxpayers.
This change only applies to people who turn 70 ½ in 2020 and beyond – if you were born in July 1949 or later. For everyone else, the old rules still apply. The Act also removes the age 70 ½ restriction for contributing to an IRA. If you’re still working, you can keep contributing.
Also on the good side, to combat retirees’ fears of running out of money, the SECURE Act has made it easier for employers to add a lifetime income annuity as an investment option in retirement plans.
This is an especially important change for those employees without access to a corporate pension, now giving them the option of saving into their own annuity that will provide lifetime income in retirement.
While the SECURE Act has many positive provisions beyond the two already mentioned, there is also a huge tax blow lurking for people who inherit IRA’s and Roth IRA’s beginning in 2020.
Under the old rules, non-spouse beneficiaries could generally stretch their taxable inheritance distributions out over their lifetimes – thus leaving the bulk of the inherited IRA asset safely tax-deferred and generally growing at a rate that exceeded the required distribution.
In theory, these inherited assets, especially Roth IRA’s, could pass from generation to generation in a tax-sheltered way. But now that’s changed.
The new rules dictate that non-spouse beneficiaries must empty these accounts by the end of the 10th year following the year of inheritance, and it applies equally to traditional IRA’s and Roth IRA’s.
For traditional IRA’s that “emptying” process is all taxable income. Your heirs will report that income on top of their regular income, and at a time that they’ll probably be in their highest earning years. To think that a third of your IRA could be lost to taxes is a very real possibility.
You can mitigate this change with proactive planning. Our current lower tax rates are legislated to expire in December 2025, so you have six years left to do systematic Roth conversions and slowly convert your taxable IRA to a tax-free Roth.
Think of it as you’re paying tax on the “seed” knowing that your heirs will reap a tax-free Roth “harvest” when they inherit it 20 or 30 years from now. Someone has to pay the tax; either you, now, on a smaller amount or your heirs, later, on a larger amount – there’s no escaping it.
There is no perfect solution, though. The SECURE Act has dampened the planning value of that Roth IRA “harvest” because even though it is importantly tax-free to your heirs, they still have to empty the Roth IRA within 10 years and those assets will transition to a taxable investment account. The Roth tax-free train comes to a stop.
Needless to say, the SECURE Act has created tax planning needs at both ends of the inheritance spectrum. Proactively, for IRA account owners to minimize the taxation at their passing. And reactively, for heirs, to know how best to minimize the tax in that 10-year window.
Marsh Wealth Management, LLC, is a fiduciary registered investment advisor, 504 Ebenezer Road. Financial planning and investment advisory services offered through Marsh Wealth Management, LLC, an independent investment advisor registered with the state. Marsh is an investment advisor of MWM in Tennessee. Marsh Professional Group, LLC, is a state-registered public accounting firm and a separate legal entity from MWM. For discussion of MWM and its investment advisory fees, see Form ADV on file with the SEC at www.adviserinfo.sec.gov.