January 20, 2020
With the passing of the new tax law, the SECURE Act of 2019, Setting Every Community Up for Retirement Enhancement Act, I am reminded of something quoted by Benjamin Franklin, “there are two things certain in life, Death and Taxes”. The main objective for this tax act is to expand an individual’s access to their retirement savings and this will come at a cost to our inherited retirement accounts. It will be especially challenging for those who plan to leave a legacy thru IRAs to beneficiaries beyond their spouses. Many will rethink the beneficiaries of their pre-tax retirement accounts as well as consider tax planning strategies such Roth conversions and Life Insurance Planning. While there are pros and cons to the new changes, they impact can be significant and everyone with a retirement account should review their estate and trust plan.
Here is a summary of the key provisions:
Retirees – Required minimum distributions (RMDs) have changed from 70 ½ to 72 years of age for mandatory distributions from your IRAs, 401(k), 403(b) and other employer sponsored retirement plans. This simplifies when to begin your RMDs and can be helpful when you don’t need the additional income. It also allows one to two additional years of tax efficiency planning for those under age 72.
Beneficiaries – The SECURE Act marks the end of a popular financial and tax planning strategy called the Stretch IRA. This planning technique is allowed for anyone who inherits an IRA and allows RMDs, Required Minimum Distributions, to be spread out, stretched, over the younger of the beneficiary or the decedent’s life expectancy. For example, if a grandchild was the beneficiary, the stretch of the RMDs over more years would allow for a greater income tax benefit.
After January 1, 2020, IRAs, 401(k)s and other defined contribution retirement plans which are inherited by most non-spouse beneficiaries will have the requirement of a taxable distribution and depletion of the entire account within 10 years of inheritance. For most, the IRAs will be taxed sooner and at a much higher income tax rate(s) than originally planned by savers. This will be especially challenging if you are in the Retirement RedZone or those already retired.
There is an exception for non-spouse beneficiaries who are disabled, a minor, or chronically ill. Distributions for these exceptions would be over their life expectancy, although the exception for minors would end once they reach the age of majority with the final distribution to be taken within 10 years.
If you do not retire after age 72, there is an exception to RMDs. If you continue to work and you are not a 5% owner (or more) in the company, you can postpone your RMDs for that employer’s retirement plan until after you retire.
Spousal beneficiaries continue to be able to stretch and delay the inherited account’s required minimum distributions (RMDs) until year end of their 72nd birthday.
Trusts can be considered non-spouse beneficiaries and is area which will require more analysis for the tax impact. While a trust is often used to restrict withdrawals and access for specific beneficiaries, who may otherwise be irresponsible and possibly squander their inheritance. The loss of the Stretch IRA provisions has the potential to create income tax at a much higher trust rate. Those with spendthrift concerns for their non-spouse beneficiaries should consider the impact on their legacy and tax plan for potential changes in their estate documents and/or beneficiary designations.
The loss of the Stretch IRA results in the following challenges:
Employees – Employer sponsored retirement plans will now allow for the inclusion of annuities and other lifetime income options. With the continued reduction of employer-provided pensions creating your own personal style pension becomes more important.
Penalty free withdrawals from an IRA for the birth or adoption of a child for individuals under age 59 ½ years of age.
The age restriction of age 70 for contributions to traditional IRAs is now eliminated if you meet the IRS requirements such as earned income/wages. This will allow those who continue to work the ability to make pre-tax contributions.
Employers – There is a new 3-year tax credit for startup expenses for a new retirement plan. It’s important to note the difference between a tax credit and a tax deduction. The tax credit will reduce your tax liability, dollar for dollar. A tax deduction will reduce your taxable income at your current tax top tax rate which is currently 37% for individuals and 21% for corporations. There is a maximum tax credit of $5,000, annually for three years. There is also a $500 tax credit for automatic enrollment of employees into the retirement plan.
Depending on your objectives and unique situation, a successful retirement plan is one that must be not only created and written but also revisited annually to account for changes we can and cannot control. Tax reform and new tax laws are beyond our control. However, review your retirement plan and partner with a fiduciary to assist with navigating thru the impacts it may have on your income plan, tax plan, investment plan and legacy plan. Taxes can be your largest expense in retirement but with smart tax planning you can potentially add more to your bottom line and the legacy you desire for loved ones.