While you were busy wrapping presents on December 20, 2019, Congress was busy changing the way we withdraw money out of our retirement accounts as we know it. The SECURE Act (Setting Every Community Up for Retirement Enhancement) has many provisions, but the biggest changes we want to bring to your attention are the "Death of the Stretch" and the age you take your Required Minimum Distributions.
“Death of Stretch” is most easily illustrated with an example. Let's say a relative died on January 1, 2020 (or after) and leaves you $1,000,000 from their IRA. Prior law required you to take out required minimum distributions based on your age & life expectancy each year. Now, under the SECURE Act you have 10 years to withdraw the entire $1,000,000 balance, accelerating your tax liability and accelerating how soon the IRS collects their tax revenue. You could take out $0 for 9 years and in the 10th year withdraw the entire account balance. But, here is where you start thinking - is there a strategy we could consider for ourselves and our future heirs to minimize taxes? The answer is yes.
While the “Death of the Stretch” sounds like a big deal, and in the tax retirement law world it is, the number of people it impacts is quite slim. Many people don’t have IRAs to leave at death or a lot of people that receive IRAs as inheritances withdraw the money as quickly as they can. This change impacts individuals who would rather not have a lot of additional taxable income and would have preferred to have the continued tax deferred growth for as long as possible. The IRS made this change for a variety of reasons, but a main reason is that they never intended IRAs to be permanent tax deferral vehicles for wealth transfer across generations. Depending on how old your beneficiaries were, you previously could have had decades of tax deferred growth.
Of the people the rule does affect, the group is quite small. If you receive an IRA from your spouse, give your IRA to a charity, leave it to your estate, don’t name a beneficiary, leave it to a chronically ill or disabled individual, or someone that is less than 10 years younger than you, nothing has changed – you still withdraw the balance of the IRA over your life.
Those that are impacted are called Designated Beneficiaries – this category includes children, grandchildren, friends, neighbors, and anyone not covered by one of the previously named categories. Designated beneficiaries now have to take the entire balance out of the IRA within 10 (really 11 years, because the clock starts the year following the year of death.)
STRATEGIES TO CONSIDER
- This rule applies to IRAs and Roth IRAs. If you receive an IRA, it may be beneficial to take money out equally over the 11 years to potentially minimize taxes. If you receive a Roth, it may be beneficial to let it “cook” tax-free for 10 years and withdraw the entire balance tax-free in year 11.
- If you receive an IRA you could be strategic with the withdrawals to supplement or accelerate your retirement and bridge a gap until you receive Social Security.
- If you will be leaving an IRA at your death, you could consider starting to convert some of your IRA to Roth to minimize the tax liability for your heirs.
These are just a few ideas to get you thinking about how this change may impact you. If you are a client of our firm we will be reviewing these changes during our 2020 planning meetings with you. As always, if you have time sensitive questions we are here to help.
CHANGE TO RMD AGE
The next provision of the SECURE Act with the biggest impact is for the original account owners of an IRA and that Required Minimum Distributions are no longer required at 70 ½ but rather at 72. Only those that will turn 70 ½ after January 1, 2020 are impacted by this change. If you were born on June 30, 1949 or before then you turned 70 ½ on December 31, 2019 and you still have to take your RMD in 2020. This is for the original account owner of the IRA, not for a beneficiary.
Other key changes included in the SECURE Act:
- You can now contribute to an IRA if you have earned income at any age (previously disallowed if over 70 ½.)
- Penalty-free withdrawals of up to $5,000 from retirement accounts to help pay for childbirth or adoption expenses (you still owe taxes but the 10% penalty is waived and you can also put the money back into the account later if you desire.)
- Permitted withdrawals from 529 plans for up to $10,000 of qualified student loan repayments for the beneficiary and $10,000 for each of the beneficiary’s siblings (an aggregate lifetime limit, not an annual limit). Previously student loan debt was not considered a qualified education expense.
- Allowing graduate students to count stipends and non-tuition fellowship payments as compensation for IRA contribution purposes.
IN CONCLUSION
This is a summary of the changes and not an all-inclusive list of the 124 page legislation. As with any sweeping change to retirement law there will be many things to learn and consider. The important thing to note is that anyone who is impacted by these changes can consider these good problems to have. For example, if you have a retirement account, don’t use it all during your lifetime, have heirs to leave it to and are concerned about those heirs’ tax liability and want to proactively manage that, you can consider yourself fortunate. If you don’t need to take withdrawals from your IRA until the last required date, you can consider yourself very lucky to live until age 72 and not need those savings. While changes to tax laws can be confusing, when you peel back the layers of this new law and put it in real terms, while there are plenty of financial and tax planning opportunities to take advantage of, it is good to remember that we are lucky to have such problems to manage in the first place. We will be keeping you up-to-date on relevant changes and, as always for our clients, feel free to reach out with specific questions. We are here to help.