Nearing the conclusion of 2019, Congress enacted a spending bill to keep the government running. Part of this legislation was the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act is the most sweeping legislation dealing with retirement in over a decade. The legislation will have substantive repercussions as many retirement account owners will need to seriously analyze their retirement and estate planning strategies to determine whether any adjustments are warranted. The SECURE Act has many components, but for now, we would like to focus on the parts of the Act we think will have the greatest impact on our clients.
The most significant change resulting from the SECURE Act is the elimination of the so-called “stretch” provision for most non-spouse beneficiaries of inherited IRAs and other retirement accounts such as 401(k)s. Prior to 2020, non-spouse beneficiaries could take distributions over their own life expectancies. Under the new law, for many retirement account owners who pass away in 2020 and beyond, beneficiaries will have to empty these inherited accounts within ten years with the exception of certain beneficiaries noted below. There is no longer a schedule for how much beneficiaries have to withdraw each year; beneficiaries now have flexibility on when and how much to withdraw. The only requirement is that the inherited account must be emptied by the end of ten years. For beneficiaries of inherited 403(b), 457(b) plans and Thrift Savings Plans the requirement for emptying the account within ten years does not begin until January 1, 2022; until then beneficiaries may continue to use the “stretch” provision.
Certain types of trusts drafted to serve as beneficiaries of retirement accounts may find that they can no longer make annual distributions to that trust under the new rules (and will suddenly have both the IRA and trust forcibly liquidated at the end of the 10-year window). We highly encourage clients who have a trust as a beneficiary of their IRA or retirement account to consult with their attorney or tax advisor.
The SECURE Act creates three classifications of retirement plan beneficiaries for determining post-death payouts beginning in 2020 and beyond:
- Eligible Designated Beneficiary (EDBs) – For EDBs the old “stretch” rules still apply. The classes of (EDBs) include:
- Surviving spouses
- Minor children until age of majority
- Disabled individuals and chronically ill persons
- Individuals less than ten years younger than the account owner
Each of the classes has its own rules which exempt them from the requirement of having to empty an inherited IRA within ten years, or in the case of a minor child, delaying the requirement until the age of majority.
2. Non-Eligible Designated Beneficiary (NEDB) – The new ten-year rule applies; beneficiaries not qualifying for EDB status MUST empty an inherited IRA in ten years. Withdrawals are flexible, in that they may be in any amount in any year. Any remaining balance must be distributed by the tenth year following the date of death.
3. Non-Designated Beneficiary (NDB) – Not an individual; examples are charities, the estate of the owner, etc. There is no change in Required Minimum Distributions (RMDs).
Other notable changes beginning in 2020 include raising the age for beginning Required Minimum Distributions (RMDs) from age 70 ½ to age 72 (an IRA owner who turned 70 ½ in 2019 or earlier must follow the old rules), and eliminating the age limit (previously age 70 ½) for making IRA contributions for those with earned income.
We encourage you to carefully consider how these changes may impact the beneficiaries you’ve designated for your IRA and other retirement accounts to determine whether any adjustments need to be made.
Tax Strategies for IRAs
QCDs – The Act did not change the age for allowing Qualified Charitable Distributions (QCDs) from an IRA, leaving the age at 70 ½. Once an account owner turns 70 ½, they may have their IRA custodian distribute up to $100,000 annually to a qualified charity, which allows the IRA owner to take distributions for this purpose that are not considered taxable income. All other IRA distributions are considered ordinary income, and the recipient is taxed in the year of distribution. For many IRA owners, QCDs are now the most tax-efficient way to make charitable contributions.
Roth Conversions – Under the SECURE Act, non-spouse IRA beneficiaries may find themselves in a higher tax bracket than they would have been previously. Therefore, for some IRA owners, it may be advantageous to convert some of their traditional IRA funds to a Roth IRA prior to those funds passing to a non-spouse beneficiary, taking advantage of currently low income tax rates. Taxes should be paid with funds outside of the traditional IRA, but by paying taxes at today’s low rates, Roth conversions may potentially save their non-spouse beneficiaries significant income taxes in the future. For Colorado residents, an additional benefit of Roth conversions is that converted funds, along with IRA distributions, pension, and Social Security income up to $20,000 at age 55 and $24,000 beginning at age 65 are excluded from state income taxes.
Beyond changing or eliminating various age-based thresholds for retirement accounts, the SECURE Act also allows a penalty-free distribution up to $5,000 for a qualified birth or adoption, though the distribution is still subject to tax. In addition, the Act includes numerous changes for employer-sponsored retirement plans and 529 accounts, which we will not address here.
IRA and Roth IRA contributions, distributions from IRAs, and naming beneficiaries all present challenges. The SECURE Act presents new issues for IRA account owners, but it also creates new planning opportunities. IRA and retirement plan owners should discuss strategies for these accounts with their financial advisor, particularly as they pertain to income tax and estate planning. As always, we stand ready to assist you in any way we can.
Clarissa R. Hobson, CFP®
Director of Financial Planning