The most significant retirement legislation in a decade was signed into law by President Trump just before Christmas as part of a broader government spending bill.
We first reported on the Setting Every Community Up for Retirement Enhancement Act of 2019 (known as the SECURE Act) back in May of this year when it quickly passed in the House of Representatives. While the name implies that this new legislation will help Americans with their retirement, not all the changes are for the good.
The legislation contains several modifications to the current law designed to help small business employees, home care workers, long-term part-time workers, and benefit annuity-issuing insurance companies.
But as advisors, the main takeaways for us are the following:
- Investors will be able to contribute to traditional IRAs for as long as they want after age 70 ½, instead of being stopped at that age under the previous law;
- Retirees won’t have to take required minimum distributions until age 72 (changed from 70 ½); and
- The so-called “Stretch” IRA will be eliminated for most IRA inheritors.
Of these three, the most significant by far is the elimination of the Stretch IRA.
The Stretch IRA has become a staple estate planning technique that allowed IRA beneficiaries to take distributions over the course of their actuarial lifetimes. Think small payout, small taxes and stretching the IRA over an extended period with tax-advantaged investment gains.
Under the new law, IRA beneficiaries will be required to deplete their inherited IRAs within 10 years. In other words, IRA distributions will be subject to higher taxes sooner, as distributions are made in larger amounts.
For example, a 23- year-old who inherited a Roth IRA under the old rules could take required payouts over 60 years while those assets kept growing; now they will need to be exhausted within 10 years. Ed Slott, a CPA and nationally recognized IRA specialist, has estimated that this hypothetical 23- year-old with a $1 million Roth IRA under the current plan could receive a total of $23 million over that 60-year span.
But with the 10-year rule in place, the heir would receive about $16 million, or 30% less over the same 60-year period. (This assumes a 6% annual rate of return, a 25% average tax rate, and no withdrawals from the Roth under the new law until the end of the 10th year. Amounts are unadjusted for inflation). Unless your name is Bill Gates, you probably could find good use for an extra $10 million over your lifetime.
There are some exceptions to the 10-year rule, namely surviving spouses and certain beneficiaries (minor children and people with disabilities).
These legislative changes require IRA owners to revisit their plans. The good news is there are sound planning strategies and workarounds to consider.
- Roth Conversions: A conversion is a great way to ease future tax burdens. Although the account owner would have to pay the taxes now, the beneficiary withdrawals would be tax-free under current tax law. With tax rates expected to increase in the future, retirees could presumably pay less in taxes now than their beneficiaries would pay had the funds stayed in a traditional IRA. Nevertheless, even Roth IRA beneficiaries would be subject to the 10-year payout rule.
2. Charitable Donations: Consider using IRA assets to make charitable donations during life as well as at death, instead of other available assets. Qualified Charitable Distributions (QCD) allow retirees to make donations directly from their IRA to a qualified charity. The amount given to charity is excluded from taxable income. Because IRA distributions are taxed as ordinary income, this is a very tax-efficient way to support those causes that are important to you. Charitable distributions from an IRA at death receive a charitable deduction equal to the amount of the gift, thereby reducing the size of the decedent’s estate.
3. Bequest Non-IRA Assets: Instead of passing on the IRA to their heirs, IRA owners could spend down those assets and bequeath assets from their taxable (investment) accounts instead. Assets in taxable accounts, such as stocks, receive a step-up in basis at death. Because the beneficiaries are free to sell inherited stocks whenever they wish, they can better time their sales to minimize taxes. These assets are also subject to more favorable capital gains taxes as opposed to IRA assets, which are subject to ordinary income tax rates.
Every individual’s circumstances are different, so these recommendations may not apply to all, but if you have IRA assets, now is the time to review your beneficiary designations within the context of your estate plan. We would welcome the opportunity to review your circumstance and provide you with our best possible advice.
The government estimates that over the next decade it will extract $15.7 billion from the pockets of IRA inheritors with the passage of this act. We’re reminded of that line in the song “Lyin’ Eyes”, a Grammy-winning ballad sung by the Eagles in 1975: “Every form of refuge has its price.”
Adieu, Stretch IRA, adieu.