Last week, President Trump signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act into law. Here are some of the retirement enhancements the act offers, effective January 1, 2020:
- Required Minimum Distributions (RMDs) from 401k, 403b, and IRA accounts will not be required until the year in which the account owner turns age 72. Note: If you were born on or before June 30, 1949, you then are subject to the existing 70 & ½ starting age even if you elect to delay your first 2019 RMD to the April 1, 2020 deadline.
- Those age 70½ and older can now still invest into IRA plans
- Long-term part-time workers will have more access to retirement plans
- Some penalty free distribution exceptions have been added
But wait… all these come with a cost. The Act was meant to be revenue neutral, so where are taxes going to come from?
Congress killed the stretch IRA, and your children will pay the price! The SECURE Act does more to affect transferring wealth to your children than any other recent budget provision. If you do not spend all your Traditional IRA or 401k money before you die, your children who inherit those accounts must deplete them and pay all the income taxes within ten years! The effects of this act are significant, and in three days the House passed the amendments, the Senate passed it, and the President signed it into law. Passing laws in this manner gives constituents no time to react and/or object. Even now in mid-January, the only media coverage is by the financial press, not the mainstream media.
Prior to this bill, your children, or heirs other than your wife, were required to take distributions over that heir’s life expectancy. For example, if you pass away at age 75 with $1,000,000 in an IRA at the end of that year and your child is 39, the 2019 rules say that in the year following your death, your now 40 year-old beneficiary must distribute 1/43.6 (about 2.29%), specifically $22,936. The next year the factor would be reduced by 1 to 42.6, and the percentage would be about 2.35%. Assuming no change in value, the required distribution would be $23,474. Your 40, then 41-year-old child also gets taxed on that amount.
Starting with account holders passing in 2020, your 40-year-old child has ten years to take the money out. Even at one tenth for the first year, this adds $100,000 to your child’s taxable income. It should be noted that:
- A surviving spouse can still take over a decedent spouses’ IRA assets as their own.
- Minor children can use the stretch provision until they are age of majority before their ten-year clock starts.
- There are a few other, less common, exceptions as well.
Given the fact that most adult children have their peak earning years from 40 to 65, adding large taxable events during this period is very punitive, tax-wise. This is also the period during which most children’s parents will pass.
Additionally, Conduit Trusts that were written specifically to protect IRA assets may now be counterproductive. These See-Through trusts were put in place to protect assets from creditors while allowing beneficiaries to stretch payments using the eldest beneficiary’s life expectancy. Many of these trusts were written to pass-through the RMDs to the ultimate beneficiary. Now there is technically only one year a distribution is required: the tenth year! So, it is possible by creating efficient trusts for IRA assets that your trust can create a one-year blowout of all the value of an IRA, including ten years of growth, to be distributed in one single tax year.
While there are many other less prominent provisions, these are the key points you must know to plan accordingly. One smaller provision allows for easier certification and a lower corporate liability for a company to put an annuity into their retirement plan, leaving no question as to why the insurance industry lobbied so strongly for this bill!
Tax deferral is only efficient when the taxes paid in the future are less than the taxes paid now. Given the development of the passage of the SECURE Act, it is easily possible from the viewpoint of intergenerational wealth transfer that you may defer taxes only to pay a higher rate later. Given this, Roth conversions may be a more viable alternative in some cases. Additionally, leaving IRA assets via a trust will require careful examination of existing trusts created for that purpose, and could possibly mean not using a trust at all.