The end of the year is always a good time to check in on your financial and estate plans, but Congress has given you an extra incentive to do so this year. Congress recently passed the SECURE Act, who’s proponents are hailing it as one of the biggest changes to our retirement system in years. Regardless of your position on the SECURE Act, here are a few key points you need to know.

In this article we will be focused on the portions of the SECURE Act that affect all individuals, whether they own a business or not. I will be writing a separate article focused specifically on some of the changes the SECURE Act is bringing to the 401(k) space. 

If you read nothing else, read this next section.

The Death of the Stretch IRA

Under the SECURE Act, individuals who inherit an IRA (with certain exceptions) may no longer take the annual Required Minimum Distributions over their own life expectancy using the single-life expectancy table. Instead they have to withdraw the funds over 10 years after inheriting the IRA. 

This new rule does not apply to:

1. Spouses
2. People who are disabled (as defined by IRC Section 72(m)(7)) or chronically ill (as defined by IRC Section 7702B(c).(2), with limited exceptions)
3. People who have already inherited IRAs
4. Individuals who are not more than 10 years younger than the decedent
5. Certain minor children (of the original retirement account owner) but only until they reach the age of majority

OK, let’s explain that in plain English.

First, If you inherit an IRA from your spouse you have the option of rolling that IRA into your own IRA. This is generally favorable as the spouse who inherits the IRA can then wait to take RMDs until they reach age 70.5. That option still exists after the SECURE Act.

However, prior to the SECURE Act if you inherited a traditional or Roth IRA from anyone other than your spouse, you could take the annual Required Minimum Distributions (RMDs) from the account out over your lifetime using the single life expectancy table. This was a nice benefit because it meant you could allow the bulk of the money to continue to grow tax-deferred (or tax-free if you were using a Roth IRA) within the account. Yes, you had to take out some money each year to satisfy the RMD but most of it continued to grow within the account. 

An example may help.

Let’s say you’re 45 years old and you inherit a $1 million dollar IRA from your aunt. If you were able to use the single life expectancy table to calculate your RMD, your first RMD would be approximately $25,773.

This would leave over $974,000 left in the IRA to potentially grow and compound tax-deferred. Clearly, even with increasing RMDs each year, a significant amount of money would be left in the IRA after 10 years to continue growing tax-deferred (or tax-free in the case of the Roth IRA).

The new 10 year rule for IRAs

Under the SECURE Act non-spouse beneficiaries (and a few other exceptions listed above) can no longer use the single life-expectancy tables to calculate a Required Minimum Distribution based off of their life expectancy. Now you have 10 years to withdraw all of the funds from an inherited IRA (inherited in 2020 or later). However, in an interesting wrinkle, there is no requirement that you take out a specific dollar amount over those 10 years.

This leads to a planning opportunity and a risk. 

First the opportunity

A small silver lining to this new rule is that you will have some flexibility to determine when and how much you take out of the IRA, as long as all of the funds have been withdrawn before the 10 year deadline. There is no rule that you have to take an even amount each year or an amount based on a formula. How much you withdraw is completely up to you.

For business owners it may be that you can manage your income in such a way that in some years the income from your business is lower, which would be an opportune time to withdraw more money from the IRA. Or if you are within a few years of retirement, you may wish to wait until you reach retirement to start withdrawing assets from the IRA. Generally, with a lower taxable income, you will pay less in taxes on the IRA distributions.

The risk if you anticipate leaving an IRA to your heirs

The lack of a required withdrawal amount also poses a risk to individuals who have set up a trust as the beneficiary of their IRAs. Some trusts have been written to prevent the trust from making distributions above the RMD required. However, under the SECURE Act there is no annual RMD required under the 10 year rule, until the 10th year! 

This could mean the entire IRA would be distributed in year 10, potentially creating a huge tax-bomb for your heirs.

Other trusts have been set up to hold some, or all, of the IRA distributions. These distributions are taxed at the unfavorable  trust and estate tax rates, where you hit the 37% income tax bracket at just $12,951 worth of income in 2020. You may not know that trusts and estates have their own income tax table, and it’s very unfavorable compared with the single or married filing jointly tax tables. Here is the projected trust and estate income tax table for 2020:

Image credit @Forbes https://www.forbes.com/sites/kellyphillipserb/2019/11/06/irs-releases-2020-tax-rate-tables-standard-deduction-amounts-and-more/#13ac225e4937

Compare this to the married filing jointly table where you wouldn’t hit the maximum 37% tax bracket until you earned $622,051 in income in 2020. Here are the projected tax brackets for a married couple filing jointly in 2020:

Image credit @Forbes https://www.forbes.com/sites/kellyphillipserb/2019/11/06/irs-releases-2020-tax-rate-tables-standard-deduction-amounts-and-more/#13ac225e4937

Under the trust and estate income tax brackets you quickly pay much higher tax rates on very low amounts of income. This can mean significantly more money paid in taxes overall. 

Not all trusts have to be rewritten but you need to call your Trust and Estate Planning attorney to review your documents.

A mad dash for Roth conversions?

There has been some speculation that many people will start converting massive amounts of their traditional IRA and 401(k)s to Roth IRAs. Before you start doing that, pause for a minute.

Yes, it may make sense to do Roth conversions now but it may not. Are you in a higher tax bracket than your heirs? How much taxable income do you have already? Are you experiencing a temporary lull in income before you claim Social Security? Are you charitably inclined?

Talk to your tax advisor and financial planner before you start converting large amounts of your pre-tax money to Roth.

Changes to RMDs and IRA Contributions under the SECURE Act

Changes to RMDs

Now under the SECURE Act you can delay your Required Minimum Distribution (RMD) until age 72. Realistically, this only helps a very small percentage of the population, as most people withdraw more than the RMD annually anyways. According to the IRS only about 20.5% of the population takes the RMD, in other words, nearly 80% of the population withdraws more than the RMD, so delaying RMDs until age 72 only benefits a few, primarily wealthy, individuals. 

However, with the new 10 year rule on inherited IRAs it may be less appealing to delay taking withdrawals from your IRA. Clients will need to consider their tax rates and the proposed tax rates of their beneficiaries when deciding how much money to take each year and from which account. Managing your tax rate throughout retirement, so it is neither too high nor too low, will become even more important. 

Changes to IRA Contribution Rules

Savers can now continue to save in a traditional IRA past age 70.5 Again, this benefits a relatively small portion of the population who still have earned income beyond age 70.5 and the means to save it in an IRA. There were no changes to the Roth IRA rules (you can contribute to a Roth IRA at any age as long as you have earned income).

Qualified Charitable Distributions under the SECURE Act

Important note, Qualified Charitable Distributions (QCDs) can still begin at age 70.5. Charitably inclined individuals over age 70.5 can make charitable distributions directly from their IRA, that are excluded from income and can count towards their annual RMD (if you follow some specific steps, talk to your tax advisor and financial planner). 

However, with the new changes to the IRA Contribution rules, any pre-tax contributions you’ve made to your IRA after age 70.5 will reduce your Qualified Charitable Distribution allowance.

For example, let’s say Laura contributes $7,000 to a traditional IRA when she is 71 and again when she is 72 (a total of $14,000 in traditional IRA contributions made after Laura turned 70.5). Later in her life, Laura chooses to make a large charitable distribution of $25,000 directly from her IRA. Only $11,000 of that charitable distribution would qualify as a QCD because the $14,000 in traditional IRA contributions made after Laura turned 70.5 will not qualify as a QCD. However, the $14,000 can be claimed as an itemized charitable deduction if Laura itemizes on her taxes.

Watch out for annuities in 401(k)s

One change to the 401(k) space that is concerning and thus I have decided to include it in both this article and the article directed more specifically at business owners is the new “Fiduciary Safe Harbor for the Selection of Lifetime Income Providers.” That all sounds well and good but what it means is that now it will be easier for employers to offer annuities in 401(k) plans.

Annuities are not inherently bad and can serve a purpose within one’s retirement plan. Unfortunately, as a financial planner I don’t see very many of low-cost or single premium types of annuities being sold by insurance companies. We must only look at the terrible investment options in many 403b plans to see how ugly this can get for retirement savers.  

While the SECURE Act does specify that the plan fiduciary must ensure the costs of the annuity are “reasonable” that is a fairly broad definition and there is no requirement to choose the lowest cost provider (which is reasonable as cost and value are often different). The Plan sponsor also only has to meet a relatively low threshold in terms of conducting due diligence on the insurer providing the annuity products, and is largely absolved of legal liability should the annuity provider become unable to make the promised guaranteed payments. 

If you participate in a 401(k) plan or offer one be very wary of new annuity options that may be popping up more frequently in the coming years.

Miscellaneous Provisions in the SECURE Act worth noting

529 College Savings Plans can now be used for certain registered and certified with the Department of Labor apprenticeship programs, and for up to $10,000 in student loan debt repayment. The $10,000 lifetime limit on student loan repayment is per beneficiary but it appears you can use 529 money to pay $10,000 of the student loans of the beneficiary’s sibling(s) as well.

Early Withdrawal Exemption for up to $5,000 in IRA withdrawals to use to cover the costs of childbirth or adoption. The withdrawal must take place after the event, but appears to be available for multiple births or adoptions and, importantly, it can be repaid to the IRA later.

Firefighter and Emergency Medical Responders will enjoy a 1 year repeal of the SALT limitation (currently you are limited to a deduction of just $10,000 in state and local income taxes on your federal tax return). Again, this applies to such a small group of individuals it’s nice but not that meaningful. 

The Kiddie Tax reverts back to the parents’ highest marginal tax bracket instead of being taxed under the trust and estate tax brackets. Under the 2017 Tax Cuts and Jobs Act (TCJA) children with unearned income were taxed under the trust and estate brackets, which may have been favorable for some children with relatively little unearned income. Now Congress has changed its mind and reverted back to the old rules where children’s unearned income is taxed at their parents marginal (read = highest) tax bracket. 

This may or may not be a positive depending on the parents income tax bracket, and the children’s level of unearned income. On top of all of this, you can actually choose to have your children’s unearned income taxed under either the old (new) rules or the new (old) rules for 2019 and 2018. 

If your child has significant unearned income talk to your CPA about the best strategy for filing 2019 taxes and whether or not it makes sense to amend your 2018 return as well.

This is certainly not everything covered in the SECURE Act but we’ve covered some of the most important changes. While the SECURE Act may be overhyped in terms of how much it will help the majority of Americans it does have some important points that will affect many of the clients of Spark Financial Advisors. As always, it’s a good idea to reach out to your estate planning attorney, CPA or tax advisor, and financial planner to see how these changes may affect you. 

None of the information included in this article should be construed as advice.

Questions for Lauren?