Your IRAs (and other retirement accounts) Might Be Changing Big Time
Retirement FundingI'm normally reluctant to write about pending legislation. I did it a little bit with the Tax Cuts and Jobs Act (the new tax law). I'm going to do it about the SECURE act. The bill has broad bipartisan support and the President has indicated he will sign it. SECURE is an acronym, like most titles of legislation, and the exact translation isn't important. What is important is that it will make two major changes to how retirement accounts are treated under the Tax Code. If passed in time, the changes will go into effect on January 1st and apply to those accounts where the owner dies after that date..
Required Beginning Date (RBD) Changed
Under the current Code, you must begin taking distributions form your Traditional IRA or Employer Plan (401(k), TSP) the year you turn 70 ½. You can delay the first distribution until April 1st of the year after you turn 70 ½, but if you do, you'll need to make two distributions that year.
Under the House passed version of the Bill the RBD is moved to age 72. Not sure yet whether you'll be able to delay your first distribution into the next year. Since the ½ year is removed, I think it is less likely the delay will be allowed.
If you don't need the money to live on, an additional 1 ½ years of tax deferral can be a good thing. And like under current law, distributions from a Roth IRA are not required. This isn't the case for Roth TSP or Roth 401(k) and they will likely continue to have Required Minimum Distributions (RMD).
Stretch IRA Eliminated
The term Stretch IRA refers to the fact that if you inherit an IRA, you can take distributions based on your life expectancy. This will be eliminated for most of us by the SECURE act and instead all assets in the IRA must be distributed within 10 years of the death of the original owner. On a side note, since employers are not required to allow a survivor to maintain an account in the employer sponsored plan, many times those funds are rolled into an inherited IRA.
There are exceptions. Spouses can still roll the funds into their own IRA or leave the funds in an inherited IRA and in this case the inherited IRA can still be stretched out over the life of the beneficiary. Also, minor children who are beneficiaries can stretch distributions until age of majority. Then the 10-year rule comes into effect. There will also likely be an exception for beneficiaries that are permanently and totally disabled.
Planning Considerations
In the case of the later RBD, there could be concerns with income taxes and Medicare Premiums. If you start at age 72, the percentage that you will be required to take out of your account will be higher than at age 70 under the old law and your account balance will likely be larger as you haven't taken anything out. To combat this, you might look at doing Roth conversions when you start your ultimate retirement. Another option might be to take distributions from your pre-tax accounts to pay for living expenses to up to the top of your current tax bracket rather than using taxable funds. There are a lot of ways to finesse this, but it takes a fair bit of planning.
The shorter time to distribute inherited funds issue can be mitigated as well, though the techniques are more complicated. While you think this may not be a big problem, $1M in pre-tax accounts would mean a $100K distribution per year if you have one beneficiary and you want to even out the cash flow. There aren't many places in the tax code where a $100K increase in income won't put someone into a higher tax bracket. Some options to consider to deal with this are:
- Naming a Charitable Remainder Trust as the Beneficiary. The funds would come out of the IRA tax free and the trust would make distributions to a designated beneficiary(ies). These distributions, which are taxable, would stretch out over the life of beneficiaries. Any remaining funds when the beneficiary(ies) die go to the charity.
- Using a Sprinkle Trust. The trust sprinkles distributions to several beneficiaries and since they get a small amount, the tax bite is reduced. You could also get similar results by naming multiple beneficiaries (Children and Grandchildren as an example)
- Setting up a Trust in Certain States. This one gets pretty complicated. In essence you set up an irrevocable trust in a state without income tax and therefore the distributions aren't subject to state tax. It's not nearly as easy as that sounds though and it won't work in all state combinations.
So...
- If your parents are sitting on a large amount of pre-tax money, you might want to discuss changing beneficiary set-up.
- If you're sitting on large pre-tax accounts, planning for the most tax efficient way to withdraw those funds is very important.
If you like this article, you might enjoy these blog posts:
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