The SECURE Act Changes the Landscape for Tax-Efficient Retirement Planning
Since March, COVID stories have dominated the headlines, and unprecedented financial market volatility has grabbed the attention of investors. As a result, it's been easy to forget that one of the most far-reaching pieces of legislation to affect the financial planning landscape in more than a decade was passed just before the pandemic struck. The SECURE Act, or Setting Every Community Up for Retirement Enhancement Act, contains provisions that impact saving for retirement, estate planning, retirement distribution strategies, tax planning, debt management, and retirement plan administration. Let's take a look at some of the most important changes brought about by the SECURE Act, and discuss its impact on wealth management strategies.
Required Minimum Distributions Under the SECURE Act
Prior to the SECURE Act, taxpayers generally had to begin taking RMD's from their IRA's and retirement plan accounts such as 401k's by April 1 of the year following the year in which they reached age 70 1/2. The SECURE Act dictates that for account owners who have turned or will turn age 70 1/2 after December 31, 2019, the "required beginning date" for RMD's is now April 1 of the year following the year in which age 72 is reached. There are several points to note about this new rule:
- It helps taxpayers born in the first half of the year more than it helps taxpayers born in the second half of the year. Those with birthdays between January 1 and June 30 gain an extra two years of tax deferral before being forced to take required minimum distributions, while those born between July 1 and December 31 only gain one extra year.
- The SECURE Act does not affect the opportunity for a non-owner employee who has attained age 72 to postpone taking RMD's on his/her retirement plan account until he/she stops working.
- The SECURE Act does not change the ability for those who have turned or will turn age 70 1/2 in 2020, or in future years, to make qualified charitable distributions.
Traditional IRA Contributions Under the SECURE Act
Before the SECURE Act, workers and their spouses were prohibited from making contributions to their traditional IRA's beyond age 70 1/2. This rule has now been repealed for contributions for tax years 2020 and later. There are a couple of points to note about this change:
- For those permitted to make IRA contributions after age 72, it may now be necessary to take required minimum distributions in the same year from the very same IRA accounts to which contributions are being made. While this may seem like a quirky by-product of the SECURE Act, the ability to make contributions to the same accounts from which you are required to take RMD's has always applied to SIMPLE and SEP IRA's, and indeed may be a way to offset the tax bills associated with unneeded required minimum distributions.
- There is a "QCD anti-abuse" clause contained in this section of the SECURE Act. Without going into the gory details, be careful about making Traditional IRA contributions after the age of 70 1/2 if you also have a desire to make qualified charitable distributions, because the former can dilute the tax benefits of the latter.
Inheriting IRA's and Retirement Plan Accounts Under the SECURE Act
Prior to the SECURE Act, designated beneficiaries could "stretch" the required minimum distributions from the tax-qualified accounts that they inherited over their remaining lifetimes. This was tremendously beneficial for these heirs since RMD amounts are taxed as ordinary income to the recipients. So being able to spread payouts from these inherited account balances over remaining lifetimes reduced the danger of pushing the recipient into higher tax brackets and opened the door to delaying some of the associated tax bills for many decades.
In order to pay for some of the other provisions of the SECURE Act (reflecting a concern by legislators for fiscal responsibility that now seems quaintly old-fashioned given the massive bailouts since the Act passed in December 2019), this "stretch" is no longer permitted for many beneficiaries who inherit tax-qualified accounts in 2020 and beyond. Instead, unless an inheritor is an "eligible designated beneficiary", he/she will now have to empty the inherited tax-qualified account by the end of the tenth year following the original owner's year of death. "Eligible designated beneficiaries", those who may still take advantage of the "stretch", include:
- surviving spouses,
- the decedent's minor children, but only until they reach the age of majority,
- beneficiaries not more than 10 years younger than the decedent, and
- disabled and chronically ill persons.
This new rule may have serious consequences for the total tax bills incurred by the "ineligible" beneficiaries who inherit IRA's or retirement plan accounts. Consider that many of these accounts will eventually pass down to grown children who, at the time of inheritance, will be in their prime earning years in their 50's and 60's. Distributions will now need to be crowded into a ten-year period that may well include the years when recipients are already in the highest marginal tax brackets of their lifetimes. And the need to withdraw the account balance over a decade, rather than over a remaining estimated lifetime of 25-40 years for people around this age, could push these beneficiaries into even higher tax brackets.
With this in mind, owners of IRA's and retirement plan accounts should review their beneficiary designations, and especially if tax-efficiency is a primary objective in passing these accounts along to heirs. In particular, owners who currently designate a trust as beneficiary, with the idea that the trust will be a "conduit" or "pass-through" vehicle for annual RMD's to flow from the account to designated beneficiaries, should revisit their designations and trust documents with their attorneys. In effect, for tax-qualified accounts inherited by "ineligible designated beneficiaries" in 2020 and beyond, there are no more annual RMD's, just the one requirement to withdraw the entire remaining account balance in the tenth year after the original owner's year of death.
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.