The SECURE Act Changes Important IRA Rules for Retirees and their Beneficiaries

In December 2019, as the bitter and partisan impeachment hearings went on in the House of Representatives there was a brief moment of unity.  Attached to a larger bill which kept the government funded, the SECURE Act passed with overwhelming support from both parties.  Regarded as the largest change to retirement plans since the 2006 Pension Protection Act, the SECURE Act’s main purpose is to provide new ways for employers to create retirement plans for their employees.  However, there are two key changes that will make large impacts on retirees and their beneficiaries.

The new Required Minimum Distribution Age is 72 instead of 70½.

IRA and other retirement account owners who did not reach age 70½ before the end of 2019 (born after June 30, 1949) will not be required to withdraw a minimum amount from their IRAs until the calendar year that they turn 72.  Technically, for the first year of their required minimum distributions (RMDs) they can delay their distribution until April 1^st of the year after they turn 72. 

However, if your first RMD year was 2019 or earlier (born on or before June 30, 1949) you still fall into the old rules.  For example, if you turned 70½ in 2019 and were required to take an RMD from your retirement accounts in that year or until April 1, 2020, you will still be required to take an RMD in 2020, even if you will not turn 72 until 2021. 

Roth IRAs are still exempt from RMDs for the Roth IRA owners (but not if you inherited a Roth IRA) and continue to be a great way to grow wealth tax free.  The popular Qualified Charitable Distribution was unchanged by the new bill and is still available to IRA owners who have attained the age of 70 ½ (not just the year that they will reach age 70 ½).

The IRS tables remain the same for now for both the group that has already started RMDs and those that can now wait until 72.  This means that 72-year olds will have to take the same percentage of their accounts out as the 72-year olds that came before them.  The only change is that they won’t have to take out the percentage that they otherwise would have as 70- and 71-year olds. 

The Stretch IRA rules have been changed from lifetime distributions to a new 10-year requirement.

Non-spouse beneficiaries of IRAs whose original owner passed away on or before December 31, 2019 will continue to be able to take a minimum distribution from these Inherited IRAs over their lifetimes.  However, for deaths of IRA owners on or after January 1, 2020 the non-spouse beneficiaries will have 10 years to empty the IRA.  They do not have requirement for any specific year, just that the IRA needs to be depleted by the 10-year anniversary of the date of death. 

In most cases, this would allow the IRA beneficiary to spread out the taxes over 11 tax years, but this is still a much shorter time frame than previously allowed.  For example, a 57-year old beneficiary would be able to spread the withdrawals (and the taxes) over 28 years if their parent died on December 31, 2019 but only over 11 years if they died on January 1, 2020.  As attorney and retirement benefit consultant Natalie Choate observed, “The best middle-class tax shelter has been turned into a worst middle-class tax trap.” 

A fairly common scenario we see in our practice is an elderly parent who dies and leaves their adult children their IRA.  Often, the receiving parties are empty nesters living in paid off houses in their peak earning years, in other words, the IRS’ favorite taxpayers with high income and few deductions.  Piling on distributions from an inherited IRA over 10 or 11 tax years won’t be a pretty task in many cases.  In any case, it will require a lot of planning and guessing about the growth of the Inherited IRA, current vs. future incomes and tax rates.

Inherited Roth IRAs are subject to the same 10-year distribution rules, but their withdrawals won’t be taxable.  This makes planning for them much easier than Traditional IRAs.  Given the tax-free growth of Roth IRAs, the standard strategy will be to keep the money growing as long as possible and take it all out, tax-free, just before the 10-year anniversary.

Some Mitigating Strategies

So what can IRA owners with a multi-generational mindset do to minimize the overall tax impact to their family?  We have a few ideas.

·         Partial Roth Conversions

A Roth Conversion is a tool to accelerate taxable income into tax years before it is required by law through the Required Minimum Distribution rules.  The current US tax code’s lowest two tax brackets are 10% and 12%.  Historically, these are incredibly low rates that, in many cases, should be used every year by moving a portion of Traditional IRAs into Roth IRAs to be taxed that year and then allowed to grow tax-free in the Roth IRA.  The next two tax brackets are 22% and 24% which are also lower for those income ranges than in previous years and may be worth considering.

·         Qualified Charitable Distributions

With the new higher standard deduction, fewer taxpayers are able to itemize deductions even if they made significant charitable contributions.  In this case, giving to your charities directly from your Traditional IRA is a great way to support charitable work and to have a tax-free withdrawal from an IRA in addition to claiming the standard deduction on your income taxes.  These Qualified Charitable Distributions (QCDs) are available to IRA owners and Beneficiary IRA owners over age 70 ½.  Amounts distributed to charities count toward the RMD.  The annual limit on QCDs is $100,000 per IRA owner.  This is a great way to get money out of Traditional IRAs tax-free.

·         Leave IRA assets to Charities at Your Death

If charities are a part of your estate plan, the ideal scenario is to leave your Traditional IRA assets to charity and your Roth IRA and non-IRA assets to individuals.  The proportion of IRA assets relative to other assets may not match your intended allocation between charities and individuals, but if there are charities in your estate plan they ought to receive your Traditional IRA assets (since they don’t pay taxes as your family does).

Although little noticed, this piece of legislation has changed the foundations of retirement planning and multi-generational tax planning with the stroke of a pen.  It will require a new mindset and a lot of planning to figure out the best path forward for your family.  We look forward to working with each of our clients as we create the best plan for your unique situation.