The SECURE Act (Setting Every Community Up for Retirement Enhancement Act), part of the government’s spending bill, was passed and signed into law on Friday, December 19, 2019. It is the product of a bipartisan effort intended to strengthen retirement security across the country as Americans today have a longer life expectancy and are largely underfunded for retirement.
The Act includes several provisions that do incentivize American workers and business owners to save more money for retirement, and that’s a very good thing. But where there are pros, there are always cons, and the SECURE Act is no exception.
First the good. The SECURE Act increases the age for Required Minimum Distributions (RMDs) from your IRA from 70.5 to 72, if you were not already 70.5 in 2019. That avoids, at least for a few extra years, the need for you to take forced withdrawals from your retirement account when you may not even need the money. You are also able to now contribute to your traditional IRA beyond age 70.5, provided you have earned income. There is no age cap on contributing to a Roth IRA.
The SECURE Act also makes provisions for a withdrawal of up to $10,000 annually from 529 Plans for qualified student loan repayments.
Part-time employees have also gotten a win. Workers who work either 1,000 hours throughout the year or have three consecutive years with 500 hours of service may become eligible to participate in a company-sponsored retirement plan if the plan allows it.
Small business owners will receive a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with auto-enrollment, on top of the start-up credit they already receive. Additionally, 401(k) safe harbor plans have increased the cap under which they can automatically enroll workers from 10% of wages to 15%.
But the SECURE Act also contains a big drawback for wealthy investors who hoped to pass along some of their hard-earned assets to their own heirs: The end of the so-called “stretch IRA.”
For wealthy individuals who don’t really need to tap their IRA savings to fund their retirement lifestyle, the stretch IRA had been a reliable, tax-advantaged way to pass that money on to their children or grandchildren, while keeping the money growing tax deferred for many years to come. That’s because RMDs withdrawn from IRAs are based on life expectancy tables.
Previously, if you were in your 60s or 70s already, you had to take larger distributions, even if you didn’t need the money, as governed by your average life expectancy according to the IRS actuarial tables. But when IRA assets were passed on to a younger beneficiary, the distributions could be drastically reduced. This allowed your money to grow, thanks to the magic of tax-deferred compounding, for a much longer time period.
For example, a 40-year old son or daughter who inherited your IRA previously could have re-calculated the RMD over a 40+ year life span, allowing for much longer tax advantaged growth of the gifted IRA assets. And a 20-year old grandchild could have stretched out the period of withdrawal for 60+ years, while the money grows without being taxed until withdrawn.
However, the SECURE Act states that beneficiaries must withdraw ALL IRA assets within 10 years after the inheritance, eliminating the stretch IRA.
For example, a $1,000,000 IRA inherited by your 40-year old daughter, now must be withdrawn within the next 10 years, instead of much smaller annual withdrawals of a few thousand dollars each year over the next four decades or more.
This could easily push her into a much higher tax bracket, drastically reducing the value of your inheritance. And for younger beneficiaries, the wealth-eroding implications of the Secure Act could prove even worse.
For instance, let’s say you were to leave that same $1,000,000 IRA to your 15-year old granddaughter instead. The bulk of these assets previously could potentially have grown in value, tax-deferred, for another sixty years or more.
But, under the new law, your granddaughter is forced to withdraw the entire sum in just ten years, with a big cut of your hard-earned money being paid in taxes. Adding insult to injury, the distributions could be taxed at the rates paid by trusts and estates, or the so-called Kiddie Tax rate which in this case could run as high as 37%! Meaning both your granddaughter and daughter could get hit with an exorbitant tax bill.
One solution might be to convert your traditional IRA account to a tax-free Roth IRA. You’ll take a big tax hit up front, but Roth IRAs have no RMDs, so your money can compound tax-free until you withdraw it. Better yet, your beneficiaries can inherit your Roth IRA assets completely tax-free.
Another possible solution is to withdraw some of your IRA assets and use the money to fund a life insurance policy that is held in trust for your beneficiaries. That way your children or grandchildren pay no taxes on the policy’s value.
There are many more provisions to the plan, as well as solutions to help mitigate the possible tax implications, but we wanted to highlight those that we believe could have the largest impact for you. For more information on the SECURE Act and how it could affect you, consult your plan administrator or call us at (772) 257-7888.