New Tax Law Reduces "Stretch-ability"

The recent federal government spending package enacted on December 20, 2019 included the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act is the most significant  change to retirement legislation in more than a decade.  All provisions take effect on or after January 1, 2020.

While much of the Act is beneficial, there is one important change that will impact investors with significant assets in traditional IRAs and retirement plans.

Elimination of the "stretch IRA"

Prior to the SECURE Act enactment, non-spouse beneficiaries (most commonly children) who inherit traditional IRA and retirement plan assets could spread distributions — and therefore the tax obligations associated with them — over their lifetimes. This ability to spread taxable distributions from an inherited IRA or other retirement plan, over potentially a long period of time, was commonly referred to as the "stretch IRA" rule - the beneficiary could stretch distributions over their lifetimes, reducing each future years tax impact.

The Act generally requires any beneficiary who is more than 10 years younger than the account owner to liquidate the account within 10 years of the account owner's death unless the beneficiary is a spouse, a disabled or chronically ill individual, or a minor child. This means your spouse will be able to continue to stretch distributions over their lives but most other heirs will need to take distributions over 10 years.  This shorter distribution period could result in unanticipated tax bills for beneficiaries who inherit significant amounts in traditional IRAs or employer retirement plans. 

If you do have a significant amount of your planned estate in traditional IRAs or employer retirement plans, you may want to revisit how these tax deferred dollars fit into their overall estate planning strategy. For example, it may make sense to consider converting traditional IRA funds to Roth IRAs, which can be inherited income tax free. Although Roth IRA conversions are taxable events, investors who spread out a series of conversions over the next several years, or tactically during low income tax years, may benefit from the lower current income tax rates.

Benefits of the SECURE Act

The SECURE Act also includes several potentially beneficial provisions, including:

• If you choose to work beyond traditional retirement age, you will be able to continue to contribute to traditional IRAs beyond age 70½. Previous laws prevented such contributions.
• You no longer have to take required minimum distributions (RMDs) from traditional IRAs and retirement plans the year after you turn 70½. The new law generally requires RMDs to begin after you turn 72.
• For workplace plans like 401(k)s, employees will receive annual statements from employers with an estimate of how much their retirement plan assets would produce in monthly income received over a lifetime beginning at retirement, similar to Social Security or an annuity. 
• Employers will be able to offer lifetime income annuities within retirement plans. 
• Individuals can now take penalty-free early withdrawals of up to $5,000 from their qualified plans and IRAs due to the birth or adoption of a child. Regular income taxes will still apply.
• In addition, individuals may withdraw money from their qualified retirement plans and IRAs penalty-free to cover expenses that exceed a 7.5% gross income threshold in 2019 and 2020 (although regular income taxes will apply). The threshold returns to 10% in 2021.
• 529 account assets can now be used to pay for student loan repayments ($10,000 lifetime maximum) and costs associated with registered apprenticeships.

We will be incorporating these significant changes as we update retirement and estate plans.  If you would like to know more about how these changes might affect you, please reach out.  

As always, my best,

Mark