The SECURE Act, which stands for “Setting Every Community Up for Retirement Enhancement,” has been called the most significant piece of retirement legislation in a decade, and with wide bipartisan support, seemed like it would be a shoo-in for passage earlier this year. But after the House voted overwhelmingly to support the Act, it stalled in the Senate. It finally took lawmakers attaching the Act to the 2020 spending package to bring it to a vote. The Senate has now passed the bill and sent it to the President for his signature.
The Act offers some significant positive steps to help more Americans save for retirement, but a couple of provisions generated controversy. One, in particular, raised alarm bells among financial advisers who provide tax planning services to clients. In April, when it appeared that a version of the Act was on the fast track to passage in the Senate, I commented for an article in Forbes highlighting the provision that would eliminate so-called “stretch” IRAs. I later wrote about it on our blog. Because this provision is a tax revenue driver for the government, it survived the Act’s various iterations.
To recap for those of you who aren’t familiar, a stretch IRA is an estate-planning tool. Let’s assume you have an IRA and are unmarried, so you name your nephew as the one who will receive the proceeds from your IRA when you die. Your nephew is what’s known as a non-spouse beneficiary. If he elects to receive the money in your IRA as a lump sum, your nephew would have to pay taxes on the entire amount in the year that he received the funds. But, if he rolled the funds into another retirement account set up in his name, the funds could continue to accrue either tax free or tax-deferred, depending on the type of IRA (Roth vs. Traditional). That’s where the “stretch” part comes in. Prior to SECURE, non-spouse beneficiaries had to take required minimum distributions (RMDs) beginning in the year after the original owner’s year of death. Your nephew would calculate his first-year RMD by using his age and the IRS Single Life Expectancy Table. In each subsequent year, he would subtract one year from his initial life-expectancy factor. The “stretch” part of this situation is that your nephew could stretch the RMDs over his expected lifetime.
Under the SECURE Act, your nephew would have to take all distributions of the IRA by the end of the 10th year following your death. In this scenario, the money in the account wouldn’t have as much time to grow, and your nephew would have to pay taxes on the full amount of the IRA sooner — perhaps while he’s earning the most money of his career and in a high tax bracket already. Receiving the IRA distributions could push him into an even higher tax bracket, making the inherited funds more of a burden than a benefit.
What to Do Now?
If you have an IRA that you plan to leave to a non-spouse beneficiary, you may want to review your plans with your estate planner or adviser. Some people choose to roll their IRAs into a trust, and sometimes trusts require beneficiaries to receive an RMD every year. If that’s the case for you, now is good time to reconsider that requirement.
For those who expect to be on the receiving end of an IRA, some tax planning around RMDs would be prudent. Your financial adviser can help you determine whether a Roth conversion or a different tactic can help you potentially save on your taxes.
Benefits of The SECURE Act
While the stretch IRA provision will send some people scrambling, the SECURE Act does offer a number of positive features that will provide greater access to workplace retirement plans and encourage Americans to save more. First, the Act makes it easier for small businesses to create “safe harbor” retirement plans that are less expensive and easier to manage, and it would enable some part-time workers to participate. In addition, SECURE pushes back the age by which you need to take RMDs from 70 ½, as I noted earlier, to 72. This enables you to save just a little longer, giving those who aren’t diligent savers an opportunity to make up for lost time. If you have student loan debt, SECURE will also allow you to use a 529 Plan for qualified student loan repayments, up to $10,000 each year.
The Bottom Line
The SECURE Act has the potential to both help, and hinder, some Americans as they plan for the future. Take time to familiarize yourself with how the Act affects you and your family, and consider working with your financial adviser, tax specialist and/or estate planner to optimize your plans. You (and your heirs) will be glad you did.