SECURE Act changes to IRAs will affect you or someone you know in 2020. The ‘‘Setting Every Community Up for Retirement Enhancement Act of 2019’’ (SECURE Act) begins on page 604 of H. R. 1865, the 715-page Congressional appropriations bill that President Trump signed on December 20, 2019 (see a copy of the law published online at https://www.congress.gov/116/bills/hr1865/BILLS-116hr1865enr.xml). This article highlights some SECURE Act provisions and suggests income tax planning strategies that may help some families reduce tax burdens.
SECURE Act Changes to IRAs
SECURE Act changes to IRAs will transform basic savings and wealth transfer strategies recommended by estate planning lawyers and financial advisors over the past 2 decades. Americans that worry about outliving their savings may be able to build IRA accounts more effectively to reduce that risk. Changes in how IRA beneficiaries must withdraw inherited IRA funds will require more careful planning for IRA owners to pass wealth to their children and grandchildren.
SECURE Act Repeal of IRA Contribution Age Limit
Prior tax law prohibited an IRA owner from investing money in IRAs after reaching 70 ½ years of age. Now, any person that earns taxable income through any kind of lawful employment can contribute to an IRA regardless of age.
SECURE Act Extension of Age for Required Beginning Date
The SECURE Act extends the minimum age at which an IRA owner must begin withdrawing IRA funds from 70 ½ years of age to 72 years of age (the “Required Beginning Date”). The 18-month extension of the Required Beginning Date age may seem like a small change, but it can promote significant IRA growth. Coupled with an employed person’s ongoing IRA contributions, savvy plan owners should be able stretch their savings even if they live beyond their 100th birthdays.
SECURE Act Limitation of “Stretch” IRAs
The SECURE Act almost eliminates the “Stretch” IRA wealth transfer strategy that became very popular in recent decades. We will explain some of the IRA withdrawal requirements and stretch IRA strategy before explaining how the SECURE Act effectively neuters the stretch IRA strategy.
An IRA owner must begin taking a fully taxable minimum annual withdrawal (the “Required Minimum Distribution”) from the IRA after reaching the Required Beginning Date (now age 72). The Required Minimum Distribution is a percentage of the IRA value based on the IRA owner’s statistical life expectancy that the IRS published in life expectancy tables. If the IRA owner does not contribute additional funds to the IRA under the new rules, the Required Minimum Distribution will force the IRA owner to withdraw and pay taxes on most of the IRA account within the IRA owner’s life expectancy.
If a deceased IRA owner designated individual beneficiaries, old IRA rules would give the beneficiaries an option of the inherited IRA funds over their life expectancies. An IRA owner’s children or grandchildren could take such tiny IRA withdrawals that most of the IRA funds would remain intact to grow faster than their withdrawal rates. The stretch IRA strategy takes its name from the way it has enabled multiple generations to stretch IRA withdrawals. Savvy family IRA owners and beneficiaries have used the strategy to build tremendous wealth while delaying income taxation of that wealth for many decades.
The SECURE Act requires most beneficiaries to withdraw their inherited IRA accounts within 10 years after the deceased IRA owner’s death. Beneficiaries do not have to take annual distributions, but they must complete the entire IRA withdrawal within the 10-year deadline. The 10-year inherited IRA distribution rule does not apply to these beneficiaries of deceased owner’s IRA:
- the surviving spouse;
- the deceased IRA owner’s children younger than 18 years old (but the rule applies after each child’s 18th birthday);
- the beneficiary with a disability that prevents the beneficiary from maintaining gainful employment;
- a chronically ill beneficiary with the kind of disability that might require the level of health care service that a nursing home provides; or
- a beneficiary that is less than 10 years younger than the deceased IRA owner.
SECURE Act Wealth Management Strategies
Healthy People with Modest IRAs
Average American life expectancy has dropped slightly in recent years still, but we are living longer than previous generations (see the PBS News Hour article, “American life expectancy has dropped again. Here’s why” published online at https://www.pbs.org/newshour/health/american-life-expectancy-has-dropped-again-heres-why). Most people in 1950 did not think about living into their late 90s when average life expectancy was just over 68 years of age, but today’s average life expectancy is 78.87 years (see U.S. Life Expectancy 1950-2019 published online at https://www.macrotrends.net/countries/USA/united-states/life-expectancy). A healthy person with a family history of long life should consider a financial plan that will support the person in extremely advanced age. The new rules allow such a person to delay withdrawing from an IRA and to continue contributing to it long after traditional retirement age.
IRA Owners with Children in Higher Tax Brackets
The stretch IRA strategy’s demise under the Secure Act changes our view of multi-generation wealth and income tax planning. We are encouraging clients to compare income tax returns with their kids and consider bracket management of inherited retirement plans. People that pay income taxes in lower brackets than the income tax brackets of their children should consider converting their traditional retirement plans to Roth IRAs (see our discussion of the Roth conversion strategy in our SECURE Act preview article, “SECURE Act IRA Changes – A Bag” online at https://www.hawkinselderlaw.com/secure-act-ira-changes-a-mixed-bag/). The strategy reduces the family’s tax burden by taxing the IRA at the older generation’s lower tax rate so that the younger generation’s higher tax rates will not consume the IRA savings.
IRA Owners with Children in Higher Tax Brackets
People that are paying income taxes in higher tax brackets than their children should consider a reverse strategy to pass the tax burden to their children. High-tax bracket parents may want to continue contributing to their plans later in life so that they can grow the size of their plans to increase the wealth transfer to their children at their children’s lower income tax brackets.
Charitable IRA Planning
We encourage everyone to consider funding their charitable interests with retirement plan distributions. All distributions from traditional IRAs are fully taxable to individual distributees, but tax-exempt charitable organizations can receive IRA distributions tax-free. Therefore, we encourage charitably-minded people to consider designating charities as IRA beneficiaries. We also encourage high-income tax bracket people to consider making qualified charitable IRA distributions to tax-exempt charitable organizations after they reach age 70 ½ (find our blog articles about charitable giving by entering “charitable” into the search field at https://www.hawkinselderlaw.com/blog/).
About the Authors
Jeff R. Hawkins and Jennifer J. Hawkins are Trust & Estate Specialty Board Certified Indiana Trust & Estate Lawyers. They are also active members of the Indiana State Bar Association and National Academy of Elder Law Attorneys.
Jeff is a Fellow of the American College of Trust and Estate Counsel and the Indiana Bar Foundation. He is also a member of the Illinois State Bar Association and the Indiana Association of Mediators. He served as the 2014-15 President of the Indiana State Bar Association, and he is a registered civil mediator.
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