Congress went out with a bang in 2019 by slipping the Secure Act into the year-end spending bill — which quickly sailed through both houses of Congress to become law after President Trump’s signature despite months of delay earlier in the year.
The Setting Every Community Up for Retirement Enhancement Act (Secure Act) presents clients with some new IRA planning perks going forward — but also curtails the popular “stretch IRA” estate planning strategy for most clients. As we roll into 2020, all clients should be made aware of the new changes so that they can modify both their savings and withdrawal strategies to maximize tax value in their retirement and estate planning strategies.
Key Secure Act Changes Affecting IRAs for 2020
The Secure Act contains a number of provisions that will impact almost every client who is planning for retirement. One key change extends the “required beginning date” — which is the age at which clients have to begin taking required minimum distributions from IRAs. For clients who have not yet reached age 70 ½ by the end of 2019, the required beginning date is extended from age 70 ½ to age 72.
This means that clients who are not already relying upon their IRAs for living expenses can take advantage of the tax deferral offered by IRAs for another year and a half. The remaining RMD rules were unchanged — so clients who reach age 72 in 2020 will be required to take their first RMD by April 1, 2021 (i.e., April 1 of the year following the year they turn 72).
The Secure Act also removes the age restriction on contributing to traditional IRAs, so that clients can now continue to contribute even after they have reached age 70 ½.
For clients who pass away after December 31, the “stretch” inherited IRA strategy will also be largely eliminated. Under the new Secure Act rule, almost every client who inherits a retirement account (IRAs, 401(k)s and even Roths) in 2020 and beyond will have to empty the account within 10 years. The new rule does not apply to surviving spouses who inherit the account. Disabled beneficiaries, as well as minor children, those who are chronically ill or less than 10 years younger than the account owner, are also excluded from the 10-year distribution rule.
Planning for 2020 and Beyond
Clients with sizeable IRA balances should evaluate whether pushing back their RMD obligations is a positive. Waiting to take RMDs could lead to higher overall RMDs, potentially pushing the client into a higher tax bracket in retirement without smart tax planning. Converting IRA funds to a Roth over time (or even purchasing a qualified longevity annuity contract, or QLAC) could help clients avoid this scenario.
Clients who had relied upon the availability of the stretch IRA rules should be advised about alternative planning strategies if they don’t plan to spend their IRA funds during retirement. For some, this could be as simple as naming a spouse as beneficiary rather than a child or grandchild (the spouse retains the ability to stretch the tax benefits of the IRA over his or her lifetime). Others might wish to increase the number of IRA beneficiaries to spread (and potentially minimize) the tax hit over the 10-year distribution period.
Some clients might be more attracted to the qualified charitable distribution (QCD) strategy, which allows them to give to charity instead of adding to their taxable income with IRA RMDs after their required beginning date has passed. Each account owner can transfer up to $100,000 per year to a qualified charity in a trustee-to-trustee transfer, eliminating or reducing their taxable RMD obligation and simultaneously reducing the overall IRA balance.
Others might be more inclined to explore alternative trust strategies to pass their accumulated retirement funds onto children or grandchildren on a tax-preferred basis for the beneficiaries. Combining life insurance with a trust is one potential option. Clients can direct their RMDs into a trust to fund purchase of a life insurance policy (with the trust as beneficiary of the policy, and the client’s heirs as beneficiary of the trust itself).
The RMDs transferred into the trust can be used to pay the insurance premiums. When the policy death benefits are eventually distributed to the trust, the benefit will be tax-free to the beneficiaries and the trust (unlike the required distributions that the beneficiaries would have to take from the IRA, which would be fully taxable to the beneficiaries).
Like so many other laws, the Secure Act creates both benefits and burdens for clients depending upon their individual circumstances.