Congress means well – we’re nearly certain that’s the case.
It’s latest effort, the SECURE Act, gained final approval in December and was quickly signed by the president. The law aims to make it easier for citizens to save money for retirement, and we believe most of its provisions will do just that – but there are caveats. Estate planners for wealthier clients, in particular, might have their equanimity rattled by one key change in the old way of doing things.
Let’s examine the good new first. In the previous system, once people reached the age of 70½ (we’ve often wondered why such an odd age barrier was chosen), they were prohibited from making contributions to their traditional IRA accounts (Roth IRA contributions were allowed, and still are). The SECURE Act has removed this limitation: starting in the 2020 tax year, citizens can make IRA contributions after the cutoff age. This could be a major boon for people working after 70½, as more and more seniors are doing today.
The rules governing required minimum distributions (RMDs) have also been changed in favor of your clients. Previously, one had to take the RMD on traditional IRAs, 401(k)s and other popular retirement accounts starting at age 70½. The age limit has now been raised to 72, which as a byproduct supports easier calculations for planners and clients alike.
There is a catch. People who turned age 70½ in 2019 must still operate under the old rules. Those who reach the magic age in 2020 and beyond will enjoy the SECURE Act’s benefits and can take RMDs starting at 72. Anyone who turned 70½ last year must be sure to take their first RMD by April 1, 2020. If they miss the deadline, a fine totaling 50% of the shortfall awaits.
Financial advisors and accountants should act quickly and speak to clients who turned 70½ last year to assure they understand the ins-and-outs of the new law. We see plenty of room for confusion, potentially leading to avoidable financial pain. Keep in mind that for these clients, a second RMD – this time for 2020 – must be taken by December 31.
So far, so good – a little convoluted, but that’s the nature of the game. One little SECURE Act change might not be so happily received, we fear. Adjustments to regulations governing RMDs taken post-mortem the original account holder – that is, by beneficiaries other than a spouse who inherit the plans – will strangle the tried-and-tested Stretch IRA strategy.
In the new regime, in most cases, non-spousal beneficiaries of defined retirement plans must empty those accounts within 10 years of the original holder’s death. Here’s the problem: let’s say you have a wealthy client who can live comfortably in retirement without excessively tapping their IRAs. Instead, they hope to leave these plans to their heirs, who can then enjoy their largesse in a tax-positive manner.
Under the old system, the heir could steadily take the RMD and enjoy the plan’s benefits over time. Most commonly, the RMD is only a few percentage points of the balance and an account can often last the better part of a lifetime. Under the SECURE Act, unless you fall into one of the categories specifically excluded from the new rules, it’s ten years and counting. For most people, the Stretch IRA strategy is effectively dead.
The damage shouldn’t be too great: people who take their RMDs in retirement are unaffected, and a ten-year deadline is enough time for most beneficiaries to adapt – there’s other ways to tax-shield your assets. Eligible designated beneficiaries will be exempt for the 10-year rule, including the spouse of the account holder, minor children, an heir no more than 10 years younger than the benefactor, and people legally defined as suffering from chronic illness.
For more information, please read: Secure Act includes one critical tax change ‘that will send estate planners reeling’ | MarketWatch