Last week we went over the basics of the SECURE Act’s provisions, who it will affect, and what the potential impact will be. To recap, the SECURE Act is a new set of tax laws that went into effect on January 1st, 2020 and significantly impacts how IRA funds are distributed to non-exempt beneficiaries.
This week, we’re breaking down how the SECURE Act will affect retirees and their beneficiaries. We will also discuss your options for getting around the ten-year rule that effectively eliminated stretch IRAs for non-exempt beneficiaries.
How Will the SECURE Act Affect Me?
The two main provisions that apply to retirees are the changing required minimum distribution (RMD) age and the elimination of contribution age restrictions.
Now that the RMD age has been changed from 70.5 to 72, individuals can postpone taking IRA distributions for another year and a half, thus allowing their accounts to grow for a little more time and postponing income tax on unnecessary withdrawals.
However, the SECURE Act did not change the working exemption. If an individual is still working at age 72 and does not own more than 5% of their employing company, they are not required to take RMDs from their employer’s plan until after they have retired.
Non-exempt beneficiaries are more affected by SECURE Act changes than retirees themselves. With the elimination of the stretch IRA, some beneficiaries may be adversely affected by tax implications. As a reminder, exempt beneficiaries from the ten-year rule are spouses, chronically ill and disabled individuals, minor children (only until they reach the age of majority), and beneficiaries who are less than ten years younger than the account holder.
The requirement of draining an inherited IRA account within ten years of the account holder’s death will have the greatest impact on beneficiaries who are already financially comfortable. For example, if a beneficiary inherited an IRA worth $1 million and wanted to take equal distributions, they would have to withdraw $100,000 each year (adjusted for growth). This would easily put that person in a higher tax bracket, resulting in a larger tax burden.
There is no RMD for inherited IRA beneficiaries, but each delay in withdrawal means that they must take a larger distribution in later years within that ten-year window. If the non-exempt beneficiary does not drain the account in ten years, the penalty is 50% of the total account value — a gross misuse of accumulated funds.
What Can I Do About the Elimination of the Stretch IRA Provision?
For IRA account holders who were planning to use the stretch IRA provision for their heirs, there are a few things that you can do to help ensure that they are not burdened by excessive taxes or forced to let some of your hard-earned IRA funds go to waste. Some of these strategies will also help lessen the tax burden on the account holder, once RMDs go into effect.
Charitable Remainder Trust (CRT)
Instead of designating a person as the beneficiary of your IRA, you can create a CRT and designate it as the recipient of your remaining funds. CRTs allow the income beneficiary to take distributions for the entirety of their life. This amount is based on a formula preordained within the trust document, e.g. 5% of the prior year’s final value. When the income beneficiary passes away, the remaining funds will go to a charity of your choice. The non-exempt beneficiary will end up paying less in taxes and you will have the knowledge that any remaining funds will go towards a cause that you find personally meaningful.
Increase the Number of Beneficiaries
One simple way to reduce the tax burden on any one beneficiary is to have more beneficiaries of your IRA. This does not change the fact that all funds must be distributed within ten years, but each beneficiary will pay less in total.
A Roth Conversion means that you as a traditional IRA account holder are choosing to move assets held within that account from a tax-deductible IRA to a non-deductible Roth. Since taxes are already paid on funds in Roth IRAs, this significantly lowers the tax burden on non-exempt beneficiaries. There are no RMDs on Roths, either.
Aside from doing a Roth conversion, you have other rollover options. If you’re still working, you may have stock in your employing company as part of your 401(k). If you leave that job, you can choose to take a lump sum distribution of that stock and pay taxes only on the initial amount.
If you have a trust set up as a conduit for your retirement accounts, this could be problematic for your beneficiaries. Depending on how the trust is organized, your beneficiary may be unable to access funds until the tenth year after your death, which would result in them paying all of the taxes on distributions in just one year. If you believe that your IRA is set up in this manner, you may wish to speak to your financial advisor to evaluate your options that will minimize the tax burden for your beneficiaries.
Qualified Charitable Distributions
If part of your legacy planning involves charitable contributions, taking qualified charitable distributions (QCDs) once you reach the age of 70.5 may make sense. This is especially true if you seek to fully deplete your IRA by the end of your lifetime and want to avoid paying some taxes on your RMDs.
Now, when IRA account holders take their RMDs, it will not count towards adjusted gross income when it is given to charities as part of a QCD. The annual limit for a QCD is $100,000 and account holders can begin using IRA funds for QCDs at age 70.5 still, as they could under the old law. Once account holders turn the new age of 72 and begin taking their RMDs, they can withdraw up to $100,000 RMD-eligible funds every year, put it towards a charity, and not be taxed on the withdrawal.
If you believe that you or your beneficiaries will be negatively impacted by your current financial plans under the new SECURE Act, please speak with your financial advisor. For more information on the SECURE Act and your options for setting yourself and your heirs up for success, feel free to reach out to the CERTIFIED FINANCIAL PLANNER professionals at Morris Financial Concepts.
The opinions expressed herein are those of Morris Financial Concepts, Inc. (“MFC”) and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. The CFP® (Certified Financial Planner) certification is a voluntary certification; no federal or state law or regulation requires financial planners to hold CFP® certification. It is recognized in the United States and a number of other countries for its (1) high standard of professional education; (2) stringent code of conduct and standards of practice; and (3) ethical requirements that govern professional engagements with clients. The CFP® certification is granted by Certified Financial Planner Board of Standards, Inc. (CFP Board). For more information, https://www.cfp.net/
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