JAN. 10, 2020
The Setting Every Community Up for Retirement Enhancement (SECURE) Act is the broadest piece of retirement legislation in more than a decade. Effective January 1, 2020, this legislation creates new pathways to retirement security and, as such, will have wide reaching effects on retirement and estate planning for most Americans.
The SECURE Act’s changes
Perhaps one of the most notable personal planning changes arising from the SECURE Act are changes in distributions from inherited retirement accounts. In particular, the elimination of the “stretch” IRA life expectancy-based payout option, for most beneficiaries unless a few narrow exceptions apply. Most beneficiaries of inherited accounts are now required to fully liquidate these accounts within a ten-year1 period following the original owner’s death, for deaths occurring in 2020 and beyond. With the reduction in the time frame that beneficiaries must take out IRAs – going from life expectancy down to ten years – it’s important to consider planning strategies that will provide beneficiaries of these accounts with the most tax-efficient distributions in the future.
Elimination of the stretch IRA
Consider this scenario to show how the ten-year rule will work: On January 5, 2020, Michael’s father passed away, leaving Michael his IRA valued at $650,000. At age 64, Michael is still working and earns approximately $85,000 annually. However, Michael plans on retiring in three years at age 67. Michael has until December 31, 2030 to liquidate the entire inherited IRA. One option Michael can utilize to maximize the benefit from his inherited account would be to avoid taking any distributions while he is still working (years 1-3). Once he retires at age 67, and his yearly income decreases, distributions taken during years 4-10 can replace these lost wages.
While the stretch IRA is no longer an option for all beneficiaries, there are exceptions to the new ten-year rule that allow for life expectancy-based distributions. Exceptions to the new ten-year rule also include those for spouses, minor children of the IRA owner, and people with a disability2 or chronic illness3 and for individual beneficiaries who are no more than 10 years younger than the IRA owner.
Retirement planning opportunities
Effective long-term planning requires clients to think about both their lifetime income needs in retirement and what they will leave behind. As advisors, there may now be a path to discuss the SECURE Act’s impact with your clients as it relates to wealth transfer opportunities.
The reduction in the payout time frame from life expectancy to ten years for most IRA and defined contribution plan beneficiaries will impact the efficiency of such inheritance (from an income tax perspective). Historically, the greatest utility for the family from a tax efficiency and wealth building perspective, was typically to limit distributions from the IRA both by the owner and beneficiary to have as much as possible in the IRA/inherited IRA for as long as possible to potentially grow tax deferred.
Given the acceleration of the payout time frame window for these inherited accounts, different strategies may become more useful for IRA owners as they look to create tax-free distributions for their beneficiaries. The potential for a higher individual tax obligation from distributions now occurring in a shorter time frame can be minimized through effective planning with an advisor. If clients have already developed a retirement plan that relied on the stretch option remaining in place indefinitely, it would be beneficial to review the impacts these changes will have on their future savings. For example, Doug Ewing recently discussed the benefits of leveraging Roth conversions considering the SECURE Act to likely avoid a higher tax penalty on distributions in the future. Wealth transfer opportunities like Roth conversions (i.e. annual small Roth IRA conversions over time, back-door Roth conversions, and mega back-door conversions) are some that you should highlight when engaging with your clients.
The SECURE Act will bring about several changes to the American retirement landscape. It will increase an individual’s ability to save more for their retirement and create mechanisms for them to generate lifetime income. It will also accelerate the payout time frame for certain beneficiaries of inherited accounts. Therefore, it presents a unique opportunity for IRA owners, their families, and advisors to undertake thoughtful retirement income and wealth transfer planning. Effective retirement planning can be accomplished by readily engaging with your clients to ensure they’re properly addressing these new changes and opportunities.
Be sure to listen in as specialists from the Nationwide Advanced Consulting Group discuss the SECURE Act in their ongoing podcast series. Split into two parts, Part 1 covers the various changes to IRA distributions and contributions, and Part 2 discusses planning opportunities for advisors.