What did the SECURE Act do to yourIRA?
At the end of 2019 a piece of legislation was passed called the SECURE Act. It drastically changed the way an IRA is passed to a beneficiary by essentially eliminating something called the Stretch IRA. This altered many a retirement plan, as the Stretch was a viable planning tool prior to the legislation passing.
So what happened?
A popular planning tool for years when it came to spending your retirement income, was to save your qualified money for last. What this meant was that you would spend the money that you had in the bank first, and then spend your non qualified investment assets, and finally get to the assets that were subject to tax. Typically this meant your retirement savings including your IRA's. When the SECURE act was passed it limited the amount of time that those IRA accounts be retained by future beneficiaries. Under the old rules when you passed away and left your IRA to a beneficiary that was not your spouse they were able to take distributions over their remaining lifetime. This meant that if you left the money to your children they could "stretch" the IRA distributions over a period of many years, sometimes as much as 20 or 30 years. The change that happened as a result of the SECURE act was that that time period is now limited to a maximum of 10 years from the date of your passing. This is a huge change and as we'll see in a bit it can have a major impact on the taxation of your beneficiaries, and how much of your money makes its way to them versus the IRS.
A Stretch IRA example
For most folks, who may pass away in their 80's or even their 90's - their children are in their 40's or 50's. One thing we know about that time is that it typically coincides with peak earning years. Let's walk through an example of the impact this change can have on your beneficiaries. For our example let's assume that you were very diligent in saving and investing, and at the time you pass away you leave $1.5 million in your IRA account to your daughter. She is 54 years old, and between her and her spouse they currently have a household income in excess of $200,000 per year. Under the old rules with a remaining life expectancy of more than 30 years she would only have to take a distribution of around 3.3% per year, which would be just under $50,000 per year. Now it's no small task to add $50,000 a year to your taxable income, but it's still a much preferred option to the current scenario. As a result of the 10 year window, if she stretched it evenly over 10 years (she doesn't have to, she just has to distribute all the funds before the 10 years is up) she is looking at adding an additional $150,000+ to her taxable income each year for the next decade. Don't get me wrong, it's a wonderful "problem" to have, but in reality what this means is that more of your hard earned IRA is headed to the IRS than before. Adding such a large amount to taxable income could easily push your beneficiary into a higher bracket, meaning more of your money is not going to end up where you want it to go.
So what can you do?
As a starting point, if you are early in retirement you may want to look at taking distributions from your IRA earlier, or more heavily than you would have before this change. The trick is to take the money from the IRA. You don't necessarily need to spend it, simply taking it out of the IRA and subjecting it to tax, even if you turn around and reinvest it into a non qualified vehicle will help limit that future tax liability. Another option can be a Roth conversion. Similar to taking a distribution - in this case you are moving the money from the Traditional IRA where it is to be taxed, paying the tax on it, and getting it into a Roth IRA where it will be free from future tax. This is especially valuable for funds that you are likely to never draw from in your lifetime because it allows for the most efficient future growth being tax free without leaving a large potential tax burden to your beneficiaries.
Planning is the key!
Now more than ever having a retirement income distribution plan is necessary. Planning for this sort of thing in advance can allow you to limit future liabilities, and to pass on your funds more efficiently. If you don't have a current distribution plan, or if you are worried that yours might be out of date feel free to drop me a line and we can help get a plan in place for you!