The SECURE Act of 2019 is making its way through Congress. The Setting Every Community Up for Retirement Enhancement Act passed in the House in May. While the Act has not passed in the Senate, it still has many investors concerned they will lose a considerable chunk of their retirement savings to taxes.
Among the many things the Secure Act aims to modify, the main concern is how it may affect non-spousal beneficiaries of retirement plans. Currently, should a non-spouse inherit an IRA, the recipient can stretch the required minimum distributions from the IRA over their lifetime using the IRS actuarial tables. For example, if a 35-year-old inherited her father’s IRA, she could take the RMDs over 48.5 years. This would result in a relatively small distribution, allowing the balance to continue to grow tax-deferred.
The Secure Act aims to change the time period non-spouse beneficiaries have to withdraw the assets to 10 years. So, if a 35-year-old inherited her father’s IRA, worth $1 million, she would have to withdraw around $100,000 every year for 10 years to spread the tax out as long as possible. This would also likely bump the beneficiary up into a higher tax bracket; thus, the account assets would likely be taxed in at least the 32 percent, if not higher.
Spousal beneficiaries will still be able to inherit an IRA and treat it as their own, subject to RMDs based on their own age.
The concept of the Stretch IRA developed around 1999 but was refined in 2001 when the IRS simplified the guidelines for payout rules. This created an opportunity for investors to leave assets to their children or grandchildren that could potentially last through their lifetime. That is, it became an unintended estate planning tool. Prior to that change, beneficiaries had to withdraw assets by December 31 of the fifth year following the original account owner’s death if the owner had not yet begun RMDs.
The point is, tax laws change, and your financial and estate planning need to be able to account for these changes. Even if this bill were to pass in some form, it could also change again before you pass and leave your retirement accounts to your heirs.
It is important to remember that IRA assets were always taxable. IRAs only provide tax-deferred growth, so it is better to think about this money on an after-tax basis. A $1 million IRA will not actually yield you $1 million. For planning purposes, you and your adviser should look for opportunities that will allow you to pay the least tax possible. For some, that may be pulling out more than your RMD requires without increasing your own tax bracket, and then investing it into a brokerage account. For other investors, they may consider converting portions of their IRA to a Roth IRA. While a non-spouse beneficiary of a Roth IRA will still be subject to the 10-year withdrawal period, taxes on the assets in the Roth IRA will have already been paid.
Finally, let’s also consider that most investors have IRAs that will be depleted over their lifetime. The money was always intended for the account owner’s retirement. Furthermore, when beneficiaries do inherit IRAs, most also withdraw more than the RMD and deplete the account within 10 years anyhow. While there are some ultra-high-net-worth families that may be affected by the potential end of the Stretch IRA, the majority of investors should be able to weather changes to tax laws.