The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20th, 2019. This Act made sweeping changes, some of the biggest in recent history, to the law governing retirement plans. The intention of the Act is to provide more opportunities to save for retirement, with the objective of strengthening retirement security for a wider segment of the population.
Many of the changes have a lifetime impact on taxpayers’ retirement planning. Strategies that may have been considered conventional wisdom now need to be revisited, to ensure that they are still effective in light of the changes. Retirees and their advisors need to make sure that they are well-versed in the changes, and how they impact retirement income and distribution strategies.
Planning to take distributions from your retirement plans? Take a quick pause.
You worked hard and made sacrifices and smart financial decisions to save into your retirement accounts during high-income years. The next step would be to make sure you maximize the power of your nest egg over your lifetime. If you have access to both retirement and non-retirement assets, revisit your retirement distribution plan to ensure that you are taking advantage of the most tax-efficient strategy.
Uncle Sam requires that you start taking money out of your tax-deferred retirement accounts by a certain age, so that he can get his share of the money that you, potentially, haven’t paid tax on for decades. The age at which you are required to start taking out that money has been changed from 70 ½ to 72. This gives you the opportunity to defer taxes for approximately an additional 1.5 years, just to enjoy some more tax-deferred growth.
Even though you are no longer required to start taking distributions from retirement accounts until age 72, some distributions may still be worth considering, in order to take advantage of a lower tax bracket. Despite starting social security distributions, you may be in a low tax bracket. However, once you reach RMD age, and are required to take large distributions, your taxable income will go up and stay up for many years to come. There is a widespread view that current tax rates are at historical lows and they are bound to increase. If you share that view, it makes sense to report income in the years where your income is low, as well as the tax rates.
One strategy to consider, if you do not need any money from your retirement accounts, is converting your IRA savings, perhaps even partially, to a Roth IRA by paying taxes now in low tax years. Money converted to a Roth IRA grows tax-free and is never subject to RMDs during your lifetime. It’s a great vehicle for passing on an inheritance.
If you do need to take money out and have the choice between taking it from a retirement account vs. a non-retirement taxable account, it might be worth considering taking the money out of a retirement account to take advantage of the potentially-lower tax rate, now. This would allow you to decrease future RMDs and also take advantage of the lower tax rate. This strategy would involve making tax projections, so it would be advisable to consult your financial planner or tax preparer before making this kind of decision.
Ability to continue tax-deductible contributions, irrespective of age.
Before the SECURE Act was signed, you were not allowed to make tax-deductible contributions beyond age 70 ½, even if you continued working, which was disadvantageous to those who chose to continue working into their 70s. With that restriction lifted, workers and their spouses have the option to contribute to a tax-deductible form of savings. The requirements to make these contributions remain unchanged – you need to have earned income, and it has to be at least the same amount as your IRA contribution.
When evaluating the opportunity created by this change, keep in mind your current cash flow, other tax deductions, and the impact on future RMDs. On one hand, it would be nice to get a tax deduction while adding to your retirement savings; on the other, might that tax deduction be worth giving up in order to contribute to a Roth IRA, so that it can grow tax free and never be subject to taxes?
Another important factor to keep in mind while deciding to make a contribution is whether you are (or are planning on) making Qualified Charitable Distributions (QCDs). After age 70 ½ you can make up to $100,000 per year of charitable contributions from your IRA and exclude that amount from taxable income, while having it count towards your RMD. Any deductible IRA contributions added to your IRA while making a QCD, will cancel out the RMD offset from the QCD. For example, if you make a $7,000 deductible IRA contribution and donate $10,000 to a charity, then only $3,000 can be used to offset the RMD requirement.
With the ability to contribute to an IRA account, the obligation to take RMDs starting at age 72 doesn’t go away. Between the deductions and contributions, the net effect could be very close to zero, depending on your tax situation. Additionally, depending on the timing of all this, the contributions may increase the amount of your RMD.
Is an inherited retirement account part of your future? You will need to empty it out in 10 years.
One of the most extreme changes made to the rules is that there are no more “stretch distributions” allowed from an IRA inherited from a non-spouse. Originally, you were allowed to stretch out the distributions over a long period of time. Now, in most cases, you are required to take all the money out within ten years. You can do it over that period of time, or all in one shot – the choice is yours. This change is going to generate a large amount of tax revenue for the government, while putting a large burden on the taxpayer, who needs to pay income taxes on the amount of distributions.
This change will have a widespread impact. The largest effect will be on people like Susan, 69, who is expecting a large inheritance from her (still pretty healthy) mother, 96. Most of the inheritance will be in the form of retirement assets and Susan will need to take out all the money, and pay taxes on all of it, within a 10-year time period beginning the year after her mother’s death. This will likely put her in a much higher tax bracket than she had expected.
The question about making Roth conversions and paying taxes on the money while you are in a low tax bracket must be re-evaluated, and it also becomes important to focus on what your goals are: how much of your savings you would like to use in your lifetime vs. how much you might want to pass down to your children. These are good discussion points for conversations with your financial advisor and estate planning attorney.
Bottom line?
As with many things in life, it depends. The sweeping changes of the SECURE Act force you to take another look at your planning, from new angles. Given your long-term goals, cash flow, opinion on tax rates and other assumptions, revisit any strategies you had previously laid out for yourself. Consider, carefully, the opportunities and tax burden that may be coming down the pike for you and your heirs.
If you’re interested in learning more about wealth management services offered by Francis Financial, contact us for a free consultation by calling 212-374-9008 or emailing clientrelations@francisfinancial.com.
