… Unless you’ve been saving for your heirs using your retirement plan, then this Act is a fairly legitimate disaster.
I was planning to publish an article on optimal contributions to retirement plans, but Congress has “gifted” America a new set of retirement regulations. The SECURE Act, which stands for Setting Every Community Up for Retirement Enhancement Act of 2019, is a fairly significant overhaul to how business has been done in retirement, estate and tax planning. For a wide variety of unrelated reasons, Congress was nearly unanimous in its approval of this legislative renovation. While there is undoubtedly some good in this legislation (the most relevant good parts, I discuss toward the end), it comes at the cost of further punishing savers, who already face record low interest rates for traditionally low-risk assets like treasury bills and bonds (making those safety nets actually quite risky in the aggregate).
This topic is a bit esoteric, which may contribute to why the underlying legislation was so lightly contested prior to passage (though special interests undoubtedly played a massive role). It also didn’t help that most news tends to get drowned out when there is an impeachment – though I note that at least two major finance news outlets have begun over the last day to address the act’s ramifications.
In truth, the SECURE Act has potent, wide-ranging financial effects on all Americans. So put in an IV with a strong coffee drip, and let’s dig into three areas of the new law and look at how each affects those who are serving or have served and their families:
Section 401 – Modifications to Required Minimum Distribution Rules:
This the most detrimental change for many families. If you are planning to leave a retirement plan to your descendants, they will generally no longer be able to take the proceeds over their life expectancies. Instead, the maximum deferral period will be ten years. In other words, descendants will have to take all of the money from inherited retirement plans in ten years after the date of death or incur a 50% penalty from the IRS. Further relevant details for this law that takes effect on all estates after 2019 are:
1) This does not apply to leaving the retirement plan to your spouse.
2) This is not retroactive, so it does not apply to those who have already inherited a retirement plan.
3) If your estate planning documents leave your retirement account to a trust for the benefit of your heirs, I recommend you re-evaluate that decision with an estate planning professional.
4) If your taxable (i.e. traditional, non-Roth) retirement plan balances are likely to be high enough that withdrawing one-tenth each year for the ten-year deferral period would be enough to place your heirs into a higher income tax bracket than you are currently in, then Roth conversions for their benefit could be a good idea. A Roth conversion occurs during a tax-optimal period when you are not earning income (or have a lower income than you otherwise would during peak earning years). This is more challenging for those service members who draw a pension in retirement but still may be worth considering if the tax brackets support converting traditional retirement accounts slowly to Roth accounts.
In sum, this new provision is calamitous for those who have diligently saved over their lifetime with the understanding that their heirs would get their retirement plans. On the other hand, it’s a tremendous boon for federal/state governments’ coffers as well as companies that sell annuities, which is now effectively the only realistic option for those who inherit a retirement account (but have unpalatable tax consequences from taking those assets).
Another possible way around this new law are what are called Charitable Remainder Trusts, which would preserve the “stretch”; however, America’s current low-interest-rate environment seems to eliminate the Charitable Remainder Trust strategy for now for reasons that are somewhat complex and not worth going into detail here. Should rates rise, this is a strategy that might be more beneficial in the future.
Section 113 – Increase in Age for Required Beginning Date for Mandatory Distributions:
This is a small, but favorable, change. For those who are not yet 72, RMDs (Required Minimum Distributions) from retirement plans will now begin at age 72 rather than age 70½, which dovetails with our country’s increasing average lifespan. Note that QCDs (Qualified Charitable Distributions) continue to have a 70½ start age.
Section 106 – Repeal of Maximum Age for Traditional IRA Contributions:
This is another small, yet favorable, change. Folks over age 70½ who have earned income can now contribute to an IRA. Note that the IRS does not consider military retirement pay or social security as qualifying earned income, so there would need to be another source, such as dividends, interest or a job, for retirees to utilize this change.
In summary, while there are some minor positive changes made by the SECURE ACT, given that many who inherit retirement accounts from their parents are themselves in their peak earning years of their 50s and 60s, Section 401 of the SECURE Act is sure to cause maximum tax pain to generations X and Y. Furthermore, it begs the question: If Congress and the President can switch the rules on the inheritance (and therefore taxation) of retirement plans, what prevents them from changing the tax consequences on Roth retirement accounts to make them taxable at withdrawal?