The Potential Impact of the SECURE Act on You and Your Family

There is a bill pending that would represent the most significant overhaul to retirement plans since the Pension Protection Act passed in 2006. The legislation, named “Setting Every Community Up for Retirement Enhancement” (the SECURE Act), would have a wide-reaching impact on company retirement plans such as 401(k)’s. However, there are a couple of provisions that would affect personal taxes as well.

Currently, people are required to distribute money from their traditional IRA’s and 401(k)’s starting at age 70.5. The government has allowed you to defer taxes on these funds throughout your career and wants you to withdraw from your retirement account so you can be taxed. The tax charged is your ordinary income rate, typically higher than the more favorable long-term capital gains and qualified dividend rates.

The proposed bill would push back the required beginning date for these distributions to age 72, and produces several implications to consider:

  • Taxpayers would receive additional years of tax deferral on income and capital gains
  • Additional time for Roth conversions
  • Less impact on tax rates for those who defer Social Security until age 70; many of our clients faced a jump in taxes since Social Security, and RMD’s (required minimum distributions) started around the same time
  • Less impact on Medicare premiums if RMD’s push taxpayers past income thresholds

There’s also a question about Qualified Charitable Distributions, which allow IRA account holders over 70.5 to give up to $100,000 per year directly to charities. Interestingly, the law pertaining to QCD’s specifically names individuals who are 70.5 or older, not those who are subject to RMD’s. So, the bill would need to change that specific part of the tax code to coordinate the two, which may be less likely to happen.

Another significant impact to our clients is the potential reduction of the benefits to so-called “stretch IRA’s.”

Under current law, if you leave your IRA or other retirement plans to non-spouse beneficiaries (such as children or other friends/relatives), they are required to take annual distributions from the account based on their life expectancy. So, if you leave your IRA to a younger beneficiary, the account gets “stretched” out over a much longer period. This allows more tax-deferred growth and reduces the impact of annual RMD’s on the beneficiary’s personal taxes.

Since Congress wanted the SECURE Act to be revenue-neutral, it needed to find a way to raise funds to pay for provisions such as the later RMD age discussed above. Therefore, Congress is proposing that non-spouse beneficiaries must distribute accounts within ten years instead of over their life expectancies.

For example, let’s say you leave your $500,000 IRA to your daughter, who is 55. Her first RMD would be $16,891. At a 7% growth rate, and assuming she only takes the minimum required amount each year, the account would last for approximately 29 years.

With the proposed provision, she would need to distribute the account in ten years. If she took out equal installments, her first annual distribution would be $50,000 – significantly more income for which she would be responsible for paying taxes. She might also be in a relatively high tax bracket depending on her career stage.

This change would require reconsideration of individual estate plans, depending on the ages of beneficiaries such as children, and grandchildren. It would also require rethinking Roth conversion strategies that were designed to benefit younger generations for decades. This provision does not apply to spousal beneficiaries.

Like many proposed bills, these new rules could change significantly before final passage. For example, the Senate version would only require the 10-year rule to apply for IRA’s over $400,000. Also, none of these provisions would be effective before Jan. 1, 2020.

We will monitor the progress of the bill and incorporate any adjustments to our recommendations once the final rules are known.