Author: Nick Prigitano
After much deliberation in Congress, the SECURE Act has made its way through and has been signed into law. For those who missed it, we wrote a post back in June about the proposed changes to the retirement saving landscape. Now that the law has been finalized, we wanted to highlight some of the key changes and how it might impact you and your retirement savings.
Increased Age of Required Minimum Distributions (RMD):
One of the notable changes to the retirement planning landscape is increasing the age of required distributions from 70.5 to 72. The increased age is to reflect the higher life expectancy from when the law was first enacted in the 1960s.
While one and a half years may not seem like a big difference, when it comes to tax planning, for some it opens up a whole new world of possibilities. What this means is that there are potentially two more years when money can be taken from retirement accounts early. This may allow you to plan and take money out at a lower tax bracket based on your income for the year. When RMDs start, you have no choice on whether, or how much money to withdraw (or face a stiff 50% penalty!). This means you now have more flexibility to take extra income at a certain lower tax bracket.
Depending on your tax situation, money can be taken out for living expenses or converted to a Roth for future use. The ability to manage your taxes for an extra two years becomes especially crucial when it comes to some additional changes mentioned below.
Shortened Time-Frame for Beneficiary IRA Withdrawals:
Another significant change to the law is that many beneficiaries of IRAs, and similar accounts, is that they will no longer be able to withdraw these accounts over their lifetime. This used to be a great estate planning tool. If you didn't use your entire IRA account over your life, a beneficiary could inherit the money and slowly withdraw it over their lifetime. In many cases since the beneficiary is younger than the decedent, and thus has a longer life expectancy, the required distributions could come out slowly. This allowed many IRAs to be passed down and withdrawn at relatively low tax rates. However, the SECURE Act changes this to require withdrawals over just 10 years for many beneficiaries instead of their lifetimes.
There are some key exceptions to this 10-year rule that are important to note. At this time, these beneficiaries can still withdraw the funds over their lifetime if they choose, and are not required to deplete the account in just 10 years:
Beneficiaries less than 10 years younger than the decedent (particularly important for unmarried couples!)
Minor child of the decedent (at least until they reach the age of majority)
Disabled or chronically ill individuals
Since many individuals leave their retirement accounts to their children after both spouses die, these changes greatly alter the tax efficiency of such a transfer. Now more than ever, it is crucial to consider taking extra money out of your IRA when your tax situation is right. Financial planners, including Milestone Financial Planning, will be reviewing IRA accounts and estate planning goals to see how they fit in with these changes. Since many children who inherit IRAs are currently still in their working years, having to take substantial income from an inherited IRA can be a tax burden to their finances. With these changes, inheriting Roth accounts and non-retirement accounts may become a better option for these beneficiaries.
However, it is important to note, depending on your estate planning goals, these changes may not impact you. If you plan to give all, or a portion of your account to charity, the impact is much less dramatic. Since qualified charities do not pay taxes, having them inherit an IRA account will not negatively impact them, regardless of whether they need to withdraw it all in 10 years or not. It's important to review your beneficiary designations to make sure the right people and entities are inheriting the right accounts. As a rule of thumb, it's best for people to inherit Roth and regular investments, while charities inherit IRA and other retirement plans. If this is not something you've reviewed lately, it may make sense to discuss this with your financial advisor.
Other Changes to Note:
While the two changes mentioned above are the more critical changes for financial planning, there are other changes that you should be aware of as well. Depending on your situation, these changes may benefit you.
529 Account Uses:
The SECURE Act increases the use of 529 accounts. The changes now allow beneficiaries to use these accounts not only for college, but for homeschooling costs, registered apprenticeships, and private or religious schools. This gives families with children many more options to use their 529 savings if they had the foresight to open one of these accounts at an early age.
In addition to that, up to $10,000 can be used for qualified student loan repayment. This not only applies to the beneficiary on the account, but also to their siblings as well.
Birth or Adoption Expenses:
Before retirement it can be difficult to get money out of an IRA account without incurring an additional penalty. There are currently some exceptions such as a first time home purchase up to $10,000, higher education expenses, among others. There will now be another exception for qualified birth and adoption expenses. While income taxes will apply to these distributions, the 10% penalty is waived as long as these expenses qualify.
Like any new tax law, some significant changes are coming to taxes and retirement planning. While some changes are beneficial, others will alter how financial planning will be done in the future. Financial planners everywhere will be digesting this new law and formulating new strategies to best take advantage of these changes and mitigate tax and estate planning risks for the future. For more questions on how this may impact you, we encourage you to reach out to your financial advisor or tax planner. To read a brief summary of the provisions in the law, click on the link here.