How Will the SECURE Act Affect You?

As you might be aware, Congress passed a new piece of legislation at the end of the year called the SECURE Act. The changes, which took affect January 1, 2020 will greatly impact estate planning.  

Investment Retirement Accounts (IRAs)

One of the principal changes, which came into effect on January 1st, is that there is no longer an age cap on contributing to a traditional IRA.  As long as an individual is working he or she can continue to contribute to their retirement account.  Previously, investors aged 70 ½ and older were ineligible for IRA contributions. While there is no age restriction, contributors to an IRA must earn an income. 

The age at which required minimum distributions (RMDs) start is now 72 instead of 70.5.  This change will only impact those not currently in RMD status already.  The benefit to this is that investments could potentially have more time to grow before required withdrawals and taxes come into play.

Before the SECURE Act, IRA beneficiaries were able to extend required minimum distributions on their inherited IRAs over their entire lifetimes, allowing more opportunity for tax-free fund growth. The SECURE act eliminates the "stretch IRA." Distributions from inherited retirement accounts, which are left to non-spouse beneficiaries, must be made within 10 years. This change will have big tax implications for non-spouse beneficiaries who will now have to pay taxes sooner than perhaps anticipated with a ‘stretch IRA’ concept. There are exceptions to the 10-year rule including distributions to a surviving spouse of the plan participant or IRA owner; a child of the plan participant or IRA owner; a chronically ill individual; (4) a disabled beneficiary; and (5) any other individual who is not more than ten years younger than the plan participant or IRA owner.  As under the previous rules, those beneficiaries who qualify under this exception generally may take their distributions over their life expectancy.

For those parents looking into adoption, you can now take a penalty free withdraws from retirement plans for individuals in case of birth or child adoption. That amount shall not exceed $5,000 and can be repaid/recontributed.

This change will impact only retirement accounts inherited after January 1, 2020. Spouses can still roll over an inherited IRA into their retirement plan or take distributions as before.

Roth IRAs should be considered for legacy planning as a potential replacement to the items lost above. One should consider where tax rates might be after their death when their heirs will need to start taking distributions. A non-spousal beneficiary who inherits a Roth IRA can take the RMDs over his or her own life expectancy. The beneficiary may also take distributions without being taxed (must be at least five years since the initial contribution). The funds left in an IRA will continue to grow tax-free.

One could also replace the Stretch IRA with permanent life insurance. While an inherited IRA can be stretched as of the prior rules, the distributions will most always be taxable. Through the use of an inherited Roth IRA, the distributions will generally be tax-free to beneficiaries. The Roth IRA distributions might be better leveraged using life insurance instead. Life insurance distributions are also tax-free to the beneficiaries and not subject to RMDs. This strategy works well for IRA holders who want to pass as much as possible to their heirs.

IRA owners also might consider taking larger than normal distributions during their lifetimes.  In this example, it is hopeful that their taxable income is much lower rate than otherwise would be at a different time in their life.  With this example, the net after-tax funds then would be reinvested either the above Roth IRA or in other assets that will receive a stepped-up income tax basis when the owner dies.

Why not consider leaving the IRA portion of your estate to your children that might have lower tax brackets?  This would allow you to leave the assets with a stepped-up basis to your children with higher tax brackets.  Even better, perhaps the IRA owner might be interested in leaving a portion of their estate to grandchildren or great grandchildren, who may be in even lower income tax brackets than the children.  Unfortunately, it is not possible to defer IRA income tax over the lives of these later generations. It’s still a beneficial income tax planning technique because of the lower overall income taxes that often result.

529 College Savings Plans

Changes were also made to improve the flexibility of the 529 College Savings accounts. Up to $10,000 dollars can now be withdrawn from a 529 plan to put towards student loan payments.  Up to $10,000 dollars can also be withdrawn from the account to put towards student loans of a sibling. Funds can also now be used to pay for apprenticeships as well. Before 2019, qualified higher education expenses didn't include the expenses of registered apprenticeships or student loan repayments. 

However, for distributions made after December 31, 2018 (the effective date is retroactive), tax-free distributions from 529 plans can be used to pay for fees, books, supplies, and equipment required for the designated beneficiary's participation in an apprenticeship program. In addition, tax-free distributions (up to $10,000 per beneficiary) are allowed to pay the principal and/or interest on a qualified education loan of the designated beneficiary, or a sibling of the designated beneficiary. Be aware that some states may not follow the federal law changes relating to 529 plans.

Finally, there are numerous examples that an IRA owner can take advantage of if they wish to pass assets to charities rather than their family members.  Individuals should meet with their financial planner to discuss these changes and how it may impact their estate plan. Our team is here to help answer any questions you may have regarding your financial portfolio.  Please don’t hesitate to contact us.

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