How the SECURE Act is changing retirement, and what the elimination of the Stretch IRA means for you and your heirs

Upon the start of the new decade, there have been quite a few changes within the political and economic domain in the United States. With new changes come new rules and regulations that will certainly affect many of those saving for retirement. The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) will be one of the most major changes to affect retirement savers in 2020 which was approved by the Senate on December 19^th, 2019 and signed into law by President Trump January 1, 2020. This Act was intended to “fix” our nation’s retirement emergency by modifying the rules related to tax-advantaged retirement accounts. In turn, this will allow more employees to save for retirement. Sure, there are positive outcomes from this Act, as it will make it easier for small business owners to set up less expensive retirement plans, and part time workers may be eligible to participate in their employer’s plans. Notice that this is beneficial for the saver. The controversy has everything to do with planning for the current heirs of these retirement accounts, and many may argue that the negative consequences outweigh the benefits. With this much change regarding such an important aspect in many lives such as retirement, it is important to review, re-evaluate, and potentially renovate your planning. Let me tell you why.

Elimination of the Stretch IRA

One of the biggest concerns of the SECURE Act has been the elimination of the Stretch IRA. Of course, the new benefits will not come without a price. By eliminating the Stretch IRA, the government will raise an estimated $15.7 billion in additional tax revenue, creating the ability to fund the benefits of this bill. Simply being unaware of the new laws can leave your heirs with hefty tax bills without proper planning. In the past, non-spousal beneficiaries had the option to take the RMD (Required Minimum Distribution) over their life expectancy, rather than distributing it over ten years. This is a loss of an enormous tax-advantaged possibility. The named non-spousal beneficiaries such as children, grandchildren, or the like will be hit with an unintended tax bill, and a shorter distribution period for inherited retirement accounts. This is especially disastrous if, due to this distribution, they are moved to a higher tax bracket. From my perspective, this leaves room for a complete disaster if not handled appropriately. It is important to note that there are exemptions to this provision, including spouses, minor children, the chronically ill, disabled, and individuals within 10 years of age of the deceased.

Importance of Review

Given the above information, it seems apparent to review your beneficiaries. However, you will want to pay extra close attention if you were using a trust as a beneficiary of your retirement account to take advantage of the stretch provisions through a “conduit” or “pass through” trust. If you are inheriting an IRA through a trust, this could create a new danger to the beneficiaries. If the original owner had planned to distribute his hard-earned IRA funds to his beneficiaries through a conduit trust? The beneficiaries may be liable to pay a huge tax bill. Why? Under the SECURE Act, there are no RMD requirements for Stretch IRAs and the only stipulation is that the recipient ensure the entire account balance is taken out within 10 years. Well, if your trust reads that the beneficiary only has access to the RMD each year, the only technical RMD is after year 10, which is the remaining balance. Doing this creates an enormous tax bill for the beneficiaries, which I am sure is not what the original owner intended.

Alternatives to the Stretch IRA

Though the Stretch IRA is dead in wake of this new regulation, there are other tools that may offer a similar tax-friendly option to meet IRA wealth transfer objectives, including the Roth IRA conversion, Life Insurance, or Irrevocable trusts. Of course, this sort of decision would need to be made after a full analysis of each individual situation, as each objective and end goal is unique.

With today’s historically low tax rates, it may be beneficial to liquidate your IRA balance. One strategy would be through a Roth conversion. A Roth conversion, though subject to RMD when inherited, does not cause a taxable event when distributed to the beneficiary. Given that information, wouldn’t it make sense to convert your IRA to a Roth prior to the owner’s death? This would maximize the beneficiary’s wealth, create lower taxes in retirement, and dodge the SECURE Act’s ten-year distribution rule.

Additionally, life insurance could prove to be your best option as a more tax efficient planning tool, in which the life insurance proceeds can be left to the trust for protection. Investing in life insurance means you would benefit from a more flexible asset, with no RMD requirement, no complex provisions, or income or estate taxes.

As complex changes arise, it is important to speak with a qualified specialist who can explain these strategies, and the consequences your current plan may hold for you and your heirs. Please consult with a trusted professional financial planner to make sure you are aware of any new tax or legislation changes to avoid inadvertent consequences for you and your heirs.