At the end of 2019, Congress passed, and the President signed into law, the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”). As of January 1, 2020, this law went into effect and drastically changes many of the rules relating to individuals’ Traditional IRAs.
Required Minimum Distributions:
The SECURE Act has delayed the age at which you must take Required Minimum Distributions (“RMDs”) from your Traditional IRA. Under the previous rules, RMDs began upon an individual reaching the age of 70 ½. After passage of the SECURE Act, RMDs now begin when the individual turns 72 years old. This change only applies to those born July 1, 1949 and later, so if you are currently taking RMDs, you will continue to do so.
Contributions to Traditional IRAs:
For individuals that continue to earn income after age 72, you may continue to contribute to a Traditional IRA, allowing you to continue to put away funds for retirement savings. This will allow the individual to continue to grow their savings on a tax deferred basis as they age. There has never been a cap on Roth IRA contributions, so individuals may continue to contribute to a Roth as they see fit.
Stretch IRAs – Major Changes:
In what many consider is the greatest change to the law, the SECURE Act has eliminated the ability for many to “stretch” required distributions from an inherited IRA over their own life expectancy. Previously, a child who received an inherited IRA from their deceased parent could take that IRA and delay the distributions from the IRA to spread out the tax owed on the funds in the IRA over many years. This was accomplished by stretching the distributions into smaller distributions based on the child’s life expectancy. Under the SECURE Act, inherited IRAs must be fully distributed to the beneficiary within 10 years. There is an exception to this rule for the following beneficiaries of an inherited IRA: spouses, minor children, disabled individuals, and chronically ill individuals. It is important to note that the 10-year period is activated once a minor child reaches 18 years old.
Here are some examples of the treatment of IRAs under the previous law and under the SECURE Act. Let’s assume Joe passes away, leaving $500,000.00 in an IRA to his wife, Tara. Under both the previous law and the SECURE Act, Tara may spread out the distributions from the IRA, deferring taxes owed on the IRA for as long as she chooses, other than the required minimum distributions based on the option she chooses.
Now let’s assume Joe leaves his IRA to his daughter, Sara. Under the previous law, Sara would be required to take a minimum distribution every year, based on her own life expectancy. If Sara is 37 years of age, that could be less than $11,000 she was required to take from the IRA and pay income tax on in a given year. While she takes the required distribution, the remaining funds are growing in the IRA tax free, until such a time that she chooses to take more than what is required from the IRA. This will allow for Sara to defer taxes owed on the IRA for many years and on her own schedule. If she chooses to wait to withdraw the funds when she is retired, her tax bracket should be lower than when she was at the peak of her earning power, lowering the taxes owed on the IRA withdrawals.
Under the SECURE Act, Sara is now required to deplete the entire $500,000 in the IRA within 10 years, which also means paying taxes on the entire $500,000 in the IRA (plus the growth that occurs after Joe dies) within 10 years. She is not required to take any specific amount yearly; the only requirement is to empty the IRA within 10 years. Sara could spread out the distributions equally, take the entire fund immediately, wait until the end of the 10-year period to deplete the fund, or take sporadic distributions. Whatever she chooses she is taking out these funds in what are likely her peak earning years where she is in a higher tax bracket than what she would expect in her own retirement. Sara would be wise to meet with her financial advisor and/or accountant at the end of each year to discuss her options with regard to taking a distribution in that year. The change in the law means that Sara has lost a major tax deferment tool that was previously available.
These laws are bound to impact both the owners of IRAs and the beneficiaries of IRAs. Talking financial advisors and estate planning attorneys to determine the impact on individual’s IRAs will be important to all individuals to see how the SECURE Act affects their plan.