SECURE Act Passes Senate: Inherited IRAs Under Attack by Congress

The SECURE Act has passed both houses of Congress. What does that mean for you?

The Setting Every Community Up for Retirement Enhancement, or SECURE, Act is tied to a bipartisan spending bill that Congress is passing today to avoid a government shutdown. The Act contains several significant provisions that could change your retirement plan. Below is a brief explanation of some of the key SECURE Act changes and how they may affect you.

10-year Withdrawal Limit for Inherited IRAs and 401(k)s

Before the SECURE Act, “stretch” IRAs were used to pass down wealth while minimizing taxes. In the past, beneficiaries of “stretch” IRAs and could spread or stretch the distributions over their lifetime. This kind of distribution will no longer be available under the SECURE Act.

The SECURE Act will require beneficiaries to distribute the account within ten years. The SECURE Act provides some exceptions to the ten-year rule, including surviving spouses, chronically ill, disabled, or minor heirs, and heirs less than ten years younger than the decedent. The Act does not require distribution every year as before, only that the account be depleted within a decade.

The new time limitation serves as a tax generator. The now accelerated withdrawals from traditional IRAs can push beneficiaries into higher tax brackets. Since withdrawals are taxable, they can create a substantial tax increase for individuals who inherit stretch IRAs during their peak working and tax years.

If you inherited an IRA before the end of 2019, you could still draw the account over a lifetime since the Act will apply only to IRAs inherited after 2019. Further, if you are inheriting a government plan, used by many federal, state, and local government employees, the time limitation does not apply until January 1, 2020.

Following the SECURE Act’s passing, individuals using retirement plans to pass their wealth to individuals other than their spouses should consider other options to bypass the likely significant tax burdens. For instance, individuals may consider changing their named beneficiaries, a cash value life insurance policy that pays out to a trust, and strategic Roth conversions during the account owner’s life.

Raising the Required Minimum Distribution Age & Eliminating the Age Cap for Contributions

The SECURE Act raises the required minimum distribution (RMD) age from 70 ½ to 72. The age increase is in response to individuals living longer today and the difficulty of using a half birthday as opposed to a typical birthday.

The SECURE Act will take effect in 2020. The effective date means if you turned or will turn 70 ½ in 2019, you still must take your first RMD by April 1, 2020. However, if you turn 70 ½ after 2019, you do not have to take your first RMD until you are 72. As before the SECURE Act, RMDs are based on your life expectancy.

Before the SECURE Act, contributions for traditional IRAs had to stop at 70 ½ even if you were still working. The SECURE Act changes this by eliminating the age cut off. Again, this change is in response to individuals living and working for longer periods of time. The age cap elimination falls in line with Roth IRAs that also allow individuals to contribute at any age. The elimination means that you will now be allowed to contribute to traditional IRAs at any age.

Annuities to 401(k)s

The SECURE Act updates the safe harbor provision and expands annuities to 401(k)s. The Act eases companies’ worries of legal liability while offering a predictable income stream to individuals. The Act’s safe harbor provision takes employers off the hook if an annuity provider fails or otherwise does not deliver. The increase in annuity options will provide more access and sources of retirement income for individuals. However, critics worry that the lessening of insurance company vetting may lead to future complications.

Conclusion

The SECURE Act’s goal is to promote retirement savings, but the Act may drastically change many retirement plans in the process. In addition to the changes mentioned above, the SECURE Act also adds penalty-free distributions for birth or adoption of a child, lifetime income disclosure, a 529 savings plan expansion, a tax credit for employers, as well as multi-employer 401(k) plans. The SECURE Act will bring the biggest changes to the U.S. retirement system since 2006. Review and discuss your retirement plans with a qualified professional to see how the SECURE Act may affect you.