As we shared with you in prior newsletters, the SECURE Act passed in the House this past summer. We watched it closely as it made its way through the Senate, as it had the potential to drastically impact the rules around taxability of a non-spouse inheriting a retirement account. In late December, it finally passed through the Senate, and the President signed it into law. This email is to update you on the most pertinent items in the final version of the Act, that we see most likely to impact our clients. Our view is that these changes do not create an immediate need to take action for the vast majority of our clients. However, as we regularly communicate and meet throughout 2020, we will be discussing these items with each client, how they impact you personally, and any potential changes that we may accordingly want to consider for your financial plan. The first most significant item in the Act that we see impacting our clients is the change in the age that they are required to start taking distributions from their pre-tax retirement accounts, i.e. their RMD (Required Minimum Distribution) start age. This age was previously 70-½ and has now risen to age 72. For clients that have already turned 70-½ prior to 2020, nothing changes for you. If you are younger than 72, but are currently taking RMDs, you must continue to take your RMDs. For clients that turn 70-½ in 2020 or later, you may now wait until age 72 to begin taking required distributions. The second most significant item in the Act that we seeing impacting our clients is that it reverted the medical expense deduction limit for those that itemize deductions back to 7.5% of Adjusted Gross Income (AGI) for 2019 and 2020, from 10% of AGI. The third most significant item in the Act that we see impacting our clients is it allows for penalty-free withdrawals from retirement plans to cover birth or adoption expenses, up to $5,000. The fourth most significant item in the Act that we see impacting our clients, and the one which will likely have the most planning opportunities, is the change to the “stretch IRA” provisions that non-spouse beneficiaries of pre-tax retirement accounts currently receive (It is important to note this change does not impact spousal beneficiaries). If you are unfamiliar with the “stretch IRA” concept, prior law stated that when an individual non-spouse beneficiary inherited a pre-tax retirement account, their most tax-advantaged way of taking withdrawals from the account was to “stretch” those distributions over their single life expectancy (determined by the IRS). This allowed them to minimize the tax burden over time, and if so chosen, to extend the balance of the account over potentially many decades depending upon the beneficiary’s age. Now, with the recently passed SECURE Act, pre-tax retirement accounts inherited by non-spouse beneficiaries in 2020 and beyond will need to be fully withdrawn within 10 years. This has an even more significant impact on younger beneficiaries as opposed to older beneficiaries, as their single life expectancies are more substantial. For example, a non-spouse beneficiary that is 74 years old under prior law would have used up their single life expectancy in approximately 14 years, versus a non-spouse beneficiary that is 48 years old would not have used up their single life expectancy for 36 years. We have a few handfuls of clients with existing Beneficiary IRAs (created due to being a non-spouse beneficiary of a pre-tax retirement account) who are already benefiting from the “stretch” provisions, and those will stay in place. However, the vast majority of our clients have significant pre-tax assets in retirement accounts, such as 401ks, and IRAs. These will now be subject to the new SECURE Act’s 10-year rule when they pass away, and accordingly, much more consideration should be given to the potential difference in their current tax situation versus their beneficiary’s tax situation. It is also worth noting that a significant portion of our clients have trusts as the vehicle with which they leave their assets to their beneficiaries, including their pre-tax retirement accounts. These trusts will also be subject to the 10-year (tax) rule. However, we will want to look at each trust more closely to determine if they are written in a way that would consider the distributions over 10 years as trust income that would go directly to beneficiaries and thus be outside of their trust (and lose trust protections) after 10 years (Conduit Trust), or trust income that will be taxed but can continue to accumulate within the trust (Accumulation Trust). An estate planning attorney we often work closely with, Matt Gibson of Pappas Gibson, recently alerted us that most trusts written by his company are Accumulation Trusts, which is good news. We will also be reviewing these documents with each client in 2020 to educate our clients on what type of trust they have and how it will impact the way their beneficiaries receive funds. There are some exceptions to the 10-year rule. Most notably is that, as mentioned above, it does not impact spousal beneficiaries. Also, it does not impact disabled beneficiaries, chronically ill beneficiaries, beneficiaries who are not more than 10 years younger than the decedent, and certain minor children, but only until they are adults. These beneficiaries continue to receive the same rules that were in place prior to the SECURE Act. A few other noteworthy items from the Act that we will not discuss in detail here, but we want to note:
The Act lifted the restriction of not being able to make IRA contributions beyond age 70-½.
The Act does not change the age at which a charitable IRA rollover can occur. It remains at age 70-½ and creates a unique planning opportunity for 1-2 years where RMDs are not yet required.
The Act repealed prior kiddie tax changes made at the end of 2017.
The Act expanded 529 provisions to be used for apprenticeships and up to $10k of student loan repayments.