You may have heard some talk about the new SECURE Act. But what are the details and how does it impact you?
The SECURE Act proposes a number of changes to retirement savings. These include changes to parts of IRAs and 401(k)s. Although it is still under review, the Act is expected to be passed in some form after revisions. Some of the changes that the Act makes look to be common sense, like broadening access to IRAs and 401(k)s, as well as including updating the rules to reflect that retirement is now a longer period of life. However, with these changes come potential limitations with stretch IRAs.
Forbes asks in its recent article “Are Concerns Over Stretch IRAs And The SECURE Act Justified?” In general, an IRA is a tax-wrapper for your investments. While the investments stay in the IRA, you do not have to pay any tax on income made from those investments. A traditional IRA is where your contributions can be made tax-free for the time being, with tax due upon withdrawal. Alternatively, you can contribute after-tax dollars and have your distributions be tax-free if you use a Roth IRA. The SECURE act isn’t changing this fundamental process during the lifetime of the person who contributed to the IRA. Instead, it is altering what happens when that person, still has an IRA balance at death.
If you’ve ever spoken with someone who inherited an IRA, you have probably heard of the Stretch IRA. A Stretch IRA can be a great estate planning tool. Here’s how it works: you give the IRA to a young beneficiary in your family. The tax shield function of the IRA is then “stretched,” for what can be decades because the length of the IRA will now extend to the end of the beneficiary’s lifetime. This is important because the longer the IRA lasts, the more your investments can continue to grow. In a sense, this will protect that growth from taxes for a longer period of time.
However, the SECURE Act could change that: instead of IRA funds being spread and distributed to the beneficiary over the lifetime of the beneficiary, they’d be spread and distributed over a much shorter period. Based on the provisions of the SECURE Act as it stands, that period will likely be 10 years. That’s a big change for estate planning because a beneficiary will now have to withdraw that investment within a shorter period of time, be taxed on that income sooner, and lose out on the benefits of letting the investments grow for longer.
It’s good to keep in mind, though, that for a person who uses their own IRA throughout retirement and uses it up or passes it to their spouse as an inheritance—the SECURE Act changes almost nothing. In fact, IRAs are slightly improved for these individuals due to the new ability to continue to contribute after age 70½ and other small improvements. Therefore, most typical IRA holders will be unaffected or benefit to some degree. For many people, the bulk of IRA funds will be used in retirement and the Stretch IRA is less relevant. If you are planning to use the IRA as a distribution for your children or other people to inherit, however, talk to a tax advisor or attorney to understand how the SECURE Act will impact your estate plan.
Reference: Forbes (July 16, 2019) “Are Concerns Over Stretch IRAs And The SECURE Act Justified?”