Top 2 Tax Changes That May Affect Your Retirement

August 6, 2019

There are likely substantial retirement account changes on the horizon which will alter planning for all current and future retirees.  Recently, the House passed the Setting Every Community Up for Retirement Enhancement or SECURE Act. The SECURE Act is expected to pass the Senate in the coming months. The two most wide-reaching changes in the bill are highlighted below along with how they impact you, and what it could mean for your estate and tax plan going forward:

1. The Stretch IRA provision is limited

The most detrimental change in the SECURE Act is the elimination of the stretch IRA. Currently, beneficiaries (kids, grandkids, friends) who inherit retirement accounts such as IRAs, Roth IRAs, and 401(k)s can “stretch” withdrawals over the course of their actuarial lifetimes. The proposed SECURE Act includes a provision that would require beneficiaries (except spouses) to distribute the account over a 10-year period instead, accelerating the depletion and income taxes due on inherited accounts. It’s estimated that as much as 33% more of an inherited IRA would get gobbled up by taxes than under current rules.

For example, let’s assume a 40-year-old inherits a $500,000 IRA. Under current law, they would be required to take out ~$12,000 or 2% in the first year and that would increase slightly over time. Under the proposal, the entire account would need to be distributed within 10 years which could mean $50,000 per year or $500,000 in year 10. Either way, more taxes will be owed quicker and with the flexibility to distribute the funds in any amount over 10 years more tax planning will be required by the inheritor to minimize tax based on their personal income and cash flow.

2. Increase Required Minimum Distribution (RMD) age from 70.5 currently to 72

Also being proposed is pushing back the RMD age to 72 which gives retirees more flexibility on how to fund retirement.

So, what does that mean for you? Below are a few considerations:

  • “Tax Planning Sweet Spot” is Extended – One of the most optimal times to do tax planning is from the year you retire until required minimum distributions start. During that time your income will likely be the lowest it has been in the last 20 years or will be in the next 20 years. With the window extending by 1.5 years you may be able to take advantage of extended lower rates to convert dollars to a Roth IRA or accelerate realization of capital gains at low or no tax.
  • Use an IRA for Charitable Giving – If you are charitably inclined and plan to leave assets to a charity at death, there is even more benefit under the proposed law to have your IRA fulfill that desire thereby avoiding the income tax due on the distribution and eliminating the need to worry about the stretch IRA changes.
  • Estate Plan Should Be Reviewed – Estate documents will need to be reviewed to ensure they account for the limited stretch provision. Specifically, if a trust is the beneficiary of your retirement account, the added flexibility of being able to take the distribution anytime over 10 years as well as the potential for a young beneficiary to get more sooner adds complexity and will likely require revisiting your documents to ensure your wishes are still reflected.
  • Roth Conversions Are Still Valuable – While limiting the ability for beneficiaries to “stretch” Roth IRA distributions dampens its tax-deferred growth slightly, there are still plenty of reasons to consider a Roth conversion now:
    • Federal Tax rates are low by historical standards and are set to revert up in 2025 – Converting before that time could save you 3% to 4% tax.
    • RMD age increases to 72 – this would extend the opportunity to convert at much lower tax rates before RMDs start.
    • Illinois Residents – For Illinois residents, retirement income, including IRA distributions, are not taxable so Roth conversions avoid Illinois tax as well. While there are no current proposals to change this, given the financial condition of the state, it would not be surprising to see this change at some point in the future.

It’s important to note, at this point, this is all “what-if” and still needs to pass through the Senate AND passing looks likely. We recommend meeting with your team to discuss the direct impact on your financial plan.