Congress recently passed a new law with yet another interesting name – The SECURE Act. Interesting in the fact that the Setting Every Community Up For Retirement Enhancement (SECURE) Act was designed to promote savings and help secure our financial future, but for many it will be a tax increase. There are multiple pieces to this law, and we will touch upon a few of the core changes. One of the main changes is related to accelerated withdrawals from inherited IRAs and how that may affect many of the benefits of trusts as beneficiaries for retirement accounts. The other two that will be discussed are the delay in age for required minimum distributions and new rules for the kiddie tax.
As many of you know, we’ve been saying for years that there is a chance that pre-tax accounts, such as 401k accounts and IRA accounts, could be a source the government turns to for raising tax revenues by taxing these accounts at a higher or accelerated rate. Our current debt is over $21 trillion, so it’s not a surprise that our government is looking for ways to raise revenues without calling it a tax increase. The SECURE Act is a stealth way of raising tax revenues from taxpayers who own large pre-tax retirement accounts.
Prior to the SECURE Act, a beneficiary of a pre-tax account could “stretch” the distributions over his/her lifetime, resulting in lower taxes. For example, let’s say an 80-year old mother leaves her $1 million IRA to her 40-year old daughter. Under the old law, the daughter could “stretch” the taxable required distributions over her lifetime. Under the new law, she would be required to withdraw the entire $1 million account over only 10 years, which means she would end up including more income on her tax return. Of course, the result is being taxed at a higher bracket; this is a stealth tax increase.
Naturally, exceptions to the law apply. If the heir is a spouse, then the money is rolled over to the survivor’s account and the surviving spouse can take distributions as normal. Minor children and those less than 10 years younger than the deceased are generally exempt from the new 10-year distribution rule.
This change may influence how people use trusts (testamentary trusts) within their estate planning to protect their retirement accounts. Some trusts are drafted in a way that allows the required distributions to pass through to the heirs and prevents the distributions from being taxed at trust rates. However, the new 10-year distribution rule has no required annual distributions, and these trusts may be worded in such a way that only a “required” distribution can be made. Since these annual distributions are no longer required, beneficiaries could find that no distributions can be made the first 9 years and then the trust is required to distribute 100% of the IRA at the end of the 10-year window. These conduit (see through) trusts will need to be reviewed and beneficiary updates may need to be made as well.
So, where are the planning opportunities here? For all clients, regardless of age, we will continue to review asset composition to potentially recommend Roth conversions, Roth 401k contributions, and the like. The 10-year distribution rule requires the distribution to be anytime over 10 years, so each year we would look at the clients’ tax bracket and plan when to take distributions. Regardless, each person’s situation is unique, and we’ve been planning for this even before the law was drafted.
In addition to the change for inherited IRAs, the new law allows retirees to delay their required minimum distribution (RMD) to age 72 versus the current age of 70.5. On the surface, this seems like a positive change, but delaying could mean larger distributions in the future, as the distributions are calculated each year based on life expectancy. Also, delaying could mean more of the retirement assets are passed to the next generation, who would be required to follow the 10-year distribution rule and could result in higher tax rates on distributions. This does; however, give us some additional planning opportunities, depending on our client’s circumstances.
As always, Congress loves to make things more complicated. In 2017, Congress changed the rules on the so-called “kiddie tax”. The kiddie tax applies to dependent children who are younger than 19 years old, or who are full-time students between the ages of 19 and 23. Until the law change in 2017, the kiddie tax was basically a tax equal to the parents’ highest tax rate. The 2017 law made those tax rates onerously high, using trust tax rates, which are as high as 37% once you reach only $12,750 in income. The SECURE Act changes this law back to the old rule. But as I said, Congress loves complexity and likes to make sure that CPAs have jobs, so they put exceptions in there. This “repeal” starts in 2020, but you can decide which way is better for you for the 2019 tax year and use that method. You can also go back to 2018 and amend your returns if this new rule is more favorable. Phew…you got all that? As a CPA and financial advisor, this is even mind-numbing for me!
As with all tax changes, we are assessing in detail how this impacts you. We are busy crafting strategies to take advantage of the new rules and to help minimize any tax increase. Stay tuned in 2020 as we discuss this with you based on your family’s situation.
Happy new year! Wishing you an abundance of good health and wealth!