The recently passed SECURE Act may be the most overblown piece of “retirement” legislation that I can recall ever being passed by Congress and signed into law by the president. Financial publications and bloggers are dutifully writing their pieces about how “groundbreaking” it is, but in my opinion, this one is a real yawner. If this legislation changes your financial plan in any significant way, you're in a tiny minority. Let's go through the changes one by one and see if you agree with me.
# 1 RMD Age Raised from 70 1/2 to 72
Now retirees who would rather hoard their Required Minimum Distributions (RMDs) instead of spending them can do so in a tax-protected account before transferring it to a taxable account (and paying the taxes due) for 1.5 more years (technically either 1 more year if born in the second half of the year or 2 more years if born in the first half) than they could before. Big Whoop. If you're in this position, I would encourage you to withdraw 3-4% of that IRA at age 70 and spend it anyway. Hearses don't have trailer hitches. It turns out something like 80% of retirees are already taking out more than the RMD anyway, so this doesn't apply to many.
Seriously though, as small of a change as it is, I guess every little bit of tax protection helps so we shouldn't look a gift horse in the mouth. You don't HAVE to wait until age 72, it just provides the option. Great! More options are usually better than fewer.
# 2 Stretch IRA (and Stretch Roth IRA) Limited to Just 10 Years
One of the coolest tax tricks out there has just been severely limited. It used to be that if you left a Roth IRA to an infant, it could potentially have provided tax-protected growth for not only your entire life (80+ years?) but for your heirs' entire life (100+ years?) for a grand total of 180+ years of tax protection. It was a cool idea and some people even built their estate plans around it, even if it was never really more than theoretical because the accounts simply haven't been around long enough for anyone to have actually done this.
You see, IRAs were only started in 1974 and Roth IRAs were started in 1997. So in reality, even if you contributed for a decade, let it ride for a decade, and then left it to your heir in 1994, they've only been able to stretch it for 25 years for a total of 45 years of tax protection, not 180+ years (and even less for a Roth IRA). However, Congress has decided this sort of tax-free legacy probably isn't good for society (similar reason to why there is an estate tax I suppose) and so has limited it to just 10 years.
In reality, most people never build much of an IRA. I mean, the median American retires with a nest egg just over $100,000. Even if they never spent any of it and left it all to an heir, it's just not going to be much. Most people burn through a large chunk of their IRA in retirement and whatever is left to heirs is probably withdrawn pretty quickly and spent. What percentage of heirs were ever going to still be stretching a large IRA for more than 10 years? It can't be very many. But for those families that were doing serious multi-generational tax planning, this change could potentially add up to a pretty significant loss. But squashing this “loophole” is pretty similar to getting rid of 529 plans–you're only really hurting the upper class here and nobody is going to feel much sympathy.
Incidentally, there is one “good” thing about this change–there are no longer any RMDs in those 10 years. You can now take it all out in year 10 (or split it over years 8-10 to minimize the tax hit).
There are a few exceptions too, in case the law wasn't complicated enough already–your spouse, the disabled, the chronically ill, children younger than 18 (at least until they turn 18), and folks who are not more than 10 years younger than the previous IRA owner.
# 3 You Can Now Contribute to Traditional IRAs After Age 70
In another yawner of a change, you can now contribute to a traditional IRA if you keep working after 70. This is like putting a double trailer on your hearse I guess. I mean, it's fine; every little bit counts. It's not like you HAVE to work past 70 or you HAVE to contribute to an IRA. It's just an option. Incidentally, they didn't raise the age on Qualified Charitable Distributions (my favorite way to give to charity in retirement, at least for the first $100K/year.) You can still start making those at 70, although their real benefit was that they counted toward your RMD for the year.
# 4 You Can Pay Off $10K in Student Loans with Your 529
Here's another one that has gotten a lot of press for some bizarre reason–you can now use 529 money to pay off student loans. I guess it sounds nice and maybe it helps a little, but it's hardly worth the additional complexity it may add to your financial life.
First, I generally recommend you pay for your own education before you starting saving for your kids, so you shouldn't really have a 529 and student loans at the same time.
Second, I generally recommend you exhaust your own and family resources before taking out student loans, so again you shouldn't really have a 529 and student loans at the same time.
Finally, some are seeing a state tax arbitrage here where you contribute to a 529, get the state tax deduction or credit for the contribution, then immediately withdraw the money to use it to pay off student loans. Well, this would certainly work, but only for the first $10K. In my state, that's a $500 tax credit. Better than a kick in the teeth, but it's not going to move the needle on the $200-300K average student loan out there for docs. The interesting thing is that the federal government has essentially just passed out a state tax break without actually asking the states for their approval. I don't think anyone cares much, but if they did, this one could get tied up in courts for years.
# 5 Annuities in Retirement Plans Now More Attractive
I'm not sure who the insurance companies paid off to get this one in there, but expect annuity sales to go up a bit. I'm not necessarily against a good Single Premium Immediate Annuity (SPIA) being used for the right person, but we all know that most annuities are terrible products made to be sold and not bought and peddled inappropriately like many other products that mix insurance features with investments. There were two changes that make it easier to sell annuities inside of qualified plans.
The first is the establishment of a “fiduciary safe harbor” that lowers the risk of a plan participant coming back and suing the plan fiduciary (often YOU the practice owner) if the insurance company goes broke and can't pay on the annuity as promised. It's disappointing that this law specifically exempts the fiduciary from having to choose the lowest cost option (which seems like a very fiduciary thing to do to me.)
The second is that annuities sold inside qualified plans are now a bit more portable. If the annuity option is taken out of the plan, the participant is no longer hosed by having to liquidate the annuity, but can roll it out of the plan “in-kind.”
Want to be secure? Be like Whitney and don't let go of your brake hand.
These two changes will have the overall effect of making annuities slightly more attractive to include in plans and more frequently used. Done properly, that's not a bad thing. But I guess I have pretty low expectations from insurance companies in this regard and expect to see inappropriate sales of inappropriate products to unsuspecting victims go up.
# 6 New Exception to the Age 59 1/2 Rule
There were already lots of exceptions to the Age 59 1/2 rule (gets you out of the 10% early withdrawal penalty) including a first home, education, early retirement (via the SEPP rule) and others. Now there is a new one–you can take $5K out of your IRA or Roth IRA for the birth of a new child or an adoption. Again, I don't recommend you raid a retirement account for non-retirement expenses, but the option is nice to have.
# 7 Kiddie Tax Changes Reversed
The TCJA changed the Kiddie Tax (tax on unearned income over $2200 in 2019 of minor children) from the parent's bracket to the trust brackets. This law changes it back. You probably didn't notice.
# 8 Changes Made to Encourage More and Better Employer Retirement Plans
Finally, there were a bunch of great changes made that should make it easier for employers to “do the right thing” with regards to retirement plans for their employees. This is actually one of the most exciting parts of the whole Act in my book, even though none of these got any headlines.
- Tax credit for a small business establishing a plan increases from $500 to up to $5,000 (be sure to get this one)
- Tax credit for adopting an auto-enrollment feature ($500)
- Automatic enrollment percentage increased. Now employers can automatically enroll employees to contribute up to 15% of income instead of just 10%.
- Part-time workers must now be eligible for the plan if they work 500 hours in 3 consecutive years (or 1000 hours in a single year), although this one really doesn't kick in until 2024
- Easier to use “multi-employer plans” which may allow small businesses (like small physician and dental practices) to band together to get more economies of scale with their retirement plans
- Employer contribution only plans can be adopted AFTER the end of the calendar year (this could affect a lot of docs starting individual 401(k)s)
All in all, mostly positive changes except for those looking to leave their Roth IRAs to their great-grandkids. Hard to complain too much here. But to think any of this is life changing? That's a bit much for me. That said, keeping up with changes like these each year is part of what I see as Continuing Financial Education, so be sure to tune back in again next year about this time for the latest update!
What do you think? What provision are you most or least excited about? How will this law change your financial plan? Comment below!
You left out
1) stipends can now be used for IRA contributions
2) Penalty free withdrawal for New parents
3) No Age restriction on IRA contributions
https://financialfreedomcountdown.com/what-is-the-secure-act-and-9-ways-it-will-actually-boost-your-retirement/
The biggest benefit though I see is for part time workers to contribute as we move more towards a gig economy. And the small business banding together to obtain efficiencies of scale.
Read again, I hit # 2 and # 3.
But I missed # 1. I suppose that could be very useful for some grad/med students, although again, a tiny little benefit that will be used by fee.
I agree those last two you mention are two great benefits.
Can you explain #1 below #8? What can apply to this tax credit? I have an single employee (me) LLC and I don’t use a financial advisor. Can this credit be used to hire a financial advisor for a fee based portfolio grooming from time to time and estate planning?
You can use the credit for whatever you want, but if you want to get it, you need to establish a new retirement plan (including a solo 401(k).
Physicians and other high income folks often wind up with very large IRAs when they roll their 401k, 403b, and DB pension plans into their IRA. You quote statistics from the average retiree, yet your usual readership is far from average. These “first world problems” that your usual readership has are great opportunities for planning and saving a lot in taxes.
I would say the 150+ year stretch IRA was something that “could have been” a great opportunity for saving a lot in taxes but never actually was. I really never expected it to last long enough for anyone to really use it and I was right. I’ll take 10 over nothing (like you get with an HSA).
As usual, I concur. When I read about this law, I almost fell asleep. I was disappointed about the annuity safe harbor. The role of government is to protect the people, and I think allowing this may lead to some unintended consequences. The hearse trailer hitch explanation was funny. You are spot on that more choices are USUALLY better, but Mark Lepper showed that too many choices can be a bad thing. In his seminal paper on selling jelly in an upscale market, having more choices (20+) vs less choices (6)—-lead to LESS sales. More was worse because no one knew what to do with so many choices. Richard Thaler, the Nobel Prize winning economist, made the point that having lots of food choices is bad because you are tempted to eat too many unhealthy things; The behavior factor is not taken into account. I think limited choices in a 401k can be more advantageous in some respects. By way of example, we make it impossible to purchase individual stocks in our medical practice 401k—you just can’t do it by program design.
Eliminating the stretch IRA is OK. It is a first world problem, and although they are taking away a clever and nuanced technique, it does help fund the treasury by taking it away. I will miss talking about his, however. I think it is a clever concept for the personal finance buff.
I liked the weekly blog themes last week about the IDR, podcast episode, and debt repayment of 500k. Is that a new concept that will continue? It integrates content nicely which helps your readers learn effectively. The topics dovetail and segue nicely off of each other. It is pleasant to tease out the nuances of the more esoteric points.
No, we’re not that organized to have themed weeks outside CFE week and scholarship week. Last week was just lucky.
I have a 401K already established at my dental office. I’m guessing I cannot receive that $5000 credit since my plan already exists or is it a yearly thing? How about the automatic enrollment?
Right, the credit for establishing is for NEW plans. But adding automatic enrollment….I think you could get that one.
Losing the stretch is not a small thing once you figure out the compound interest lost. First world problems for sure. My father a Goodyear tire salesman passed away in September. Over a million in IRAs 700k in property plus a herd of cows. This law change hurts those that have saved. I will stretch my inheritance as far as I can.
It’s not a small thing for a few people (like those inheriting 7 figure IRAs). But overall, it’s a small thing.
I agree it’s not that big of a deal.
Either you stretch it and don’t spend it, in which case a taxable account “can” do the same as a Roth, if you put non-income generating investments there. Or you and your heirs spend it, in which case those funds spent aren’t really stretched all that much.
Existing inherited IRAs are grandfathered in, so are no subject to the 10-year rule.
Quick, have anyone who may leave you money die by tomorrow!
Great overview! Thanks for posting
assured most docs and dentists have more of their wealth in IRAS versus taxable accounts
For those of us who’s kids will be affected its a BIG HIT-massive tax acceleration
And selling ANNUITIES in 401k plans-more chicanery by the lobbyists of the insurance industry
those with TRUSTS will need to revise those plans
IF Biden gets elected he wants to eliminate stepped up basis
We are going to see massive Roth conversions and Hope the govt does not tax them some day as well
Excellent review. One technical note regarding QCDs. You state that “You can still start making those at 70”. The age rule for QCDs is different than for RMDs. RMDs are based on the year you turn a specific age, while QCDs are tied to a specific age. To take a QCD you must be at least 70-1/2 on the day the funds are transferred to the charity.
With regards to stretch IRA rules, I agree that most IRA beneficiaries will be minimally affected or unaffected. That said, those IRA owners and beneficiaries who are affected should give significant thought to addressing the change, for example:
If your beneficiary is likely to be in a higher tax bracket than you are, in a given time frame, you may want to consider ROTH conversions.
If you have charitable intent, you may want to fund that intent with tax-deferred IRA funds, rather than other sources. This can be in the form of QCDs, as mentioned above, and/or naming charities as a beneficiary. This is not limited to just the IRA owner, as IRA beneficiaries, who are 70-1/2 and older, can issue QCDs from their inherited IRA. They can also name a charity as a beneficiary.
For those rare few who are affected by this issue and have named a trust as a beneficiary, they need to review and potentially revise their estate plan post-haste. Some trusts are setup such that they can only remit RMDs to the trust’s beneficiaries. Since there are now no RMDs for inherited IRAs, they would remit nothing and upon hitting the 10-year mark, the plan blows up.
Hope this info is useful.
Interesting little difference isn’t it, but I suspect you’re right and I mispoke about the QCD age.
I agree that tax-deferred money should be used for charity first. I agree that if a trust is your IRA beneficiary you need to review your estate plan with your attorney ASAP.
Does this apply to 2019 year taxes?
No.
The handwriting was on the wall with overwhelming congressional support of the Secure Act on both sides of the aisle long before it passed. Only a few stalwart bloggers like Ed Slott had been bemoaning what the government was trying to do to our savings. Once we’ve paid the taxes on our income it should be our business what we do with it, including building a legacy for our loved heirs. Personally I want my kids and grandkids, and later their heirs if they are of a saving mindset to experience financial independence. Stretching Roth IRAs over time would have allowed the magic of compounding to work for their benefit. I wish my parents and grandparents had the resources and foresight to bless future generations with money for college and a financial cushion to pursue their dreams, as well as demonstrate the future value of saving and managing money wisely. Our generation is arguably much more affluent than those in the past (just look at the houses we live in by comparison), and I believe we have a responsibility to pass that forward. Congress (Democrats and Republicans) obviously prefers the money in future tax revenue over letting your family keep what it earned. Now that this simple opportunity is gone, would like to find out more about how a trust could be structured to duplicate, as much as possible, the stretch IRA and possibly exert some control “from the grave ” on the spendthrift heirs that would blow their portion quickly.
One FU Question.
Let’s say you have assets in a revocable trust that is set/outlined to distribute to its heirs upon the death of the holder at set age pojnts in 1/3 increments at age 25, 30 and 35 respectfully. Would the clock on each of the individual amounts (1/3 each) cont to accrue until they were actually distributed to the heirs for the preset time frame outlined in the trust? For example the heirs count wait until age 35 for the age 25 distributions, age 40 for the age 30 distributions and age 45 for the age 35 distributions.
I don’t think so, but it’s not clear to me how your IRA and trust are interacting here.
I believe that the old rules still apply for beneficiaries within 10 years of your age. They can take extended withdrawals based on their age when they inherit, just as before.
My question–when those beneficiaries pass, do their beneficiaries continue to make withdrawals on the existing schedule (as the old rules specified), or must they take everything within 10 years, or something else?
Yes, that’s one of the exceptions as I noted.
Thanks for the question though, I just learned something new (i.e. what you call the old rules.) I think they’re still in effect. So there may be a loophole there to leave the IRA to someone with terminal illness that is within 10 years of your age and then the new inheritor can stretch it for a long time, although not nearly as good as the stretch IRA used to be.
Nuts – had just revised our Trust last year too. While first world issues, this hurts many of us with large IRAs and ROTH IRAs in generational wealth transfer plans.
Not surprised the lawyers and insurance companies (annuities) all were licking their chops and garnered huge bipartisan support to pad special interest coffers.
I agree with Jim that the elimination of the stretch IRA is unlikely to be burdensome for most. Those who are truly wealthy typically have most of their wealth in taxable accounts, and heirs still get very favorable tax treatment with regard to inheriting such assets (i.e. step-up in cost basis, ability to just sit on the assets forever). However, this certainly makes Roth conversions more attractive than they were before.
Why? Just because you can wait all ten years instead of spreading it out over years 8-10 or so?
I’m not quite sure what your question is Jim, but heirs may be a high bracket when they inherit a traditional IRA or 401k. Most heirs will likely be in their 50s or 60s, their peak earning years. So it may be better for the parents to pay a higher than necessary (i.e. for them) marginal tax rate on Roth conversions in order to keep the heirs from paying an even higher marginal tax rate on the withdrawals. For instance, 22% is higher than 12%, but it’s lower than 35%.
Could certainly be possible. Of course, it could also be possible the heirs are in a very low bracket.
Of course, which is why I said “may.” Like a great many aspects of personal finance, we have to make educated guesses about the future.
Will likely cost me more than 500k
How on earth did you get so much into tax-deferred assets that what your heirs inherit combined with the year 10 rule instead of the ‘stretch’ provision will result in more than $500k in additional taxes? I don’t believe that I’ve ever heard of anyone having that much in tax-deferred assets.
And it won’t cost “you” over $500k. It would cost your heirs.
If my heirs have to liquidate a Roth Ira within 10 years after they inherit it, are these assumptions correct.
1. The entire Roth Ira account distribution will be tax free to them
2. In order to mimic the Roth benefits, the beneficiary can invest that money from the Roth Ira into a tax efficient taxable account such as VTSAX or a stock that doesn’t pay dividends like Berkshire Hathaway,
Are my assumptions correct? Thank you.
Sure, it would be tax-free. Yes, it makes sense to invest as tax efficiently as you can, but it’s not a Roth if it is in a taxable account. Their gains will be taxed eventually if they wish to spend it.
The gains may never be taxed at all if the heirs pay a long-term capital gains tax rate of 0%, which is quite possible. Basically, only the ongoing dividends would be taxed.
Question on 529 for student loans:
Is it a 10k lifetime cap per beneficiary (including separate 10k lifetime caps for siblings if they don’t have separate 529s)?
Or can one double dip with more 529 accounts? Ie 10k per beneficiary per 529 account at different custodians?
I see this as being useful in the following scenario. I plan to save about half that needed for 4 kids in 529s. If oldest goes above a certain amount, especially for grad school, I’ll have them take some loans with the hope of later paying off loans with extra 529 $ once it becomes clear how much younger siblings will use.
Yes, per beneficiary I believe. Although I’m not sure we’ll know exactly how it works until we see the tax forms.
Regarding 529 for student loans. My wife and I are going for PSLF but each have a 529 account saved for our child. Can we pull money out of the 529 to pay for our loans with a state tax deduction or does this rule only apply to my child’s future student loans?
If you change the beneficiary (which you can) sure.
Wondering ab the ‘tax arbitrage’ piece for paying student loans…. in order to get the tax deduction (in Utah, and likely other states?) the beneficiary must be a minor <19 years of age – so I don’t think it’s possible unless you take from your kid‘s 529 as Steve suggested.
There is a potential for tax free growth if you contribute and down the road use the money to pay for student loans, but that is the best potential I am seeing.
Right. You’d have to change the beneficiary. But that’s easy to do.
Not sure it’s wise to borrow at 5-8% in hopes of outperforming that in the 529. Maybe if you could get loans at 2-3%…
As a general rule, I recommend you exhaust personal and family resources before borrowing for school.
most docs and other professionals have a majority of their wealth in ret. plans
for my kids this is a killer
Those that are truly wealthy almost certainly have a lot in taxable brokerage accounts, and those are still treated very favorably for heirs.
What is the age difference between you and your kids? Unless it’s well over 30 years, they’re likely to be close to retirement age by the time their inherit whatever remains in your retirement plans. So there’s a good chance that you will simply be at least partly funding your kids’ early retirement. That doesn’t sound “killer” to me.
if you do the math you will see this law is a nightmare for non spouse inheriters of large iras
listen to James Lange and get his book and sign up for h is seminar on this topic
I agree, it sucks for inheritors of large IRAs who weren’t going to spend the money within 10 years. I just don’t think there are very many of those folks out there to be honest. There aren’t many large IRAs. And there aren’t very many financially disciplined people. The intersection won’t be large.
respectfully disagree as most professionals have large iras and I am one of those who’s kids will lose a very large sum of money and it annoys me that they just change the rules whenever they wish without realizing the consequences
probably most of our legislators probably do not even know what a stretch ira is
I’m not sure you understand how rare your childrens’ situation is. I’m also surprised you thought the 100 year Stretch IRA would still be around when it came time to use it. Congress has been proposing changes to that law for at least 7 years. I’m just happy you can still stretch 10 years instead of just 5 (the House proposal) or not at all like an HSA.
the senate proposal was 5 yrs with an exemption of 400k per beneficiary so with a bunch of kids/grandkids the tax hit would be much less
james lange is pissing mad over this
Look at his book “BEATING THE NEW DEATH TAX”
anyone in my situation would feel the same; the amount my kids will lose is nothing to sneeze at
I will convert the most I can and pay the 18-20 effective tax rate until we pass
how would anyone feel if they TAX YOUR ROTH IRA SOME DAY
Ken,
I don’t see why James Lange is mad, as far as I know, he doesn’t have an IRA for anyone to inherit. Anyway, I have checked his math and he is pretty bad at converting earnings to spendable income. He made the IRS rich converting his IRAs at a pretty high tax rate of somewhere close to 29%.
Bruce Miller developed a SECURE ACT calculator, that I helped him with that calculates the effect of different withdrawal strategies over 10 years. In most cases, the equal withdrawal over 10 years wins out.
If you spread the IRA around in $1 million chunks, neglecting growth on the funds and $50k other income for a married couple the marginal tax you will owe over the 10 years is 22.4% or $224,000. If the person receiving the inheritance has no job or other income the tax will be about 16%.
So converting to a Roth @ 29% is a pretty bad idea!
A $2 million inherited IRA over 10 years is roughly 25% tax with $50k other income or 22% tax with no other income.
Also depending on whether the funds are spent or just put in a taxable account, sometimes the best strategy is to spend down the whole inherited IRA in the last 3 years with something like a 33% / 50% / 100% withdrawal structure.
PS: 2020 tax tables not inflated, meaning real taxes will probably be less.
Dave
I now wish I could convert IRAs at 29%. No way to have known that when I could have though. I don’t know how wealthy Lange is but I wouldn’t assume that a 29% conversion tax rate is necessarily bad.
How do the Stretch IRA rules apply to solo 401k’s? Is there a workaround by transferring IRA $$ to a solo 401k instead? What are inheritance rules for solo 401ks?
Same rules. Besides, most of the time once you’re done working you just transfer all your 401(k) money into IRAs. One thing that does differ between Roth IRAs and Roth 401(k)s is that Roth 401(k)s have RMDs and Roth IRAs do not. Again, another reason to transfer to an IRA.
great time to convert to roths before these tax cuts expire end of 2025
if you live till 100 the law will not affect your heirs as much as they will be retired and in lower tax brackets, possibly
I am converting to the top of the 24% bracket at an effective tax rate of 18% in Florida
My kids will pay much more in taxes with FICA, State and Federal
Lange writes extensively about Roth conversions and he details its advantages in his books
for grandkids killing the stretch will cost them a boatload