SECURE Act: Goodbye stretch - Hello tax bill

On December 18th, the United States government passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act which is part of the year end spending bill. In addition to provisions designed to help businesses increase retirement security for their employees, there are also changes that impact individual financial and tax plans. 

When our team reviewed the provisions in the SECURE act, we realized that it could potentially have a big impact on individual taxes in the future.

Here's why...

Are you afraid to pay taxes?  Most people we encounter are afraid to pay income taxes, but do not realize that some taxes are a future liability. For anyone that has an IRA (Individual Retirement Accounts), 401(k), 403(b) or a other qualified tax-deferred retirement account, the future tax liability could not only be in their lifetime but could kick the can down the road for those who inherit the accounts. 

Why should we start planning for these future tax liabilities? In our opinion the SECURE Act created a need for individuals to think about their future tax bills, now. There were a number of taxpayer friendly provisions in the SECURE Act but what we would like to talk about is the "not so taxpayer friendly" change that will cost most beneficiaries of retirement accounts more in taxes. 

The SECURE Act substantially changes the 'stretch' inherited IRA. In the past if you inherited an IRA as a beneficiary from a parent or other relative, you could stretch the payment of the account over your lifetime.  The new law limits the stretch to 10 years. *

Here is an example of how this would impact your kids if they inherit your IRA:

Under the Old Rule they could:  Under the New Rule they would have to: 
  • take smaller distributions over their lifetime 
  • choose to pay taxes at a smaller marginal tax rate
  • allow the account to continue to grow tax deferred
  • drain entire account in 10 years
  • pay all taxes at their current tax rate in those 10 years (there are several reasons these tax rates may be higher)

By using tax strategy now, you can increase the amount of money that you are leaving for your kids and reduce their tax bills in the future.

Here are a few things you can do to optimize your tax strategy:

  • Talk with your financial advisor or tax planner
  • Determine the needs and goals of your IRA or other qualified accounts
  • Pay the Taxes Now – Start to take larger distributions from your IRA and pay the taxes now with your current tax rate.
  • ROTH Conversion – Start to convert your current IRAs to ROTH IRAs. This is done by paying the income taxes now on the conversion amount, then the conversion amount starts to grow tax free, not subject to RMD requirement and is a tax free distribution to beneficiaries.

If you are currently in a lower tax marginal bracket than the heirs, who will inherit your IRA, it makes sense (in most cases) for you to pay the taxes now through a ROTH conversion.

If you are planning on leaving your IRA to charity, you have already taken a tax deduction on your contributions, you can enjoy tax free growth and the charity will receive the IRA with “NO” tax implications to you personally.  In addition if you have charitable intentions during your lifetime, you can use QCDs (Qualified Charitable Deductions) to fulfill your RMDs that are required now at age 72.

It makes sense take advantage of the opportunities of change. Talk to your financial advisor and tax professional to better understand how these changes will specifically impact your situation.   

* This does not apply to inherited IRAs from Spouses only Non-Spousal beneficiaries of IRAs.

The above list is not all-encompassing, and more importantly, needs to be discussed with your tax professional. 

Josh Yost on January 20th, 2020

Posted by Josh Yost

Josh joined Oakeson Steiner Wealth & Retirement, an advisory based, financial services firm serving individual and institutional clients in Hastings, Nebraska, in 2008 as an investment consultant working with corporate retirement plans and individuals. He leads the team which manages over 50 corporate retirement plans. He has completed a retirement plan consultants program & fi360’s Accredited Investment Fiduciary (AIF) designation to offer co-fiduciary service to plan sponsors. In 2014, Josh earned his CHARTERED RETIREMENT PLANS SPECIALIST™ (CRPS©) certification from the College of Financial Planning.

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