The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was passed in the house with a 417-3 vote in May and has made its way to the Senate during this current term. The SECURE act will make impactful changes to IRAs, 401(k)s, and 529 Plans.
The House proposed act key points are as follows:
- Increasing the required minimum distribution age to 72 from 70.5
- Allowing more annuity options for retirement accounts
- Expanding small employer access to retirement plans
- Removing age limitations on IRA contributions
- Permitting the use of 529 plans to repay student loans
- Removing the “stretch” inherited IRA provisions
Even though these provisions are designed to address the looming retirement crisis Americans face, there are hidden money grabs, specifically the removal of “stretch” IRAs.
The Death of the “Stretch” IRA
A “stretch” IRA allows a person, who is not a spouse of the deceased, to inherit an IRA and withdraw from it over their lifetime. The current law allows beneficiaries to “stretch” withdrawals over a long period of time or a lifetime to decrease the income tax burden. Many times, the tax benefit of the IRA even expands beyond the lifespan of the original beneficiary. However, with the new bill, inheritors will only have 10 years to liquidate the retirement accounts and pay the taxes due. For a Roth IRA, the distributions will not be taxable, but the beneficiary still has to withdraw the entire account within 10 years of the account owner’s death. The Senate is proposing that this requirement only apply to inherited IRAs with balances over $400,000. Basically, the government wants their money sooner rather than later, and taxpayers are the ones who end up getting hurt. On top of this, once the beneficiary withdraws all the money from the retirement accounts, it will no longer have the current tax protection. This means that if children inherit a Roth IRA, even though the distributions are tax free, the earnings on the money they are required to withdraw will be taxed.
To put this in perspective, according to Reuters, a hypothetical inherited account of $1 million that would earn a 7% return if it remained invested and only the required minimum distributions taken out. A 25-year-old who inherits this money from a grandparent would pay $400,000 more in taxes than they would under the current rules.” As shown by this scenario, the SECURE Act is detrimental to wealthy IRA owners who use “stretch” IRAs to pass on large retirement accounts to heirs. Their life-long savings would end up paying the government instead of leaving money to their beneficiaries.
How to Avoid the Government Gotcha in the SECURE Act
One strategy is to convert funds from a traditional IRA to a Roth IRA. The money in the Roth IRA will have tax-free growth for up to ten years after death. According to James Lange, Forbes writer, “One of the advantages of making a series of conversions is that the amount you convert to a Roth IRA reduces the balance in your Traditional IRA, which will reduce the income taxes your heirs have to pay on the Inherited IRA within ten years of your death.” It makes more sense to do a series of Roth conversions versus one big Roth conversion as it will allow you to stay in a lower tax bracket. Keep in mind there are certain income requirements to be eligible for a Roth IRA.
Another strategy is to determine if one qualifies for the Energy Independence programs approved inside the Tax Cuts and Job Act that enable up to a 100% Tax Deduction offset for distributing dollars from an IRA with the offset with a 100% tax deduction. This strategy then turns future inherited assets from taxed to the max to tax free with a step up in basis inherited tax treatment so the beneficiaries inherit the value of the asset at the time of death this resulting in no taxes if they decided to sell off the inheritance.
The next strategy is to be able to multiply your tax-free legacy transfer plan by using special designed life insurance. Re-direct otherwise spendable taxes into the deposits of the special designed insurance contract to allow for a 5-10 times tax free transfer that will enable your beneficiaries to receive monies tax free and pay any needed inherited IRA taxes with tax free dollars. Designed correctly this hidden wealth solution enables up to three generations of tax-free planning and enables one to leave ten times more all tax-free.
Now more than ever, education is key to understand how the SECURE act can affect you, your family and your retirement plans. Timing is key and now is the time to learn the tax-savings defense mechanisms that can best fit for you and the legacy you want to leave without Uncle Sam!