By Brad Pistole
When the clock struck midnight on Jan. 1, you might have been up celebrating the new decade into the wee hours of the morning, or you might have been sound asleep. But either way, you were probably completely unaware of the many changes that took place all across the financial world. And many of these changes will affect you and your family for years to come.
That includes the Setting Every Community Up for Retirement Enhancement Act, or SECURE act, the new legislation which includes some of the biggest changes to current retirement plans in over a decade. And just when you think you have all of the rules for IRA contributions and distributions figured out, think again.
The new law has brought sweeping change to many aspects of retirement planning. And while these changes may seem fairly simple to understand at first glance, you might be left scratching your head.
One of the most obvious changes was in the age for required minimum distributions (RMDs). The SECURE Act raised the RMD age from 70½ to 72. Sounds simple, doesn't it? That depends on when you were born.
Let's use my wife and me as an example. My wife was born on June 19. I was born one month later, on July 19. For this example, let's assume my wife turned 70 on June 19 of 2019. Since she would then reach age 70½ in 2019, she would still fall under the age 70½ rule for RMDs. She would have to take her first RMD by the end of 2019 or she would be forced to take two distributions in 2020. I, on the other hand, would not have to take my first RMD until age 72. Why? Even though our birthdays are just one month apart and in the same year, one would fall under the RMD age 70½ rule and one would fall under the SECURE Act RMD rule of age 72.
In fact, one day makes a big difference because the RMD beginning date is based on when you turn 70½. So a person born on June 30 and a person born on July 1 who both turned 70 in 2019 would have different RMD beginning dates. The person born on June 30 would have to take their first RMD by age 70½ and the person born on July 1 would not have to take their first RMD until age 72.
Another change caused by the SECURE Act that may leave you scratching your head involves your beneficiaries. Under the new law, there are five different classes of beneficiaries. Some beneficiaries can still "stretch" the decedent's IRA and some can't. Or can they? The answer is, it depends.
At first glance, the SECURE act basically killed the stretch IRA for any non-spouse beneficiary. Under the new law, a non-spouse beneficiary is required to fully liquidate the IRA of the decedent in 10 years or less. There are no required minimum distributions. They can either take the money out in a lump sum, take distributions out over a 10-year period, or wait until the last year to liquidate the account. But it must be liquidated in 10 years, unless an exception applies. One exception is if the non-spouse beneficiary is not more than 10 years younger than the IRA owner.
So let's use an example. Let's say Bill owns a $1,000,000 IRA and names his two siblings, John and Mary, to be equal heirs to his IRA. John is six years younger than Bill and Mary is 11 years younger than Bill.
In this case, after Bill's death, John could continue to stretch the distributions from Bill's IRA and would be subject to RMDs. On the other hand, Mary would not be able to continue the stretch. She would not be subject to RMDs but the new 10-year distribution rule would apply. She would be forced to fully liquidate her portion of Bill's IRA before the end of the 10th year following Bill's death. So when it comes to non-spouse beneficiaries and who can and who cannot continue the stretch option, it depends on your date of birth.
For people who have done estate planning prior to their death, this can get really tricky. In the case mentioned above, Bill had counted on the stretch IRA option for his siblings as a way to keep each of them from paying huge taxes on the inherited IRA distributions.
Now that the SECURE Act has passed, this wouldn't cause a problem for John, because of "beneficiaries not more than 10 years younger than the IRA owner" rule would apply. However, Mary is not as fortunate. If Bill left Mary a $500,000 IRA, because she is more than 10 years younger than the IRA owner, she would be forced to liquidate the account by the 10th year. This would mean a significant increase to her taxable income over the next 10 years. And if she decides to take it all out at once, she would give a significant portion of her inheritance to Uncle Sam.
To show you just how confusing the rules can get, let's further complicate this example.
Since Bill left 50% of his IRA to his brother John, who is less than 10 years younger than Bill, upon Bill's death, John would qualify for an exception and would not fall under the new "10-year distribution rule." However, let's assume Bill died in 2019, leaving John 50% of his IRA. John chose to start taking RMDs from the IRA. But then, in 2020, John died. Will John's successor beneficiary be able to continue to take the stretch?
Answer: Not in this case. If an IRA owner died before 2020, and the original beneficiary (in this case, Bill's brother John), dies after 2019, the successor beneficiary (John's beneficiary) would be forced to use the 10-year distribution rule. They would not be allowed to stretch the distributions the way John was allowed to.
However, if both Bill and John died in 2019, prior to the SECURE Act, John's beneficiary would be able to continue the stretch. For this, and many other reasons, the SECURE Act will require new estate planning when it comes to non-spouse beneficiaries who do not meet one of the five exceptions for continuing the stretch.
Another change stemming from the SECURE Act involves the ability to continue contributing to your IRA after the age of 70½. Those who continue to work and have earned income can now contribute to an IRA past the age of 70½. But don't be fooled. This option has some interesting twists with it too and can be very confusing.
Even if you have earned income and choose to make tax-deductible contributions to your IRA, you are still required to satisfy the RMD rules that apply. In a post SECURE Act-world, once you turn 72, you must begin taking required minimum distributions. And yes, you are allowed to continue making contributions to your IRA as long as you have earned income. So you can put the money into the IRA, but you must also take your RMDs out. Always remember, there is no such thing as a "still working exception" when it comes to RMDs from IRAs.
This may make Roth IRAs more appealing than ever before. Roth IRAs would eliminate the RMDs for the owner and would provide tax-free distributions for the non-spouse beneficiaries who will now be forced to use the 10-year distribution rule.
Let's tackle one more change the SECURE ACT of 2020 brought to the table, because it too, will be very easily misunderstood.
Prior to the SECURE Act, many IRA owners chose to use qualified charitable distributions, or QCDs, as a way of passing on their RMDs in the most tax-efficient manner. A QCD allows the IRA owner to satisfy the RMD without paying taxes on the distribution because it is sent directly to the charity of their choice. In fact, you can use a QCD for up to $100,000 of your IRA annually and each spouse has the $100,000 limit.
This was a very popular estate planning tool prior to the SECURE Act. Now that the RMD age has been raised from 70 ½ to age 72, you are still allowed to use QCDs, however, you don't have to wait until age 72. In a post SECURE Act-world, even though your first RMD isn't required until age 72, you can begin using QCDs at age 70½. Does that make sense to you? Me neither. Uncle Sam had to leave the ½ in there somewhere.
As you can see, the SECURE act has brought about major changes to tax-deferred accounts and retirement planning for the future. These changes can be very confusing.
Life insurance planning and Roth IRAs will move to the forefront as savvy investors look for ways to beat Uncle Sam at his ever-changing game. There's never been a better time to sit down with a qualified team that includes your financial adviser, CPA, and estate planning attorney to make sure you are passing on your wealth in the most tax-efficient manner.
About the author: Brad Pistole, a certified financial fiduciary, is the president and CEO ofTrinity Insurance and Financial Services in Ozark, Mo., the host of Safe Money Radio which airs on several stations each week in Missouri and Arkansas, and author of Safe Money Matters. Brad is also a member of Ed Slott's Master Elite Advisor Group and the National Ethics Association. He is an MDRT Top of the Table adviser.