The SECURE Act: Good or Bad for IRAs?

The SECURE Act has a provision in it which puts a wrench in the estate planning strategy of Stretch IRAs, and it looks like a money-grab on the 1%.

July 22, 2019

By: Bobby Casey, Managing Director GWP

IRA Secure Act

By the end of first quarter in 2017, US total retirement holdings was just over $26 Trillion. It turns out that the American people are better at frugality than their government. $8.2 trillion of that is in IRAs.

A country with over $22.5 trillion in debt, might be tempted to tap those accounts.

The headlines say that the “government is coming for your IRA”. That is neither entirely false, nor entirely true.

It’s not a straight up Crypriot-like expropriation. That would be political suicide. What they settled for is the devaluation of IRAs by finding a way to tax more of it, sooner. It’s called the SECURE Act (Setting Every Community Up For Retirement Act).

So far it has only passed the House, and the Senate has its own version of it.

Some of the benefits that come with this legislation are:

  • It allows small business to collectively create retirement benefit options along with a small tax credit for automatic enrollment.
  • It increases access to annuity options within retirement plans; the evaluation of which is left to the employer to assess.
  • Required Minimum Distribution is pushed later. Depending on whether they go with the House suggestion of 72 years old or the Senate version which says 75 years old, those who are still working won’t be forced to collect at 70.5 years.
  • Along those lines, the age restriction for contribution to the traditional IRA would be lifted. Currently, contributions are no longer allowed past 70.5 years old.

This is probably why it has drawn such overwhelming bipartisan support. No one would turn these down. While they likely won’t move the needle much for those struggling to save or not saving at all, hey will help those who are saving at least some.

In a study released from the GAO 5 years ago on the 2011 tax year it found the following:

More than 99% of Americans have balances of less than $1 million in their IRAs. But about 9,000 Americans have IRAs of $5 million or larger. And 314 Americans have IRAs larger than $25 million.

The politicians know to target the 1%, and that’s precisely who this legislation is after while pandering to the other 99% or at the very least leaving them alone. It has a few little provisions in it that help savers, but it basically eliminates the Stretch IRA as an estate planning tool.

It’s fine to say that IRAs aren’t meant to be estate planning tools, but the time to define that was before people got them.

The Stretch IRA is a bit of a misnomer in that it’s not a type of IRA. It’s a strategy for using an IRA. As Investopedia explains it:

A stretch IRA is an estate planning strategy that extends the tax-deferred status of an inherited IRA when it is passed to a non-spouse beneficiary. It allows for continued tax-deferred growth of an Individual Retirement Account (IRA).

By using this strategy, an IRA can be passed on from generation to generation while beneficiaries enjoy tax-deferred and/or tax-free growth.

The SECRURE Act does away with this strategy and requires instead that non-spousal beneficiaries be paid out in ten years.

This doesn’t apply to spouses, but since the spouse would be filing as single, they too will be subject to higher taxes.

Typically, accounts with fewer assets get cashed out quickly anyway, as it’s not worth it to stretch out the payments. But those with greater holdings, are deliberately structured to pay out over time based on the Required Minimum Distribution (RMD).

RMDs are determined by life expectancy of the account holder. So, if I have an IRA, under current laws, I would have to start receiving an RMD at 70.5 years old. Per this calculator, A $1,000,000 account has me getting $36,500/year minimum. A $5,000,000 account has me getting $182,500/year. This is based on best case scenario of living into my early hundreds.

But let’s say I die and pass a remaining $4,000,000 on to my kids. Under current laws, the RMD would be recalculated based on their life expectancy, so the distributions would be much lower, essentially “stretching” the funds into their retirements.

Under the SECURE Act, they must get full distribution within ten years. Unlike the ROTH IRA which is deposited POST TAX, traditional IRAs receive their deposits PRE TAX. Both mature tax-free, but only the former has tax-free distribution at the end. The latter is part of your AGI (adjusted gross income).

Lower distributions add to the longevity of the account, obviously; but they also mean the beneficiaries aren’t taxed as much.

Higher distributions are taxed at a higher rate, and when combined with their own incomes means they pay more in taxes. Which seems to be the point: get more taxes in a shorter period of time. As one article in MSN (of all places!) wrote:

As much as one-third more of an inherited IRA would get gobbled up by taxes than under current rules. When the Tax Cuts and Jobs Act expires in 2025, taxes will rise across the board.

Many pundits and politicians will play up the fact that 99% of Americans won’t be affected by this. And they are right. But if they are willing to make this sort of money grab now, don’t be surprised at the mission creep a few years down the line.

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