The SECURE Act: A Stinking Pig Wrapped in Ribbon
Reprinted with Permission by Forbes.com where Jim is a regular contributor.
The SECURE Act is being promoted as an “enhancement” for IRA and retirement plan owners. I think it is a stinking pig with a pretty bow, and I wanted to give retirement plan owners the good and bad news about the SECURE Act. As we go to press, the House approved it 417 to 3, it looks like the Senate will vote for it, the President will sign it, and it will become law, but we don’t know when. Assuming it does pass, the effective date is January 1, 2020.
The Good News about The SECURE Act
Under the current law, you are not allowed to contribute to a Traditional IRA after age 70½. (You can contribute to a Roth IRA at any age if you have taxable compensation, but only if your income is below a certain amount). The SECURE Act eliminates that cutoff and allows workers of any age to continue making contributions to both Traditional and Roth IRAs.
That same provision of the SECURE Act offers a hidden bonus – it means that it will also be easier for working older high-income Americans to do “back-door” Roth IRA contributions for a longer time. The back-door Roth IRA conversion is a method of bypassing the income limitations for Roth IRA contributions. The current law prohibits contributions to a Roth IRA if your taxable income exceeds certain amounts. Those amounts vary depending on your tax filing status. But even if you are unable to take a tax deduction for your Traditional IRA contribution, you can still contribute to one because there are no income limitations.
Why bother? Because, assuming you don’t have any other money in an IRA, you can immediately convert your Traditional IRA to a Roth IRA by doing a back-door conversion. That’s a good thing because the earnings on the money you contributed can then grow tax-free instead of tax-deferred.
Here’s more good news. The current law requires Traditional IRA owners to start withdrawing from their accounts by April 1st of the year after they turn 70 ½. These Required Minimum Distributions (RMDs) can be bad for retirees because the distributions are taxable. The increase in your taxable income can cause up to 85 percent of your Social Security benefits to be taxed and can also move you into a higher tax bracket. And once you begin to take RMDs under the existing law, you are no longer allowed to make additional contributions to your traditional account, even if you are still working. The SECURE Act increases the RMD age to 72, a change which will allow Traditional IRA owners to save more for their retirements.
There’s a hidden bonus in this change as well. Increasing the RMD age to age 72 will allow retirees more time to make tax-effective Roth IRA conversions. Once you are required to take distributions from your Traditional IRA and your taxable income increases, you may find yourself in such a high tax bracket that it may not be favorable to make Roth IRA conversions at all.
The Bad News about The SECURE Act
Now let’s get down to the stinking pig. The worst part of the SECURE Act is that it requires Traditional and Roth IRAs that are inherited by a non-spouse beneficiary to be distributed within 10 years of the IRA owner’s death. (There are some exceptions for minors and children with disabilities, and IRAs that you leave to your spouse are not subject to the rule at all). Withdrawals from Inherited Roth IRAs are not taxable to your beneficiary, so the cost of the SECURE Act to them will be that after ten years, they will lose their tax-free status.
The existing law allows owners of Inherited IRAs to “stretch” their RMDs over their lifetimes. The SECURE Act requires that Inherited Traditional IRAs be distributed within 10 years of the IRA owner’s death. The SECURE Act essentially means the Death of the Stretch IRA. Since your heirs will no longer be able to “stretch” the distributions from your IRA over their lifetimes, there will be a massive income tax acceleration for them.
This provision in the SECURE Act betrays those conscientious savers who socked money away for years under the assumption that they would be able to pass it on to their children in a tax-efficient manner after their deaths.
It will be devastating to people who have worked hard their entire lives, played by the rules, and accumulated significant amounts of money in their IRAs and retirement plans. It will be even more devastating for retirees whose IRA and/or retirement plan constitutes the biggest asset in their estate because it potentially means a difference of millions of dollars for their children and grandchildren.