If you worked with a financial planner or estate planning attorney years ago to ensure that you would have enough money saved for retirement, you may feel confident that you’re ready for that next chapter of your life. However, the federal government likes to keep us on our toes, so it’s important that you keep yourself informed of changes that might affect you.
In January of 2020, for example, a new law went into effect regarding tax-advantaged retirement accounts such as IRAs and 401k plans. Rather than trying to figure out on your own how the changes will affect you, we recommend that you go back to your advisor for some individualized advice. In the meantime, we provide an overview of how you might be impacted by these changes.
What Is the SECURE Act?
In an effort to revamp what many saw as a troubled retirement system, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. While the Act benefits some people who were previously shut out of tax-advantaged savings plans, it is not so generous in other respects. A couple of very positive changes include making it easier for small business owners to set up safe harbor retirement plans that are less expensive and easier to administer and making many part-time workers eligible to participate in employer retirement plans. Previously, part-time workers and small business owners simply could not access these advantageous plans. The SECURE Act also pushes back the age at which you have to start withdrawing from a tax-deferred savings plan from 70 ½ to 72, giving people 18 more months to accrue interest and put off paying taxes on their savings.
Now, for the Bad News
While these provisions are beneficial to many, it’s not all good news. The most significant detrimental change for most people relates to the inheritance of a loved one’s retirement account. Previous to this act, a beneficiary of an IRA account could take minimum withdrawals from the account stretched out over their expected lifetime. For example, if you inherited a parent’s IRA account when you were 50, you would only have to withdraw and pay taxes on about 1/30th of the total each year. This way, the fund could continue to grow, you could put off paying income tax on it, and you didn’t risk being bumped into a higher tax bracket.
Under the SECURE Act, however, most non-spouses inheriting IRAs must empty the account within 10 years. That means they will have to withdraw 1/10th of the account each year, which could end up costing them in lost interest and higher income tax.
Strategies to Offset the Negative Impact of the SECURE Act
If you have a significant amount of money in an IRA, this would be a good time to review your beneficiaries and see if there are ways to protect them from higher taxes when they inherit the account. While a spouse is not affected by the rule change, adult children would be. Some options an estate planning attorney can help you with are:
- Adding grandchildren as beneficiaries. When you name your children and their children as beneficiaries, the money is spread out more widely and no one heir is stuck with a large tax burden. Trusts can be established for the children so that those funds can be managed by an adult.
- Leaving a trust in a non-income tax state. Because Texas doesn’t have a personal income tax, it is smart to set up a trust in Texas to receive IRA funds. The untaxed funds can be distributed to named heirs in other states, saving them anywhere from two to ten percent, depending on the income tax in their state of residence.
- Naming a charity. Non-profit charities do not pay taxes on donations, so if you are leaving behind a large estate and would like to contribute to a charitable cause, you can set up a trust to receive the funds from your IRA.