What one hand giveth, the other taketh away
/The Secure Act became law on December 20, 2019 and became effective January 1, 2020. It covers a number of provisions to increase access to tax-advantaged accounts, but there are two provisions that throw a wrench into retirement planning:
1. Required Minimum Distributions must begin at age 72 (changed from age 70½) – this delays income taxes to the IRS for 1½ years .
2. Non-spousal Inherited IRAs opened in 2020 or later must be depleted within 10-years – this accelerates income taxes to the IRS.
With baby boomers retiring at record levels, this new law takes away the ability to stretch an Inherited IRA over the beneficiary’s life expectancy and replaces it with a mandate to deplete the account within 10 years. The U.S. Treasury is estimated to raise almost $16 billion due to this change. (Per Forbes article dated December 29, 2019. Gail, make sure article is saved in support scan file.)
To clarify what this means for retirement savers, let’s assume John’s dad passes away with a $1,000,000 retirement account. Fortunately for John, he is the only beneficiary. Unfortunately, John has to deplete the entire account within 10 years. If he withdraws 1/10th per year, his taxable income would increase $100,000 per year for 10 years.
Let’s further assume that John is 50-years old, has a good job and makes $163,300 per year. Over the next 10 years his taxable income will be $100,000 higher (even more if the Inherited IRA account grows), which will take him from the 22% tax bracket to the 35% federal tax bracket.
So, what can someone with a sizable retirement nest egg do while still in the retirement planning stage?
If John’s dad had seen this change coming, he should consider weighing his own tax situation each year to see if there’s room in his tax bracket to convert part of his IRA to a Roth without moving into a higher tax bracket. Of course, this makes sense as long as his son John would be in an even higher tax bracket once he inherits. Keep in mind that Inherited Roth IRAs also have to be depleted in 10 years, but they are not subject to taxation.
Or, if John’s dad was 70½ and of a charitable nature, he may consider gifting through a Qualified Charitable Distribution. This would directly shift money from his retirement account to the charity without increasing John’s dad’s taxable income.
Lastly, it would be worthwhile for dad and son to have a conversation about the long- term goals for this money. Because even though the withdrawals are completed within 10 years, these large payouts can be reinvested in John’s non-retirement account for long-term growth. This would be ideal!
