The Demise of the ‘Stretch’ IRA
By: Arvind Ven
January 8th, 2020
On Dec. 20, 2019, President Trump signed into law a $1.4 trillion spending bill to fund the federal government through the end of its fiscal year (Sept. 30, 2020). Attached to the bill was the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
The SECURE Act is mainly intended to expand opportunities for individuals to increase their retirement savings. But it also includes changes to IRA’s and (both Traditional and ROTH) and retirement plans that has significant impact to retirees and to those who plan to pass on their IRA’s and other retirement plan savings to non-spouse beneficiaries.
According to the Congressional Research Service, the lid put on the Stretch IRA strategy by the new law has the potential to generate about $15.7 billion in tax revenue over the next decade.
How does this new law affect retirement savings?
Let us start with the positives:
The starting age of Required Minimum Distributions (RMDs) is now 72.
Increases age for commencing RMDs for retirement plans and IRAs from 70½ to 72 starting 2020. That means that if you turned 70 ½ in 2019 or earlier, this part of the new law does not apply to you.
Post Age 70½ IRA Contributions
Repeals limit prohibiting individuals age 70½ and above from making non-rollover contributions to traditional IRAs. Unlike before, you can now make contributions to your IRA even after age 70 ½.
And now, for the not so good part..
The ‘demise’ of the "Stretch" Required Minimum Distributions (RMDs)
This change probably has the most impact for baby boomers and Gen-X’ers and for those who have saved diligently in their retirement accounts and IRA’s. An illustration with an example below will help understanding this change.
Example: Bob and Sally are a retired couple with $2 Million in their IRA/Tax deferred assets. Bob passes, and his wife Sally now is the IRA beneficiary and the new law has no impact as she is a surviving spouse. Sally passes away, and there is still $1 Million left in her IRA. Now, their daughter Val, 40 years old, is the beneficiary.
Old law: Their daughter, forty-year-old Val, would have had her lifetime years for her RMD’s and to take distributions from her inherited IRA’s. That would have ‘stretched’ her inherited IRA’s over almost 45 years and manage tax impact to her own income more favorably.
New law: Val will now have 10 years to draw down her inherited IRA’s, whether traditional or ROTH. If she is in a well-paid profession, her tax rate may go up significantly based on the additional income from the inherited IRA’s.
What would have happened if Bob and Sally had left the IRA to their ten-year-old grandson, Danny?
In that case, the clock starts ticking as soon little Danny turns eighteen (or as defined by state law) and he will need to draw down the inherited IRA in ten years, or by the time he is twenty-eight years old!
Are there exceptions to this new law?
The Secure Act’s RMD change will not affect accounts inherited by a so-called eligible designated beneficiary. An eligible designated beneficiary is: (1) the surviving spouse of the deceased account owner, (2) a minor child of the deceased account owner, (3) a beneficiary who is no more than 10 years younger than the deceased account owner, or (4) a chronically ill individual.
Note that once a minor child turns eighteen (or when designated as an adult by prevailing state law), then the 10-year RMD clock starts ticking at that point.
The RMD rules for accounts inherited from owners who died before 2020 are unchanged.
What are the next steps? What are some options?
Having a conversation with your financial advisor and estate planner will be a good next step. Your advisor should be able to analyze your scenario and offer solutions that take your financial goals and tax implications into account. Some things to think about:
Conversion to ROTH IRA: ROTH IRA’s are popular due to the fact that there is no RMD requirement (assuming non inherited) and gains are tax free. However, it is good to remember that this is funded by after tax money. We end up paying taxes, either now or later.
The strategy of converting traditional (tax deferred) IRA’s to a ROTH is an important consideration. However, it should be considered very carefully and should not be based on ‘knee jerk’ reactions due to tax treatment changes. When you convert to a ROTH, taxes are due the year the conversion is made. It is also important to remember that changes can be made to ROTH tax treatment down the road by the government if they want to bring in more tax dollars!
Those living in high tax states like CA and NY are still feeling the pain of SALT deductions (tax cuts act of last year) limiting tax form Schedule A deductions to $10,000 per year. Diversification of asset classes in addition to diversification of assets is equally, if not more, important.
Cash value life insurance: While life insurance may not be for everyone, and has some fees built in, distributions/income from whole life insurance and death benefits for beneficiaries are usually tax free. Strategies such as Hybrid LTC (Long Term Care with life insurance), Indexed Universal Life policies, fixed and indexed annuities are aspects that should be considered and evaluated to see if they fit individual needs. These can be funded with both pre and post-tax money.
Municipal bond ladders could also add to tax advantaged investing although there is no lifetime benefit or life insurance associated with them.
Arvind Ven is Founder/CEO of the Capital V Group, a Registered Investment Advisory firm. He has an MBA from the MIT Sloan School and a Master’s Degree in Computer Engineering.
Note: This write-up is for educational purposes only and should not be considered financial or tax advice. For questions about this educational piece, please reach out to Arvind: Phone (408) 725 7122 or by email: arvind.ven@lpl.com