Tag: Secure Act

More IRA Changes Coming

          This week’s post will be a bit different than what you are used to seeing each week.  This week, I want to bring you up to speed on some proposed changes out of Washington relating to Roth IRA accounts.

          I’ve often stated in this weekly publication and on my radio program and podcast that I am of the opinion that the tax-hungry politicians will find retirement accounts a difficult target to resist given the numbers

          According to the Investment Company Institute, at the close of the first quarter of 2021, the total assets held in retirement accounts in the United States was $35.4 trillion.  (Source:  https://www.ici.org/statistical-report/ret_21_q1)

          Given that the ‘official’ national debt is approaching $30 trillion, if politicians could get their hands on the retirement account assets, the nation’s fiscal problems could be solved temporarily.  Actually very temporarily given the downright out-of-control spending that has been characteristic of Washington politicians for the past couple of decades.  As we are all keenly aware, spending by the Washington politicians has only grown increasingly irresponsible and wild as time has passed.

          But, I digress.

          In my book “Economic Consequences”, published ten years ago, I first made this point.  At that time, the Fed had recently begun quantitative easing or currency creation out of thin air as a temporary, emergency measure.

          I suggested in the book that history taught us currency creation programs were rarely temporary, rather they become policy until the consequences of currency creation are worse than dealing with the consequences of debt excesses.  I also suggested that retirement accounts would likely prove to be a tantalizing tax target.

          In the book, I offered examples of countries that had actually taken control of some of the retirement accounts of the citizens by requiring that retirement account assets be invested in that country’s government bonds “in the interest of retirement safety and stability.”

          I also suggested that politicians could raise significant revenues at the expense of those who’s worked hard and accumulated assets in retirement accounts by changing tax laws.

          Fortunately, there has been no requirement to invest retirement account assets in government bonds, but over the past year or so, tax rules relating to IRA’s and other retirement accounts have changed.

          For example, the SECURE Act, while raising the age at which required minimum distributions need to be taken from a retirement account from 70 ½ years old to age 72, also killed the stretch out IRA.

          If you’re not familiar with a stretch-out IRA, it allowed a non-spouse beneficiary on a retirement account (typically a child), to inherit an IRA and spread the unpaid tax liability out over the beneficiary’s lifetime.  For example, a 50-year old inheriting an IRA with a 35-year life expectancy could use a stretch-out IRA by taking a distribution of 1/35th of the inherited IRA account in year one; followed by a distribution the next year of 1/34th of the remaining account and so on.

          After the SECURE Act, all taxes on an inherited IRA must generally be paid within 10 years.

          In my latest book, “Retirement Roadmap”, I do a hypothetical analysis on how this affects the beneficiary of a retirement account.  I assume a 50-year old inherits a $1,000,000 IRA before the SECURE Act became law and used the stretch-out option.  Assuming the inherited IRA account grows at a rate of 5% per year and the 50-year old beneficiary is in the 25% tax bracket, the beneficiary realizes an after-tax net of more than $1.9 million from the $1 million inherited IRA.

          If we use the same 5% growth assumption for inherited IRA assets but now assume the taxes on the inherited IRA need to be paid within 10 years, the IRA beneficiary now receives an after-tax net of about half of what the beneficiary would have received using the stretch out strategy.

          Even more interesting is the IRS’ tax take over the first 10 years after inheritance.  After the SECURE Act, based on our stated assumptions, the IRS receives more than $225,000 in additional taxes during the first 10 years!

          It’s no wonder that when the SECURE Act was proposed, “The Wall Street Journal” ran an op-ed piece titled “They’re Coming for Your IRA”.

          Now, the Washington politicians are at it again; proposing more IRA tax changes as well as limits on Roth conversions.  Here are selected excerpts from a recent article in “The Wall Street Journal” (Source:  https://www.wsj.com/articles/retirement-savers-love-the-backdoor-roth-ira-strategy-it-might-not-last-11632475801?mod=e2fb&fbclid=IwAR0J8fibwyR5_YDYP7UIPm–rJ47yrItWmzPpgixmR_VxPJb8uC-iD8CgCo)

Many Americans are using a previously little-known tax method to boost their savings. Now, the government is trying to stop it.

The tax strategy at issue is the mega-backdoor Roth conversion and it has allowed some Americans to amass sizable balances in tax-free Roth retirement accounts. On Sept. 15, the House Ways and Means Committee approved legislation from House Democrats that would prohibit use of the mega-backdoor Roth conversion starting Jan. 1, 2022.

The proposal is one of a series of measures Democrats are backing in an effort to prevent the wealthiest Americans from shielding multimillion-dollar retirement balances from taxes. The move is part of a broader agenda that includes raising taxes on higher-income Americans and cracking down on tax avoidance to help pay for measures including the party’s $3.5 trillion healthcare, education and climate bill.

The legislation also proposes eliminating Roth conversions of after-tax contributions to traditional individual retirement accounts starting Jan. 1, 2022. It would require most people with aggregate retirement-account balances above $10 million to take distributions, regardless of their age. And it would ban holding unregistered securities, including private equity, in IRAs.

Starting in 2032, the legislation would prevent single people earning more than $400,000 a year and married couples with incomes above $450,000 from converting pretax retirement-account money to Roth accounts.

          Admittedly, the proposed changes won’t affect the majority of those who do Roth IRA conversions or participate in company retirement plans, at least initially.

          Color me cynical, but being a student of history and studying how taxes and tax policy come to be, tax changes and tax increases are always imposed on the high earners first.  But then, more times than not in my judgment, these tax increases, and tax changes extend to more and more taxpayers.

          For example, when the income tax was introduced in 1913, it originally significantly affected only VERY high earners.

          After a $3,000 standard deduction, the income tax rate was 1% to $20,000.  Only income earners who had incomes in excess of $500,000 were taxed at a rate of 7%.

          Let me attempt to put those numbers in context, adjusting for the diminished purchasing power of today’s US Dollar.

          Today’s dollar has lost more than 96% of its purchasing power since 1913.  That means a dollar today is the 1913 equivalent of 4 cents.

          Doing a little math, one quickly concludes that a $3,000 standard deduction in 1913 would be the equivalent of a $75,000 deduction today.

          Imagine getting a $75,000 deduction and then paying income tax of 1% on income over and above the $75,000 until your income reached the 1913 equivalent of $20,000 or about $500,000 today.

          The top tax bracket in 1913, 7% on incomes over $500,000 would be like entering the highest tax bracket today with $12,500,000 of income.

          In 1913, there was no tax withholding by employers.  However, after-tax withholding began and the Social Security Act was passed, even part-time employees were paying taxes.

          My point is this – if you have not seriously examined a Roth conversion strategy for your individual financial situation, you should do so.

          I discuss this at length in my recent book “Retirement Roadmap” which was a number one Amazon best-seller thanks to many of you supporting the book.

          Given the negative tax momentum surrounding retirement accounts presently and the fact that tax rates will increase in 2026 if Congress doesn’t change them before that, now may be the perfect time to look at the ultimate tax liability on your retirement accounts.

          Procrastinating could be costly.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com.  Our webinars, podcasts, and newsletters can be found there.

SECURE Act Overview

As 2019 drew to a close both the House and Senate passed the SECURE Act.  The President signed it into law, and it is effective as of January 1.  I break this new law down in more detail in my January client newsletter “The You May Not Know Report” but will give you an overview of this week’s post.  (If you’d like a complimentary copy of the newsletter, just give the office a call at 1-866-921-3613.)

Here’s the overview and a quick planning idea.

The SECURE Act allows required minimum distributions to be postponed until you are 72.  Prior to the passage of the SECURE Act, required minimum distributions had to start at age 70 ½.

But, if you turn age 70 ½ after December 31, 2019, you can now postpone your first distribution until age 72.

The SECURE  Act also changes the rules regarding IRA contributions.  Now as long as you are working, you can contribute to a traditional IRA regardless of your age.  Previously, you could not contribute to a traditional IRA once you attained age 70 ½.

The SECURE Act also expands access to Multiple Employer Plans (MEP’s).  A MEP is a plan that allows employers to band together and pool resources to give employees access to retirement plans.  The SECURE Act incentivizes the establishment of these plans by smaller employers by offering tax credits.

The SECURE Act also allows employers to auto-enroll employees in a plan at a savings rate of 6% of pay.  Workers can opt out at any time.

The SECURE Act also allows plans to add annuities as investment options in employer sponsored retirement accounts.  This is a big legislative victory for insurance companies that openly lobbied heavily for the bill.

529 plans were also revised under the SECURE Act.  A 529 plan is a tax advantaged plan that allows for educational savings.  529 plan assets can now be used to pay for registered apprenticeships, homeschooling, up to $10,000 of qualified student loan repayments (including for siblings) and private elementary, secondary or religious schools.

The student loan provision allows for student loans to be repaid for a 529 plan beneficiary up to $10,000.  An additional $10,000 can be used from the 529 plan to pay off student debt for each of the 529 plan beneficiary’s siblings.

The SECURE Act would also allow investors to have early access to IRA funds for any ‘qualified birth or adoption’ without paying the 10% early withdrawal penalty.  This change allows each parent to take a penalty-free withdrawal of up to $5,000.  The withdrawal will be taxable but would not be subject to the 10% penalty.

But the SECURE Act is not all good news in my view.  The new law eliminates the stretch-out IRA that has been used as a cornerstone of estate planning for many IRA and 401(k) owners.

A non-spouse beneficiary (often a child) of an IRA or 401(k) had the ability to inherit the retirement plan and spread the taxes on the inherited account over his or her lifetime prior to the passage of the SECURE Act.  For example’s sake, a 50-year-old child inheriting an IRA from a parent could take minimum distributions based on his or her life expectancy, pay tax on the distribution but allow the remaining IRA balance to continue to grow on a tax-deferred basis.

According to the IRS’ life expectancy table, a 50-year-old has a life expectancy of another 34.2 years.  That means that prior to the SECURE Act becoming law, that 50-year-old would have to take the inherited retirement account balance at the end of the year and divide that total by 34.2 to determine the required distribution from the inherited IRA. 

The next year, the IRA beneficiary would adjust the divisor by subtracting 1 from it.  In this example, the 34.2 would be adjusted to 33.2 (34.2 – 1 = 33.2).  The prior year-end balance would be divided by 33.2 to get the new required distribution for the current year.

In this way, should the beneficiary elect, the inherited IRA could be maintained for their life expectancy.  In this example, to age 84.

That stretch out option is no longer available under the new law.  The SECURE Act mandates that inherited IRA’s, 401(k)’s and Roth IRA’s be totally distributed within 10 years of inheriting them. 

            The SECURE Act makes leaving an heir money in a retirement account far less desirable.  And, it makes Roth conversions that much more attractive for some IRA owners, especially those who plan to pass most of their retirement savings on to a non-spouse beneficiary.

            Alternatively, there is another strategy that may make sense for some IRA owners to consider.  One way to potentially establish a stretch-out like outcome under the new rules would be to establish a Charitable Remainder Trust that would be the beneficiary of the IRA or 401(k) account.  The income beneficiary of the Charitable Remainder Trust would be the IRA beneficiary, typically a child.

Since distributions from a Charitable Remainder Trust are calculated based on the life expectancy of the beneficiary, the equivalent of a stretch out may be able to be established.  This strategy could be combined with a life insurance trust to replace the portion of the IRA going to charity.

Here is a hypothetical example to make the possible outcome clearer:

A 72-year-old female has $1,000,000 in her IRA.  She plans on taking only required minimum distributions and leaving her IRA balance to her only daughter at her death.  Her daughter is presently 47 years old.

Currently, her required minimum distribution will be just under $40,000 and then increases from this point on.  Assuming a 5% growth rate and taking only required minimum distributions, at her death (assuming death at age 90), her IRA balance will be about $834,000.  Under the new law, her daughter will have to distribute and pay taxes on the entire IRA balance within 10 years.  (Note:  If returns other than 5% are realized, the outcome illustrated here could be significantly different.)

What if this 72-year old client decided to establish a charitable remainder trust and name her daughter the income beneficiary?

The daughter, in this hypothetical example would be 65 years of age.  Assuming the charitable remainder trust was established with a 5% payout to the daughter and the assets continued to earn 5% annually, the daughter would receive income of $41,700 annually for as long as she lived.  At her passing, a charity would receive the $834,000 in the trust.

There is no tax on the IRA transfer to the charitable trust on the death of the original IRA owner and no tax on the ultimate distribution to charity.  Only the distributions to the daughter of $41,700 per year would be taxable.

The original 72-year old client could opt to combine this strategy with a life insurance trust in which she purchases a life insurance policy on her life in the amount of $1,000,000.  The annual premium is $25,000.  She pays this using her IRA assets.  This strategy will reduce the ultimate benefit to charity but increase the net benefit to her daughter.

Let’s compare potential outcomes:

Nice potential outcome isn’t it.  The client takes the same income.  Daughter gets a net benefit of nearly double.  And a charity wins that wouldn’t have otherwise received anything.  It’s important to note that the IRA balance at the client’s death is lower using the CRT because the IRA is funding life insurance premiums.  If you’re likely leaving retirement account assets to children, you might want to take a look at this Salvage Your Stretch TM strategy.