An Unkind Act

Adam M. Grossman

AS IF ON CUE, Ebenezer Scrooge recently showed up in Washington, DC. The result wasn’t pretty.

A bill known as the SECURE Act, a favorite of the insurance industry, had been stuck in Congress all year. But suddenly, on Dec. 20, it got tacked onto another bill and signed into law. As far as I can tell, the primary beneficiaries of this new law, which heavily impacts retirement plans, will be the IRS and the insurance industry—but probably not you.

It’s the holiday season, though, so I’ll start with the few positive aspects of the law. The biggest benefit is a change to the rule governing required minimum distributions (RMDs) from retirement accounts. Under current law, if you have an IRA, 401(k) or other tax-deferred retirement account, you must begin making withdrawals in the year that you turn age 70½—or the year after, at the very latest. Because these withdrawals are subject to income tax, and because they increase as you get older, RMDs are loathed by many retirees. Fortunately, the new rules provide some relief: 70½ has become 72.

This new RMD rule is paired with another potential benefit for those in their 70s: Under 2019’s rules, even if you’re still working beyond 70½, you’re no longer permitted to make IRA contributions. This restriction has deprived many workers of a convenient savings vehicle and the associated tax deduction. The SECURE Act removes this age cap, allowing workers of any age to continue making IRA contributions.

But that’s where the good news ends. At first glance, making additional IRA contributions seems like a good thing. But what the government is giving with one hand, it’s taking with the other—and much more significantly.

Under current rules, if your children inherit your retirement account, they are subject to required minimum distributions, but on a very modest schedule. If you inherit an IRA and you are age 50, for example, you are required to withdraw just 2.9% of the balance in that year. Even at age 65, the RMD percentage is just 4.8%. This is important because inheritances tend to arrive during children’s peak earning years—when additional taxable income is typically both unnecessary and unwelcome. That’s why the current rules, which permit very modest distributions, are so attractive.

As of Jan. 1, 2020, all this changes. Under the new rules, children inheriting retirement accounts will have to withdraw the entire balance within 10 years. Fortunately, with some planning, you can mitigate the impact of the new rules. Here are five steps to consider in the coming months:

1. Don’t panic. While I don’t like the new rules, the first thing I’d do is run the numbers. The impact may not be so bad. For example, suppose you leave a $1 million IRA to your children. If you have three children, that’s $333,000 each. Even under the new rules, if they spread the withdrawals evenly over 10 years, that would be $33,000 per year. Yes, that’s far more than the old rules require, but hardly catastrophic.

2. Asset allocation. Ideally, under the new rules, you’ll want your IRA to be the slowest-growing portion of your overall assets. To some extent, you can control this with asset allocation. In other words, if you’re going to own bonds, you might own them in your traditional IRA, while holding stocks in other accounts.

3. Roth conversions. These can be very attractive during the period between when you retire and age 72—years when your income, and thus your tax rate, are unusually low. For many, the new rules make this strategy even more attractive. Since Roth withdrawals are tax-free, they can help your heirs sidestep the tax bite of the new 10-year rule. If you think your tax rate during the early years of your retirement will be lower than your children’s, this could make a lot of sense. To the extent that you aren’t sure, remember that you can do partial Roth conversions. It isn’t all-or-nothing.

4. Charitable contributions. You can satisfy your own RMD, and reduce your heirs’ future RMDs, by making qualified charitable distributions directly from your IRA. If you have charitable intentions, this has always been a useful strategy. But under the new rules, you may want to make it more of a priority.

5. Beneficiary designations. Be sure to review the beneficiary designations on each of your retirement accounts. Assuming you have named your children, I’d make sure the “per stirpes” option is selected. When the time comes, this will give your children the option of disclaiming their inheritance—either partially or entirely—thus allowing that portion to flow through to their own children. This entails its own set of considerations. But fortunately, you don’t have to worry about that. As long as you have the right beneficiary structure in place, your children can each make their own decision after your death.

Adam M. Grossman’s previous articles include The REIT StuffCandy Land and Owning Oddities. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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