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FROM LISTENING TO financial talk radio shows, it seems the hot topic these days is the SECURE Act and how it’s hurt the middle class. One caller had $2 million in his IRA, and was worried about the impact of the stretch IRA’s elimination on his children and grandchildren.
What am I missing here? I thought IRAs were a vehicle to help average Americans save for their retirement, not an estate-planning tool. Under the new law, surviving spouses aren’t adversely affected, so that’s not the problem.
Instead, the SECURE Act affects those who want to pass along their IRA’s tax advantages to their children and grandchildren. Got so much money in your retirement accounts that you don’t believe you’ll spend much of it? Yes, the new law is aimed at you—but, no, you aren’t truly middle class. If you want to leave a nice sum to your children and grandchildren, you should be using life insurance or holding investments outside of retirement accounts, not funding an IRA.
On the one hand, we hear about pitiful savings rates, as well as tiny 401(k) and IRA balances. On the other hand, we’re now hearing about the unfairness of cutting off extended tax-deferred savings through multiple generations. For whom is this a problem, except upper-income folks? Me thinks thou doth protest too much.
What’s the worst-case scenario? Some 50-year-old children get to defer taxes for only 10 years after their parents’ death. They then put their largess in a taxable investment account or tax-free bonds and carry on.
Alternatively, to avoid bequeathing a big IRA, the parents might leave a brokerage account funded with large retirement account withdrawals. The children then get taxable account money, with everything income-tax-free, thanks the step-up in cost basis upon death. The way the federal debt is going, paying those income taxes sooner rather than later might be a good thing.
The angst being demonstrated over this issue seems to substantiate the SECURE Act’s intent. Sure, folks could die before they’ve spent much of their retirement accounts and their beneficiaries will lose some tax flexibility when handling a large IRA or 401(k). But I’m guessing the majority of people funding these accounts today aren’t worried about the money they won’t spend.
My advice: Keep calm and carry on—and keep funding those retirement accounts.
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Going Without, Getting Catty and Give Until It Hurts. Follow Dick on Twitter @QuinnsComments.
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Good points. Hadn’t thought about it this way.
Another benefit for the middle class is that there is no complicated required minimum distribution calculation. As long as the money is withdrawn by the 10th year after death, the money can be withdrawn either a little at a time or all at once at the end.
Richard – as always, I enjoy your perspectives. I might suggest Roth converting instead of “leave a brokerage account funded with large retirement account withdrawals”. In both cases, the taxes on the withdrawals are paid upfront and beneficiaries inherit future gains tax free, but the Roth offers the added flexibility that the IRA owner also retains the option to withdraw any future gains tax-free. The Roth then provides insurance against possible longevity or health-care risks, even though the original intention is to pass the uneeded money and gains on to beneficiaries.
Richard, a financial show I listen to spends 99% of their weekly hourly air time on the Secure Act. And the reason why is they want to scare everyone into hiring this financial firm to move their IRAs and retirement accounts into costly trusts, life insurance contracts etc. The ones who benefit the most is this particular financial firm and the insurance companies they work with. Bottom Line: The government gave you the opportunity to save and invest this money with PRE-TAX money. It is only fair that after you (or your heirs) withdraw this money, you pay taxes on this money.
You ask: What am I missing here?
What you are missing is that many people were accumulating wealth with multiple goals in mind, not just retirement income, but also leaving a legacy. Our friends on Capitol Hill just decided to reverse a tax code provision that has been in place for decades.
What you are missing is that Congress confirmed that the tax code is really written in pencil!
What you are missing is that Congress can, without any transition of any kind, reverse prior decisions in which people have relied – with retroactive effect.
For those of us who are preparing for retirement, my suggestion is that you read the article by Laura Saunders in the WSJ from 1/18 – 1/19, titled: The Next Retirement Tax Breaks on the Chopping Block. She indicates that future targets include ending “back door” Roth IRAs, requiring annual payouts from Roth IRAs, limiting the value of deductions for traditional IRAs and 401(k)s, and capping the size of tax-favored retirement plans.
This follows a long history of Congressional decisions that have retroactive effect – the taxation of Social Security benefits, income based premiums on Medicare Part B and Medicare Part D coverage, etc.
People expect that Congress will continue to make such changes in the future – such as adding means testing to Social Security.
Here’s an example: Once upon a time, the Tax Reform Act of 1986 added an excise tax, a surcharge, many in our profession called the “success tax”. Beginning in 1987 any withdrawals from qualified pension plans (all plans, in total) that exceeded $150,000/year faced a 15 percent additional income tax. The $150 thousand figure was left unchanged from 1987 to 1995, then raised to $155 thousand for 1996, and was then indexed for inflation. This 15 percent surtax was itself not deductible against either federal or state income taxes, so it simply added 15 points to a household’s marginal tax rate on pension withdrawals.
Luckily for those of use who are retirement savers and who took less wages because our employer sponsored a defined benefit pension plan, as part of the Taxpayer Relief Act of 1997, Pub.L. 105-34, Section 1073, Congress repealed the excess distribution and excess retirement accumulation tax.
However, you may remember that President Obama’s administration was discussing a cap on retirement savings – https://www.ebri.org/docs/default-source/ebri-press-release/pr1105.pdf?sfvrsn=f2d6292f_0
And, of course, we have the D’s who want to increase estate taxes and institute a wealth tax.
Bottom line, until we somehow limit Congress so that they can no longer pass laws with retroactive impact …
My issue is that they change the rules again. When I started my 401K 35-yrs ago, it was not for the purpose of leaving money. However, I was able to max out my 401K for many years and was making a good money that enabled me to fund a good retirement outside of my 401K. I have yet to touch my 401K. Converting to a Roth IRA is tax prohibitively expensive for me at this time. Ideally, I am going to spend all of that money. Also, if I follow the 4% rule, the principle will still be there. So my plan was to give it to the grandkids when my wife and I die. If I die tomorrow, this would be about $200K per grandchild.
Now if I had the money outside of a 401K, the $200k would not be taxable as an estate or inheritance tax. The limit is $11.58m for the IRS and grandchildren are not subject to the tax in NJ anymore. But now, because they are a direct benenifery, they are tax on the 401K withdraw. From my point of view, they should pay the tax because they wouldn’t have the money anyway if it weren’t for the fact that I died. If I withdrew the money and placed in an outside investment, I would pay the tax and if I live long enough, that is exactly what will happen due to RMD.
I told my financial planner that I am going to give it six months and see what all the “experts” come up with in estate planning. Maybe it is as simple as leaving everything to the estate and have the estate pay the taxes and then passing out the “tax” free inheritances? Who will pay the least amount of taxes, me or the kids? I think me paying the taxes will have a more known affect then guessing how it will affect the grandkids in the future. Maybe it will screw up their taxes or college scholarships by showing a taxable income.
Estate planning was not my goal in saving for retirement, but I owe it to my children and grandchildren to plan how to let them inherit my money in the smartest possible way. So in that sense, if I have money leftover when I died, I should have thought about how to minimize the taxes since I have thought about who I was going to give it to. That is estate planning in a nutshell.