March 30, 2020
By: Marshall K. Brown
The SECURE Act is a law affecting Individual Retirement Accounts (IRAs) and other retirement plans which Congress passed with rare bipartisan support. The House passed it last spring and the Senate added it to a budget bill in December 2019. Like all so-called “revenue neutral” tax legislation, the SECURE Act gives and takes.
One beneficial change in the SECURE Act is the extension of the beginning date for Required Minimum Distributions (RMDs) from the year in which one reaches the age of 70 ½ to the year in which one reaches the age of 72. An RMD is the amount which an IRA owner must take annually as a distribution from a traditional IRA.
The concept of IRAs is that workers who receive a tax deduction for saving and tax deferral on the earnings benefit from lower tax rates at retirement age. RMDs are supposed to ensure that the treasury collects that tax. There are problems with that concept. First, taxpayers may be better able to pay the taxes during their earning years than they are in their retirement years. And, the RMDs may exhaust their IRAs if the IRA owner outlives their life expectancy.
Roth IRAs may help with these problems in that Roth IRAs, while not deductible when established, are not taxable when distributed. Further, there are no required minimum distributions from Roth IRAs (and a tax break on the Roth income). However, there are income limits on Roth contributions so they may not benefit higher income taxpayers.
Prior to the SECURE Act, taxpayers could no longer make any contributions to traditional IRAs beginning in the year in which they became 70 ½ years of age. Now the age limitation is completely removed. To make any IRA contribution, a taxpayer must have earned income (wages or self-employment income) in at least the amount of the contribution.
If the IRA owner or his or her spouse are active participants in another retirement plan, the deductibility of the contribution is subject to income limitations. Even nondeductible contributions are beneficial, because all earnings on the non-deductible IRA are tax deferred. Further, the nondeductible distributions create basis so that the beneficiary recognizes less income on withdrawals (or conversions to Roth IRAs).
To offset the expected revenue loss from allowing the longer tax deferrals for traditional IRAs, the SECURE Act limited the period in which an inherited IRA can be held. Prior to 2020, the beneficiary of an inherited IRA could elect to take distributions over the beneficiary’s life expectancy. This extended the tax-deferral and asset protection of IRAs for another generation.
The SECURE Act limits the period of distribution for an inherited IRA to ten years from the original owner’s date of death. This rule does not apply to a spouse, minor child, or another beneficiary who is less than ten years younger than the decedent owner. Because of this change, beneficiary designations and estate planning documents which refer to plan distributions should be reviewed. Charitable gifts should be made from IRAs where possible, and a bequest of an IRA to a charity could indirectly save income tax to other beneficiaries.
During the 2008-2009 recession, the RMD requirement was suspended so that owners need not withdraw funds from IRAs, which were depleted by the market crash. Also, a 2-year tax deferral was enacted making it cheaper to convert traditional IRAs to Roth IRAs. It might be wise to delay any withdrawals pending any new tax changes later this year.
In an emergency, IRA beneficiaries can write themselves an interest and tax-free loan by 60-day rollover from a traditional IRA but remember, there absolutely no rollovers allowed from an inherited IRA.
“The full name of the SECURE Act is “Setting Every Community Up for Retirement Enhancement Act of 2019.” Let’s hope so!