The SECURE Act's Impact on Financial Planning
Major legislative changes to our tax and retirement system typically occur once every decade or so. In 2017 the Tax Cuts and Jobs Act (TCJA) significantly changed many of our tax laws and planning opportunities. Then, last month, just two years after the TCJA was passed, congress passed the SECURE Act, bringing additional changes to our tax and retirement system.
There were many changes—some significant, some not. Below are the ones we think are most relevant for our clients.
Required Minimum Distributions (RMDs) have been pushed back from age 70.5 to 72
It was always unnecessarily confusing to base retirement plan distributions on one’s half-birthday, so this is a welcome change due to its improved simplicity alone. However, this will also be financially beneficial to most of our clients because it allows for an additional 1-2 years of tax deferral.
For many this change will also lower taxable income during these additional “gap years” thereby creating an opportunity for partial Roth conversions during these years. Partial Roth conversions accelerate the recognition of income, but if doing so results in a lower tax rate it can be advantageous over one’s lifetime. It also has the benefit of reducing future RMDs.
Qualified Charitable Distributions (QCDs) which allow IRA distributions to be made directly to charities and excluded from income are still allowable starting at age 70.5. Once reaching age 72, QCDs are not only excluded from income but also count toward fulfilling RMDs. For those with charitable intent who are over 70.5 but under 72, QCDs will still make sense in most cases.
Elimination of “Stretch” IRAs for beneficiaries
Previously, the beneficiary of an IRA or other retirement plan had the ability to stretch out distributions over their lifetime. Naming adult children or a trust with “see-through” provisions as the beneficiary of an IRA was not only an estate planning strategy, but also efficient from the income tax perspective of the beneficiary.
With the passage of the SECURE Act, most non-spouse beneficiaries will no longer be able to stretch distributions over their lifetime and instead will have to fully distribute the account 10 years after the account owner dies. Notably there are no year-by-year required distributions, only that it be fully distributed by the end of the 10th year following the death of the account owner. This means the beneficiary will have some flexibility as to timing, but it’ll be important to be strategic from the beginning, otherwise there could be a large tax hit in the tenth year.
This change makes the consideration of Roth conversions even more important for multi-generational planning. In addition to evaluating the account owners current vs. future tax rates, it’ll be imperative to also consider the income tax rates of the future beneficiary. Both traditional and Roth IRAs must be distributed within 10 years under the new rules, however a beneficiary who inherits a traditional IRA during their peak earning years could pay a much higher tax rate than the original account owner would have if they can converted to a Roth during their lifetime. These will be case-by-case strategies but significant opportunities could exist
529 Plans can be used to pay off student loans
Under provisions in the SECURE Act, 529 plans may now be used to repay the principal and interest on student loans up to $10,000 (lifetime max per beneficiary). While this is an exciting development for some, it’s important to note that not all states currently conform to the federal laws around 529 plans. Over the coming weeks and months it should become clear which states will go along with this.