New legislation is in the works that may have an impact on your financial plan. The SECURE Act – Setting Every Community Up for Retirement Enhancement Act, has passed the House and is currently in the hands of the Senate. While there are several components of this proposal, there are three that I feel will have the greatest impact on individuals and their current financial plans.
Increasing the Required Minimum Distribution Age from 70 ½ to 72
Tax-deferred retirement accounts such as the 401(k), IRA, or 403(b) are designed to have tax-deferred dollars contributed, growing tax-free until they are withdrawn. Upon withdrawal, the funds are taxed as ordinary income. Once you reach age 70 ½, you are required to begin taking required minimum distributions (RMD) out of your account. The proposed legislation pushes the withdrawal starting age to 72. With more individuals working past age 70 and living longer, this delayed requirement may be a beneficial move.
10-year Distribution Rule for Non-Spousal Inherited IRA’s
When a spouse passes away, their retirement accounts can be transferred into the surviving spouse’s retirement accounts. When the surviving spouse passes away, those retirement accounts must be transferred into a new inherited account for the benefit of the non-spousal beneficiary, usually the children or siblings of the deceased. These non-spousal beneficiaries must begin taking distributions on the accounts regardless of if it is a traditional IRA or a tax-free Roth IRA. The traditional tax-deferred IRA distributions will be taxed, but the Inherited Roth IRA remains tax-free but follows the same distribution rules. Currently, this is a great strategy for long term tax-deferred or tax-free growth for the non-spousal beneficiary.
Unfortunately, the proposed changes state that non-spousal retirement accounts must now be fully distributed within 10 years. This can cause significant increases in taxable income and marginal tax rates.
Under the current terms, a $1 million IRA passed on to a 30-year-old child has the potential for long term tax-deferred growth. The 30-year-old non-spousal beneficiary is required to only distribute around 2% of the Inherited IRA in the first year, with subsequent small percentage increases annually. In many cases, the value of the $1 million account would grow beyond what was required to be distributed, allowing for a lifetime of tax-deferred growth. Under the new rules, that 30-year-old non-spousal beneficiary would have to distribute the entire account balance in 10 years, eliminating much of the tax-deferred growth.
Expanded Lifetime Income Options Inside Employer Retirement Plans
In the past, it was common for a company to offer a pension plan that would pay a monthly amount for the rest of the employee’s life, but today those plans are few and far between. Creating a dependable stream of cash flow from your retirement assets is a difficult task, but this proposed change would help alleviate that by making it easier to offer lifetime income options inside of employer-sponsored retirement plans such as 401(k) plans. While increased options are good for individuals, buyer beware. Lifetime income options, such as annuities, are complex and not always the best option for retirees. If lifetime income options are offered in your retirement plan in the future, be sure to review the options with your Financial Advisor before making an irreversible decision.
It is likely that the SECURE Act will be changed prior to passage, if passed at all. One thing is clear, laws and rules change over time. Planning is never a one and done event, it’s an ongoing process that must be reviewed as new information becomes available.
If you have any questions about the SECURE Act and how it may affect you, contact your Soundmark Advisor.
James Nevers,CFP® is a Senior Advisor at Soundmark Wealth Management, LLC. James works closely with physicians, business owners, directors and executives at Amazon, Microsoft, and Boeing, and other successful individuals to help them define their financial goals and implement an ongoing financial planning process.