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Does Uncle Sam Want to Tap Your Retirement Savings?

Yes, thanks to the SECURE Act.

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With the constant and unpre- dictable ups and downs of the stock market, it can be difficult (at best) to feel like your retirement savings

are stable. But you may soon have even more reason to be concerned about your retirement nest egg.

This comes by way of the pending SECURE Act, which was recently drafted to address the difficulty that Americans are having with saving and investing for retire- ment. A recent study showed that one in three Americans have less than $5,000 in retirement savings, and that one in five Americans have no retirement savings at all.

On top of that, given that life expectancy is much longer than it was just a few decades ago, retirees must make their savings last for around 20 years or more once they’ve entered retirement. That can prove to be a challenge, especially after accounting for future inflation.

In order to provide more flexibility to retirement savers, and to reduce some of the penalties that investors face with regard to contributing and accessing funds in their retirement plans, the SECURE Act has been introduced in Congress.

But taking a closer look at this bill shows that its biggest beneficiary could be Uncle Sam!

What the SECURE Act Could Mean for You

The Setting Every Community Up for Retirement Enhancement (or SECURE) Act is a bipartisan bill that is designed to help Americans save for retirement in a number of different ways, such as:

• Providing tax credits and protections on collective Multiple Employer Plans, which will make it easier for small businesses to offer their employees 401(k) retirement savings plans;

• Making long-term, part-time employees eligible for retirement benefits;

• Doing away with the maximum age limit of 701/2 for making contributions into certain types of retirement plans (such as 401(k)s and traditional IRAs);

• Increasing the required minimum-distribution age from 701/2 to 72 on certain retirement plans (again, 401(k)s and traditional IRAs);

• Allowing retirement-plan participants to make withdrawals of up to $5,000 penalty-free when they have or adopt a child;

• Allowing penalty-free withdrawals of up to $10,000 from 529 college savings plans if the money is used to repay certain types of student loans;

• Relaxing the rules on companies that offer annuities via sponsored retirement plans; and

• Revising certain areas of the Tax Cuts and Jobs Act that raised taxes on bene- fits that are received by family members of a deceased veteran, as well as from a student and some Native Americans.

While the SECURE Act is not yet law, the bill has passed the House of Representatives in a 417 to 3 vote. And although components of the SECURE Act could be beneficial to some investors, it may not be as ideal as it initially seems.

Under current tax law, funds that are in- vested in traditional IRAs, as well as in many other types of employer-sponsored retirement plans, are allowed to grow tax-deferred. This means that there is no tax due on the gain each year, which can allow these savings to grow and compound faster than they could in a tax- able account.

Currently, if an IRA owner passes away without having spent all of the money in the account, it is possible for another individual such as a spouse or child to inherit that ac- count and to “stretch out” the mandatory distributions (based on the younger beneficiary’s life expectancy).

Likewise, non-spousal beneficiaries (regardless of their age) must take required minimum distributions (RMDs) that are based on their own life expectancy. So the younger the beneficiary is, the lower the required minimum distribution will be. In turn, this “stretching” can allow more funds in the IRA to continue growing over time.

Under the proposed SECURE Act, it is possible that any IRA account that has a balance of $400,000 or more when inherited by a beneficiary will have to be distributed—and in turn, taxed—within ten years of the passing of the initial IRA owner.

So, what exactly does this mean for IRA beneficiaries?

It means that his or her tax liability will most likely increase substantially on these mandatory withdrawals. For example, if the 55-year-old child of a traditional IRA owner inherits his mother’s $1 million IRA, under the current law, he or she could “stretch” out the distributions (and the accompanying taxation) for almost 30 years (based on his life expectancy). That would help the IRA nest egg continue to grow, and the taxes due would be lower, due to the smaller annual withdrawals based on the child’s life-expectancy calculation.

But under the proposed SECURE Act, any IRA account balance that is over $400,000 (which in this example is $600,000) would have to be withdrawn within ten years. Given the much shorter period of time, the IRA beneficiary’s income-tax liability would increase substantially because the beneficiary would be required to take a much larger annual distribution.

Taking More Control of Your Money

Although this proposed legislation is still be- ing debated, now would be the time to consider how to prepare and plan ahead, should this law come into effect. This starts by working with an experienced financial professional.

Due in large part to the non-spouse beneficiary rules for inherited IRAs and other retirement savings vehicles, making sure that all accounts are properly set up is even more important for those in the LGBTQ community. Otherwise, you could run the risk of letting Uncle Sam take an even larger percentage of your loved one’s savings.

This article appears in the September 2019 edition of OutSmart magazine. 

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Grace S. Yung

Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the September 2017 issue of Texas Monthly.

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