On January 1, 2020, some significant new rules for retirement savings accounts went into effect. The Setting Every Community Up for Retirement Enhancement (SECURE) Act is the most sweeping legislative change to our retirement system in over a decade. With the goal of boosting retirement savings across the country, the SECURE Act provides some nice incentives for investors. But where Uncle Sam gives, he oftentimes takes away as well.
In fact, some of the components of the SECURE Act can be particularly detrimental to the LGBTQ community, especially those who have listed someone other than a spouse as a beneficiary on their Traditional IRA or other retirement plan.
Here’s an overview of the SECURE Act, along with details on how you or your loved ones may be impacted and some ideas on what you can do now.
Keep Saving beyond Age 70
Given that the average U.S. savings rate is an abysmal 7.9 percent (as of late 2019), the SECURE Act is aimed at easing the nation’s looming retirement crisis. With a whole host of obstacles like market volatility, low-interest rates, inflation, and longevity, one of the top worries on the minds of both retirees and those who are approaching retirement is running out of money while it’s still needed.
But the SECURE Act includes several provisions that could help, such as:
- Allowing investors to continue making contributions to Traditional IRAs and retirement plans indefinitely. Previously, those over the age of 70½ were required to stop contributing.
- Increasing the required minimum distribution (RMD) age on traditional retirement plans from 70½ to 72, which can allow funds in the account(s) to keep growing tax-deferred for a while longer. (As it currently stands, an individual who turned 70½ in 2019 will still have to take their RMD in 2019 and 2020, even though they may not turn 72 until 2021. Those who turn 70½ in the year 2020, however, will not be required to take their RMD until they reach age 72, which could be in 2021 or 2022.)
- Allowing longer-term part-time employees to participate in employer-sponsored retirement plans.
- Letting workers take withdrawals of up to $5,000 penalty-free from retirement plans for the birth or adoption of a child.
- Allowing penalty-free withdrawals of up to $10,000 from 529 college savings plans to help repay student loans.
- Allowing taxpayers with high medical bills to deduct unreimbursed medical expenses that exceed 7.5 percent of their adjusted gross income (in 2019 and 2020). Funds may also be accessed penalty-free from IRAs and qualified retirement plans to cover costs that exceed this threshold.
Simplified Savings Plans for Businesses
If you own (or you are employed by) a small company, the SECURE Act will make it easier and less costly to set up and administer “safe harbor” retirement plans such as a 401(k).
Businesses can also offer lifetime income annuities within their retirement plans, which allows employees to plan for an ongoing, predictable income stream in retirement. Similarly, if an employer-sponsored retirement plan is discontinued, participants may directly transfer their annuity (as well as other lifetime-income investments) penalty-free to another retirement plan.
A Significant SECURE Drawback
While the SECURE Act definitely offers some enticing features, there is one area that can place a significant amount of your hard-earned retirement savings directly into Uncle Sam’s pocket. That is due to the elimination of the “stretch” IRA.
Previously, when Traditional IRA funds were inherited by a non-spouse beneficiary, the recipient was allowed to take withdrawals over a long period of time, based on his or her life expectancy. This, in turn, helped to ease the tax burden—especially for younger beneficiaries whose withdrawals could be spread out for many years or even decades (thus the term “stretch IRA”).
Following the passage of the SECURE Act, though, non-spouse beneficiaries who are more than ten years younger than the deceased account holder must liquidate the entire account within ten years of the account owner’s death (unless the non-spouse beneficiary is disabled, chronically ill, or a minor child). This can result in a significant tax burden for those who stand to inherit high-value Traditional IRAs.
It is important to note that for anyone who passed away in the year 2019, their beneficiary may still “stretch” his or her beneficiary IRA. However, if someone passes away in 2020 or thereafter, their beneficiaries (other than a surviving spouse who is not more than 10 years younger than the original account holder) must withdraw the entire amount of the account within the 10-year time period. This shorter withdrawal window will of course increase taxes owed, due to the need for larger accelerated distributions.
Given this new rule, estate planning will change for many people. With that in mind, many in the LGBTQ community who are on the fence about whether or not to get married may want to take this into consideration.
Keeping Your Savings Out of Uncle Sam’s Pocket
There are some things you can do now to help protect your beneficiaries from a heavier tax burden on any IRA accounts they inherit from you. One solution is to reconsider who you have listed as your beneficiaries. (This may not be the best option if someone is counting on those funds for their ongoing living expenses if you should predecease them.)
Another alternative could be to transfer some, or even all, of your Traditional IRA funds into a Roth IRA, which may be inherited tax-free. Even if your income exceeds the maximum limit for being Roth IRA-eligible, there are still strategies available (such as a “back door” Roth IRA) for taking advantage of this type of account. Although this type of transfer may result in a taxable event now, the tax-free accessing of funds from a Roth IRA could allow for a much higher net benefit in the future.
The new SECURE Act regulations can make both Roth IRAs and life insurance more attractive. That’s because both of these financial vehicles can allow for tax-free access to funds, regardless of what the income-tax rates are.
In some cases, then, it could even make sense to use funds from a Traditional IRA (earmarked for contributions or RMDs) to fund a life insurance policy that, in turn, will eventually pay out tax-free and/or “living” benefits.
Before you take any action, though, it is recommended that you consult with a qualified Certified Financial Planner (CFP) who is well-versed in asset protection as well as tax-efficient planning. In addition, a financial professional who specializes in working with LGBTQ individuals and couples can help to better ensure that your plan meets your specific needs and objectives.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax-free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59½ or prior to the account being opened for five years, whichever is later, may result in a 10 percent IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
This article appears in the February 2020 edition of OutSmart magazine.