The SECURE Act and the End of the “Stretch” IRA

By the end of 2019, our president is expected to sign into law something called the SECURE Act. This will change the way all Americans will handle accounts like IRAs and 401k plans into retirement and after death.

Most people with these types of plans know that they must begin taking distributions in the year which they turn 70 1/2 years old. That age has been raised to 72. By and large that is a good thing, and the SECURE Act will have a negligible impact.

Who will be affected by the SECURE Act?

The heirs of retirees are the ones who will feel the pain of this law.

It’s not unusual for us to see clients with between $1 and $5 million in retirement plan assets. For most affluent members of the upper middle class, the 401k or its cousin the IRA represent the bulk of their liquid assets. For retirees who pass away with large balances, their heirs have been able to draw down these assets over the rest of their lives. This has been referred to as the “Stretch IRA.” It worked by spreading the income and thus the tax burden over a long period at most likely a low effective tax rate.

Those days are over.

How will the SECURE Act change tax rates?

For retirees who die in 2020 or later, their heirs must withdraw those assets over no more than 10 years.  The law is odd in that it does not specify any more exact time frame. For example, the money could be withdrawn evenly over that period or all of it could come out in year 10. NOTE: that would be a bad idea.

The SECURE Act requires withdrawing assets in a more compressed period. This will likely to push heirs into higher marginal tax rates for those distributions. Retirement plan distributions are considered ordinary income, NOT capital gain. They are subject to escalating tax rates as income increases.

To cite one example, imagine a retiree with a $2 million IRA who leaves it to a single heir. That person could withdraw $200,000 per year. I’ll ignore growth for sake of illustration. At $200,000 per year, a married couple already making $250,000 in taxable income jumps from the 24% to the 32% marginal rate on that distribution. Under the old rules, if that heir was 60 years old in the first year she would only have to distribute about $80,000 and would still be at the 24% tax rate.

What does this mean for planning?

We see two likely impacts. First, it will make the idea of Roth conversions during lifetime more appealing in some cases. Distributions from Roth IRAs are always tax free if you meet the other requirements, which most do. This rule will have much less impact on Roth accounts than taxable ones. Second, it makes the case even stronger for fulfilling charitable intent from the IRA instead of other assets at death.

If nothing else, it’s a good excuse to haul out your estate plan in the new year and check your beneficiary designations. You and your financial planner will want to think about the impact of the new law during your retirement and beyond.