"The Good, The Bad, and The Ugly" of The Secure Act of 2020
Chairman's Blog: SECURE Act
What you need to know now in order to protect your retirement plan assets from this latest government grab.
Call me a skeptic, but whenever the government passes legislation that is meant to help me, my antennas go up. In my mind’s eye, I picture two men in black suits carrying large briefcases at my door announcing, “we're from the IRS and we are here to help you!” Sure they are. However nothing is for free. This is certainly the case for the brand new SECURE Act (Setting Every Community Up for Retirement Enhancement Act).
Signed into law in December 2019 with an effective date of January 1, 2020 SECURE makes sweeping changes to the U.S. retirement system. In a world where guaranteed pensions are a thing of the past for most workers SECURE will be very beneficial. SECURE works to expand everyone’s access to retirement plans that are flexible and less expensive through their employer. But what about current retirement plan participants? How will they be affected by SECURE?
SECURE has 29 different provisions. The following three provisions are the most relevant for University Retirement Plan participants and IRA owners. These are the provisions that are most likely to change how financial and estate planning is navigated going forward.
First, the Good.
Under SECURE, the initiations for Required Minimum Distributions (RMDs) changes from age 70.5 to age 72. Under prior law RMDs began at age 70.5. This meant that the balance in one’s IRA began to decrease over time leaving less money to compound tax deferred into the future. With people living and working longer, pushing the RMD age to 72 makes a lot of sense. Retirement plan assets will be able to grow at compounded interest rates, with income tax deferred for a longer period than under current law. This is a meaningful benefit.
Now, the Bad.
SECURE eliminates “Stretch IRAs”. Under prior law spouse A could leave at their death an IRA/retirement plan to the surviving spouse B. At spouse B’s death, the remaining balance in the account could be passed on to the couple’s children or grandchildren, who could then take their distribution over their own life expectancies. This “Stretch IRA” greatly minimized the income tax obligation of the child/grandchild heir. The stream of income under the prior law in many cases did not move the child/ grandchild into a higher marginal income tax bracket. Now, under SECURE (with a few exceptions) the ability to “stretch” out the income tax over the life expectancy of a child/grandchild beneficiary is no longer possible.
Now, under SECURE, the child/grandchild beneficiaries of an IRA will need to drain the account and pay income tax on the distributions spread over 10 years, not a lifetime. This will cause much larger distributions of assets subject to income tax during what may be peak earning years of the beneficiary. While not a tax increase, this modification in the rule is certainly a “tax accelerator”. The primary beneficiary of this rule change is the U.S. Government. An estimated $15 billion in tax revenue is expected to be raised in the first decade from this alteration alone.
And the Ugly.
Under prior law, various estate planning strategies were implemented by plan participants to protect IRA and retirement plan assets from the claims of creditors. For example, if a child beneficiary of an IRA who was going through a divorce, or if an IRA owner had concerns that a child beneficiary because of age or ability could not manage a large distribution, protections were put into place to alleviate that concern. SECURE puts these plans in jeopardy.
SECURE requires that inherited IRAs be totally emptied within 10 years. This means that in addition to paying substantially more in income taxes, child/grandchild beneficiaries will now have complete access to large sums of money that could be subject to the claims of creditors or mismanaged for a multitude of reasons. This major modification in the rules of distributions for inherited IRAs is a real game changer and necessitates a review of estate planning documents for all IRA owners.
University retirement plans and IRAs are great ways to accumulate assets. Pre-income tax contributions fund these plans and are allowed to grow income tax deferred. However, supporters of SECURE, including representative Kevin Brady of Texas, the top Republican in the House Ways and Means Committee have said that tax-favored funds should be used mainly for the owner and the spouse’s retirement security. In August 2019 Representative Brady said, “They are not wealth succession management tools.”
That statement is no surprise to any financial advisor. What’s concerning is the changing of the rules in the 9th inning for current retirement plan participants and IRA owners. But, as with much of recent legislation, what the government gives with one hand, it takes away with the other. This certainly begs the question, under the new law, who is really more SECURE?
Michael J. Filbrandt, CLU, ChFC
Chairman of the Board