Written by: Dan Honsberger, CFP®
On December 20, 2019, the president signed into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
While the most widely publicized changes are to retirement planning, there are wide ranging impacts that should be examined with respect to your financial plan.
One of the key tenets of the legislation was to increase the age at which the owner of a retirement account must take required distributions from a traditional 401(k) or IRA.
- For those born on or before June 30, 1949, the Required Minimum Distribution (RMD) must still be taken by the April following the year one turned 70½.
- For those born on or after July 1, 1949, the RMD can now be delayed to the April following the year one turns 72.
This was a widely praised change that acknowledges that many people are working and living longer, thereby allowing the public to delay taxation on retirement plan distributions.
In a move that brings to mind Newton’s third law of motion (for every action, there is an equal and opposite reaction), Congress inserted additional changes to the tax code that partially offset the lost tax revenue from increasing the RMD age.
The primary impact is to those inheriting retirement accounts on or after January 1st, 2020.
- Previously, in many cases, the beneficiary of an IRA or 401(k) was able to ‘stretch’ the required minimum distributions over their lifetime, with the RMD calculation tied to one’s age and the IRS’ life expectancy tables.
- Now, most non-spouse beneficiaries must fully distribute their inherited IRA within 10 years.
While not an exhaustive list, the following are a number of planning opportunities that can help protect your retirement accounts from taxes, and enable you to keep more of your money.
Strategically Time Distributions from Inherited Retirement Plans
Tax law only requires a minimum amount be distributed from an inherited retirement account – one could fully distribute an inherited IRA or 401(k) at any time. In a situation where the full liquidation of an IRA is a sizeable amount, it may have significant tax consequences, increasing the income paid at higher than normal tax brackets.
One way to reduce the tax impact of inherited IRA distributions is to distribute the account over time, up to 10 years. In a year where you expect to have higher income, you could distribute none or less. And in a year where you expect to have lower income, you could distribute more. This would allow you to “fill up” lower tax brackets and pay less over time than if you fully distributed an account in one year.
Consider a Qualified Charitable Distribution
For those who are charitably inclined, the age at which you can make a charitable distribution from an IRA has remained at 70½. This remains a tax-efficient way to make charitable contributions as you’re distributing funds from a traditional IRA without incurring taxes at ordinary income rates. For those with Required Minimum Distributions, the QCD counts against your required distribution and can lower your tax bill for the current year.
Utilize Roth 401(k) and IRA
The benefit of investing in a traditional 401(k) or IRA is “tax-deferral”, the idea that you can invest money before taxes and allow the funds to compound and grow tax-free until the time in which you distribute funds from the account.
On the flip side, the benefit of investing in a Roth 401(k) or IRA is that you can invest after-tax money, let it compound and grow tax-free, and then ultimately you pay no taxes at the time you distribute funds.
There is an argument to be made that we are in a time period with unusually low tax brackets, especially for high income earners. Without the action of congress, many of the provisions from the Tax Cuts and Jobs Act of 2017 expire in 2025, and could raise taxes on higher income earners.
Roth accounts remove the uncertainty of future tax rates, therefore it’s worth evaluating whether it makes sense to contribute to a Roth account and/or convert traditional IRAs to Roth.
Review Estate Plan
It is common to leave retirement accounts in trust for one’s beneficiaries, say for minors or other beneficiaries deemed not ready to have full control over the inherited assets. It is important to revisit the provisions of one’s will, trust, and beneficiary designations to ensure they take full advantage of current tax law and are not negatively impacted by the SECURE Act changes to inherited retirement accounts.
Take, for example, a trust document that requires a trustee to make minimum distributions from retirement plans, but does not allow the discretion to make other distributions. This may create a situation in which the trustee is required to distribute the account in full in the 10th year after inheritance, probably the least optimal outcome for keeping taxes low.
Open Small Business Retirement Plan after Year-end
Post-SECURE Act, any employer-funded retirement plan can be established up until the due date of the employer’s tax return, including extensions. This allows a business owner to evaluate the level of income generated in the prior year, and utilize retirement plan contributions to reduce their income, and, therefore, their taxes. Popular retirement saving vehicles like Profit Sharing 401(k) plans, Cash Balance Pension plans, and Stock Bonus plans previously had to be established prior to the end of the tax year.
In a situation where a self-employed individual has an extremely successful year, the owner could establish a Solo 401(k) and fully fund the employer contribution (up to $57,000 in 2020), thus making a substantial contribution to their retirement and significantly reducing their taxable income.
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