On May 23, 2019, the House of Representatives overwhelmingly passed the SECURE Act (Setting Every Community Up for Retirement Enhancement) by a 417-3 margin. The Act includes many provisions intended to expand and preserve retirement savings, improve administration, and a couple small ‘other benefits’. The most important provision to IRA and defined contribution plan (e.g. 401k’s) owners is listed in the last section under the title ‘Revenue Provisions’. This is where the Government, after 45 years of encouraging individuals to save, and establishing the rules in order for investors to make intelligent and prudent decisions, changes the rules and takes back a significant portion of the benefit. Although the Senate has a slightly different version, it’s extremely likely some version of this money grab at the expense of retirement account owners and their families will pass.
The legislation modifies the required minimum distribution rules with respect to a defined contribution plan and IRA balances upon the death of the owner. Basically, distributions to individuals other than the surviving spouse of the employee, or IRA owner (with some exceptions) will be required to be fully distributed by the end of the tenth calendar year following the employee or IRA owner’s death.
The law presently allows for distributions to occur over the beneficiaries’ life expectancy. For example, the life expectancy for an individual at age 40 is 43.6 years, 50 is 34.2 years, 60 is 25.2 years and 70 is 17 years. The ability of the beneficiary to take the distributions over their life is called a ‘stretch IRA’ and is very commonly used by financial and estate planners. The benefit to the family can be life-changing.
Shortening the payout to just 10 years costs the investor in 2 significant ways. First, in the case of a traditional IRA, the benefit of deferring taxes on the gains is shortened. So for decades, the compounding benefit of deferred taxes on investment returns is lost. Even worse, for Roth IRA’s, the tax-free returns on investment are lost during this shortened period. This is like imposing an additional 20% (possibly more) tax on the investment returns for the beneficiary for the period over 10 years. For a 40 -year old this could be 33 years of lost tax-free benefit.
Secondly, since the retirement account must be liquidated faster, the RMD (required minimum distributions) must be higher in each of the 10 years. The additional RMD could be significant and push the individual into a higher marginal tax bracket paying higher rates than planned for or would be achieved under the present rules.
Given how common it is for individuals to have created significant wealth through these tax-advantaged retirement vehicles, the financial impact to those affected by this could be staggering. It is not a stretch to have families with even modest retirement accounts to be disadvantaged by amounts in the millions of dollars.
This is a game-changer as far as retirement and investment planning go. New analysis needs to be done to determine what strategies can be employed to mitigate the damage of the Government’s money grab. For starters, one has to examine what, if any benefit exists in contributing to a traditional IRA, or an unmatched (by employer) contribution to a traditional 401k. The value of a Roth conversion may also be more compelling than before in certain cases.
With all the noise and partisanship that’s going on in Washington these days, this is not something I have seen given any press to. But in this case, our representatives seem to be able to agree that in order to raise significant money for their use it’s okay to raid individual’s retirement accounts and keep it their dirty little secret.
