The SECURE Act was passed a couple of weeks ago and we now know what it’s implications are.
The big thing that everyone is talking about is that it eliminates the lifetime stretch provision for non-spouse beneficiaries of IRA’s, 201(k)’s, and Roth IRA’s. Now, if you’re leaving your IRA to a non-spouse beneficiary like a child, they will have to realize it as income over the following ten years.
If your child will inherit your IRA, they will probably do so when they are at the apex of their earning years. The question is if this happens 20 years from now, will tax rates be higher or lower than they are today? That money will be piled on top of all their other income and they will be taxed at their marginal income.
This is a backdoor tax increase. This is a money grab by the IRS unless you do something about it.
This even applies to Roth IRA’s. If that money gets distributed over the next ten years, it will probably end up in a taxable account that the IRS will start earning money on.
If you have an IRA, you need to ask yourself if you will have significant amounts of money in those accounts at the end of your life and might they go to a non-spouse beneficiary.
This underscores the importance of doing Roth conversions during your lifetime. If you have a large IRA and plan on leaving it to the next generation, you need to consider what taxes will look like in the future.
There has been a new estimate that the SECURE Act will generate $15.7 billion in tax revenue over the next decade. The implications for retirees will be largely positive, but the heart of the law is about forcing people to pay higher taxes in the short term.
When these beneficiaries inherit these accounts, they will be forced to realize the income whether they need it or not. Once they pay the taxes, they will have to put the money somewhere and the question will be where do they put it. Traditional tax-free options like a Roth IRA are too prohibitive so it will likely end up in the taxable bucket, where the IRA will benefit once again.
This is where the L.I.R.P. comes into play. It’s an optional place to put the money that comes with a number of additional benefits.
This makes an even more compelling case for people who were still on the fence. They now also have to consider if they want their beneficiaries paying up to half the inheritance in taxes.
This is an opportunity to start doing some tax planning, we still have six years to stretch out our tax liabilities if we act now.
The other big change coming with the SECURE Act is the required minimum distribution age going from 70½ to 72. 80% of Americans with RMD’s are taking more than they need to anyways so this won’t impact them too much.
The last change allows people to do backdoor Roth conversions after the age of 70½.
The big question that people now have to ask themselves is “do you think you will have money left over in your IRA when you die?” Because if you will, do you really want to have scrimped and saved for your entire life only to have your beneficiaries pay half the amount in taxes?
We need to be taking advantage of the next six years. Don’t wait to only pay taxes at much higher rates because at that point, the sale will be over.