The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was signed into law by President Trump on December 20th of that year. In addition to making it easier for employers to establish retirement plans for their employees and increasing the age at which you have to start taking RMDs (70 ½ to 72), it significantly changed how non-spouse beneficiaries can withdraw the qualified money (Traditional 401(k) and IRA) they inherit. Previously, if a beneficial IRA was established correctly, you had your entire life to withdraw the proceeds. This made the tax bite significantly less onerous! Under the new law, there is no longer a required minimum distribution (RMD); instead you have up to 10 years to withdraw all of the proceeds. This seemingly innocent change will likely cause the beneficiary to pay anywhere between 11 and 24 times more in federal taxes then they would've under the previous rules.
Certainly, it seems more like six years then six months have passed since this was placed into law and, under current circumstances, the ramifications of this law have gone mostly unnoticed. Let's run through a quick case study to illustrate the significance.
The following assumptions were utilized in making the comparison (this is intended for illustration purposes only - consult your tax professional for specifics regarding your situation):
- Inheritance of 1 million dollars coming from a Traditional IRA
- The beneficiary is a 40-year-old single individual with no other taxable income, filing with the standard deduction (the only tax calculated will be as a result of taxable distributions from the inherited IRA)
- The current tax rates/tables were used in determining the tax liability
- The Uniform Lifetime Table - Single Life Expectancy Table was used in determining RMD figures
3 calculations are made:
- RMDs and tax liability pre-SECURE Act
- Two iterations under the current SECURE Act: $1,000,000 is withdrawn the 1st year, or
- 10 equal payments of $100,000 distributed over 10 years
Under the old law, the non-spouse beneficiary would have paid approximately $14,000 in federal income taxes over the first ten years of their inheritance. Under the SECURE Act, the beneficiary will have to pay approximately $330,000 if the entire balance is withdrawn in the 1st year and approximately $151,000 in taxes if the balances are withdrawn over the 10-year timeframe. That is a potential increase of 11 to 24 times in taxes paid by the beneficiary! This change has certainly created the need for a new level of planning.
So, what are the potential solutions?
- Do nothing - not recommended but always an option
- Roth conversion - is your tax liability lower than the beneficiary's?
- Roth or after-tax contributions instead of continuing contributions to the pre-tax 401(k)
- IRA spend down instead of utilizing non-IRA assets for current living expenses
- Shift beneficiaries - is one beneficiary in a lower tax bracket than another?
- Utilize cheaper money to pay the tax - life insurance, hybrid LTC, etc.
There is no simple or clear-cut answer. Everyone's situation will be different, although one thing is certain: the SECURE Act brings with it significant changes to the transfer of wealth and makes it more difficult to lift up the next generation.