However, chief among the changes is a provision that affects IRAs or 401(k) accounts left to beneficiaries. As part of their estate planning, people are allowed to pass along whatever is left in their tax-advantaged retirement accounts.
Under current law, if you inherit an IRA or defined contribution plan such as a 401(k) from a non-spouse, you have to take required minimum distributions (RMDs), but you can extend the withdrawals over your lifetime to minimize the tax hit. In the financial and estate planning industry, such a strategy is referred to as a “stretch IRA.” It’s called this because the required minimum distributions in some cases can be stretched out for decades, allowing the funds to continue growing tax-deferred.
But starting this year, the Secure Act imposes a 10-year window to draw down the money. There are no required minimum distributions, but beneficiaries must take all the money that’s left and close the account after a decade. This rule — a revenue raiser — would help offset tax losses due to other changes as a result of the Secure Act. For example, the new law increases the age that a required minimum distribution must start from 70½ to 72. Currently, people reaching 70½ must begin taking RMDs from their Individual Retirement Accounts (IRAs) and workplace retirement plans.
The Wall Street Journal’s editorial board criticized the change that affects stretch IRAs.
“Favorable tax treatment isn’t a holy writ,” the editorial board wrote. “But before saving money over decades in a special account, people need to have faith that future politicians won’t rewrite the rules willy-nilly.”
Financial adviser Philip DeMuth in a post for The Wall Street Journal last July wrote, “Like grave robbers opening King Tut’s tomb, Congress can’t wait to get its hands on America’s retirement-account assets.”
There is nothing wrong with trying to minimize your taxes or the tax bill for your heirs. That’s a smart money move. However, IRAs and 401(k)s weren’t meant to be used as a way to transfer wealth. They were designed to encourage people to save by giving plan participants and/or account holders — not their children or children’s children — a tax break. The loophole created by the law that has allowed beneficiaries to stretch out their tax burden was a bonus, not an entitlement that should never be touched.
The provision affecting stretch IRAs would generate $15.7 billion of revenue, according to the Congressional Research Service.
Brian Graff, the chief executive of the American Retirement Association, argued as much in a post last summer for the National Association of Plan Advisors.
“We have nothing against estate planning and we certainly don’t have anything against anyone trying to reduce their taxes,” Graff wrote. “However, to get the provisions in the Secure Act, which we believe will help improve the retirement security of millions of Americans, Congress decided it was necessary for the legislation to be revenue-neutral. Ultimately, we have concluded that the enormous potential benefits of the legislation for retirement savings outweigh the ‘pain.’”
In an interview, Graff also pointed out that the stretch IRA estate planning strategy isn’t widely used by most Americans.
“Only a certain class of people have that much money to give to their grandchildren and children,” he said. “The policy basis for why Congress made this change was that we should give a tax benefit to people who are saving for retirement.”
Aron Szapiro, the director of policy research at Morningstar, also doesn’t see a problem with the new rule for inherited IRAs.
“I don’t see this is as an unreasonable thing to do,” Szapiro said. “These accounts were not designed to be large intergenerational tax avoidance vehicles.”
With change often comes confusion. For example, the Secure Act carves out exceptions to the stretch IRAs:
— The surviving spouse of the employee.
— A child of the employee who has not reached the age of majority.
— A disabled individual.
— A chronically ill individual.
— An individual who is not more than 10 years younger than the employee who died.
Here’s a question from a reader about her inherited IRA as it relates to the exceptions.
Q: I'm a 64-year-old woman, and have been dealing with advanced, recurrent ovarian cancer. My long-term prognosis is not great. It's a pretty good bet that my healthy 83-year-old mother, who struggles to get by on Social Security, will outlive me, perhaps by a decade or more. My mother and my boyfriend (age 59) are currently my IRA beneficiaries. With the new law, can my mother and boyfriend still inherit my IRAs, and take RMDs, stretched out over their own life expectancies? Or, must they empty the IRA within 10 years as the new law states?
A: Christine Russell, senior manager of retirement and annuities at TD Ameritrade.
One of the most significant changes resulting from the Secure Act is the elimination of the “stretch” provision for most non-spouse beneficiaries of inherited IRAs. Previously, for non-spouse beneficiaries, the stretch provision meant they could take distributions over their life expectancy. Now, for retirement account owners who pass away in 2020 and later, most non-spouse beneficiaries have 10 years to drain the account. This could be the case for older beneficiaries such as the healthy 83-year old mother unless she meets one of the below exceptions.
There are exceptions to the Secure Act’s new 10-year rule for certain non-spouse “eligible designated beneficiaries” including: a beneficiary no more than 10 years younger than the deceased account owner, and a beneficiary who meets the definition of disabled or chronically ill under the Internal Revenue Code. These eligible designated beneficiaries will still be able to take IRA distributions over their life expectancies. In this situation, it sounds like the 59-year-old boyfriend may be considered an eligible designated beneficiary, based on the information provided. Thus, he may be able to take distributions from the inherited IRA based on his life expectancy.
The exceptions — and the other new provisions of the Secure Act — require careful analysis, so we strongly suggest the reader should consult with a tax professional. This is not intended as tax advice. This answer assumes that the reader’s mother and boyfriend are primary (and not contingent) beneficiaries of her IRA accounts. It also assumes that the beneficiaries claim the IRA account on a timely basis after the death occurs. It is important to note that this information is based on the law as passed Dec. 20, 2019. It is common to get additional regulations from the IRS after a law is passed and these IRS Regulations may further clarify or modify the information provided herein.
Reader Question of the Week
If you have a retirement question send it to email@example.com. In the subject line put “Question of the Week.”
Q: How would my Social Security be impacted if I moved to Nova Scotia and purchased some land.
A: “If you are a U.S. citizen, you may continue to receive payments outside the United States as long as you are eligible for payment and you are in a country where we can send payments,” the Social Security Administration (SSA) says. “When we say you are ‘outside the United States,’ we mean you are not in one of the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Guam, the Northern Mariana Islands, or American Samoa for at least 30 days in a row. We consider you to be ‘outside the United States’ until you return and stay in the United States for at least 30 days in a row.”
If you need more information you should read the SSAs publication: Your Payments While You Are Outside the United States.
There is an exception to receiving your money. The Treasury Department prohibits making payments to people residing in Cuba or North Korea. “If you are a U.S. citizen residing in Cuba or North Korea, you can get all the payments we withhold once you move to a country where we can send payments,” the agency says.
Here’s something else of interest. Your benefits are calculated in U.S. dollars. The SSA does not increase or decrease your benefits based on international exchange rates.
Please join me at noon (Eastern time) next week (Jan. 9) for the first live chat of 2020. I’ll be taking questions about your money.
I’m live every Thursday from noon to 1 p.m. (Eastern time).
Retirement Rants and Raves
Your Thoughts: How do you feel about the change in the treatment of inherited IRAs in the Secure Act?
I’m also interested in your experiences or concerns about retirement or aging. You can rant or rave. Send your comments to firstname.lastname@example.org. Please include your name, city and state. In the subject line put “Retirement Rants and Raves.”
Mary McQueen from Charlotte ranted about the inherited IRA change in the Secure Act.
“I believe there are some good aspects to the Secure Act however I am very upset with the change affecting non-spousal inherited IRAs,” she wrote. “While my husband and I worked we contributed to employer sponsored 401(k)s. For years we believed that after we passed, any remaining money in these IRAs would pass to our beneficiaries allowing them the opportunity to access the funds throughout their lifetimes, if they chose, through ‘the stretch.’ Several years ago I inherited a modest IRA from my father which I set up as an inherited IRA and I have been taking the RMDs each year. The account has grown beyond the initial amount even after withdrawing the RMDs. I am proud of my parents’ financial planning which benefited them in their retirement years and feel fortunate that they were able to pass a financial legacy on to me. It angers me that our children, who are our beneficiaries, will be required to empty their inherited IRAs within 10 years, resulting in higher taxes. Our plan and hope was to provide for our children financially after our deaths without creating a burdensome tax situation for them. Unfortunately the rules changed that.”
Romayne from the District wanted to rave about the benefits of saving early and often for retirement. “Since I started my career immediately after graduating from college, I have been working and contributing to my employer’s 401(k) plan. I have a friend who worked for a company in Richmond, VA who contributed the maximum percentage to her 401(k). [She] is apart of the 401(k) millionaire club. So it is achievable. I started off small, contributing what I could, and increased my contribution percentage whenever I got a raise. I understand that contributing to a 401(k) plan can be rough. It is additional money leaving our paychecks, but it is so beneficial to contribute something to help achieve future financial freedom.”