If you are part of the 36.1 million US households that have a traditional Individual Retirement Account, a recent change in the law will affect you.
The Setting Every Community Up for Retirement Enhancement Act was passed in December and has made some notable changes to the laws governing your IRA, especially as it relates to your retirement and your heirs’ inheritance. Here are the three main ways the SECURE Act could affect you:
- You can contribute longer. Previously, you were only allowed to contribute to an IRA in years when you earned income and were under age 70. Under the new law, though, you can continue contributing to your IRA as long as you have earned income, regardless of your age.
As Americans remain in the workplace longer and longer, this presents an additional opportunity for tax savings for older workers. There are several factors to consider, though, so if you are over age 70 and have earned income in 2020, make sure to consult your tax advisor to determine if an IRA contribution is suitable for you.
- You can wait longer to withdraw. Your Required Minimum Distribution previously began in the year you turned 70 and a half. With this law, it is now delayed until the year you turn 72. You may still opt to take distributions from your IRA any time after you turn 59 and a half.
There is no denying that the flexibility of delaying your RMD is helpful for tax planning purposes. It is also helpful that you can still make a Qualified Charitable Distribution (also known as a Charitable Rollover) from your IRA starting when you turn 70 and a half. As I’ve written before, the Qualified Charitable Distribution is one of the best tax-savings measures out there for people who wish to make gifts to charity, because it lowers your taxable income in the year you make the gift and decreases your RMD in future years. Under the new rules, you will have the opportunity to take advantage of the Qualified Charitable Distribution for two years before your RMD begins — which is two opportunities to lower your RMD amount before it even starts.
- Your beneficiaries must take their inheritance — and pay their taxes — sooner. Prior to 2020, if a non-spouse inherited your IRA, they were required to take taxable distributions that were designed to spread the payments out over the rest of their lives. Starting this year, those beneficiaries will be required to withdraw (and pay taxes on) the entire balance of the IRA within 10 years, with some exceptions. In most cases this will substantially accelerate the payment of taxes on these funds.
They say there are two things that are certain in life: death and taxes. When it comes to IRAs that is especially true. Every IRA owner will eventually die, and when they do, someone is going to have to pay the taxes: their beneficiaries. From the beneficiaries’ perspective, withdrawing from the IRA more quickly may not be a benefit.
Every time you make a withdrawal from an IRA, that amount is added to your taxable income for the year. By accelerating the withdrawals from the IRA, the beneficiaries’ taxable income will be increased even more than it would have been under the old rules. A higher-income means a higher income tax rate, which means that this inheritance may be taxed at an even higher rate than the rest of the beneficiaries’ income. This could also result in phasing out some tax deductions to which the beneficiaries would have otherwise been entitled.
One way to plan around this problem is to use your IRA to make legacy gifts to charities you care about while leaving your other assets as an inheritance for your beneficiaries. Because organizations like Plan are tax-exempt, 100% of your gift from your IRA will go to changing the lives of girls around the world and 0% will be lost to taxes.
So, what should you do about these new developments? Check-in on your estate plan. Last fall we talked about some clues that it might be time to update your will and other estate planning documents. Now, I will add the SECURE Act to that list. If you have a traditional IRA, now is a good time for an estate planning checkup to make sure your documents will still accomplish your goals in light of this change in the law.