Even though the SECURE Act was signed in 2019, the IRS has just recently publicized its interpretation of the tax code, and the resulting changes to the way IRAs are inherited should propel financial planners to review all of their clients’ beneficiary designations, said Tim Steffen, director of tax planning with Robert W. Baird & Co.
“The SECURE Act has some pretty significant and important changes that affect all of us as advisors and planners and, frankly, as future retirees ourselves,” Steffen said in a presentation at this week’s Morningstar Investment Conference. “The issue we have with the SECURE Act is it came into law in December 2019 and a few months later the world changed. And everybody kind of forgot what the SECURE Act was all about. Things like Covid and market crashes and PPP loans and the CARES Act, all these things came into play and the SECURE Act was standing in the background saying, ‘Hey don’t forget about me, I’m kind of a big deal.’”
That big deal is once again in the crosshairs of the IRS, he said, and in March the IRS released its proposed language around the new tax code, which has language Steffen described as “clear as mud.”
More details may be forthcoming, he said, but in the meantime the changes to inherited IRAs are significant and require a thorough review with any client's pre-retirement planning in terms of their beneficiaries, and with any client who is the recipient of an inherited IRA when the owner died in 2020 or after.
New Rules For IRA Owners
For IRA owners, the SECURE Act increased the age for required minimum distributions (RMDs) to 72 from 70½. The required beginning date (RBD) can still be April 1 of the year after a client turns 72, but two RMDs would be required that year.
An exception to the new RMD age is employees who keep working past 72 (they can delay distributions for an employer plan until retirement). There is no change to the age for penalty-free early withdrawals, still 59½, or to the age for qualified charitable distributions, still 70½.
“Is it really that big of a deal? It actually kind of is because it leads to a few planning opportunities,” Steffen said. “The first one is what I refer to as the 'trough year' opportunity. There’s a window of time between when people retire—call it 65-ish or so, when wages stop and income falls off in most cases—and they start Social Security, where they have a lot more control over their taxable income. And now with the extension of the RMDs out a couple of years, you have an even bigger window of time for planning opportunities.”
Some of those planning opportunities include Roth conversions, recognizing capital gains, diversifying out of company stock that has a low cost basis or selling shares and taking advantage of a lower capital gain rate, he said.
“The other thing we get is a great opportunity for spouses who are inheriting a retirement account,” Steffen said, adding that there are two options for that spouse. The first is they can roll the inherited IRA into their own name and it’s treated as if it has always been their IRA (RMDs calculated with the uniform life table). Or they can keep it as a beneficiary IRA and don’t have to begin RMDs until the deceased owner would have turned 72 (RMDs calculated with the single life table).
“Where is the planning opportunity? When the deceased spouse is younger than the surviving spouse,” he said. “If the survivor rolls it into his or her own IRA, that person is going to be hitting RMDs when they turn 72. But if you leave it as the inherited IRA, you don’t have to take RMDs until the decedent would have been 72, which might give you a few extra years to delay taking money out.”
The inherited IRA can then be rolled over to the survivor’s name before the deceased would have turned 72, and the RMDs are based on the uniform life table, which could be more advantageous.
“So don’t automatically roll those retirement accounts into the survivor’s name,” Steffen advised. “That’s not always the best option.”
On the negative side of the change to the RMD, he said, is “non-designated beneficiary risk,” which refers to a beneficiary on an IRA who is not a living person, such as an estate, charity or certain trusts. If the account owner dies before their RBD and leaves the account to a non-designated beneficiary, it triggers what is called the five-year rule, Steffen said. This means the IRA must be liquidated by Dec. 31 after the fifth anniversary of the account owner’s death.