Things got a little bogged down for the SECURE Act (Setting Every Community Up for Retirement Enhancement, H.R. 1994, but it’s still pending, and is expected to be passed. It’s impossible to know what final form it will take, but a lot is riding on it.
The SECURE Act proposes a number of changes to retirement savings. These include changes to parts of IRAs and 401(k)s. Some of the changes look to be common sense, like broadening access to IRAs and 401(k)s, as well as including updating the rules to reflect that retirement is now a longer period of life. However, with these changes come potential limitations with stretch IRAs.
Forbes asks in its recent article “Are Concerns Over Stretch IRAs And The SECURE Act Justified?” You should know that an IRA is a tax-wrapper for your investment that is sheltered from tax. Your distributions can also be tax-free, if you use a Roth IRA. That’s a good thing if you have an option between paying taxes on your investment income and not paying taxes on it. The IRA, which is essentially a tax-shield, then leaves with more money for the same investment performance, because no tax is usually paid. The SECURE act isn’t changing this fundamental process, but the issue is when you still have an IRA balance at death.
A Stretch IRA can be a great estate planning tool. Here’s how it works: you give the IRA to a young beneficiary in your family. The tax shield of the IRA is then “stretched,” for what can be decades, based on the principle that an IRA is used over your life expectancy. This is important because the longer the IRA lasts, the more investment gains and income can be protected from taxes.
Today, the longer the lifetime of the beneficiary, the bigger the stretch and the bigger the tax shelter. However, the SECURE Act could change that: instead of IRA funds being spread over the lifetime of the beneficiary, they’d be spread over a much shorter period, maybe 10 years. That’s a big change for estate planning.
For a person who uses their own IRA in retirement and uses it up or passes it to their spouse as an inheritance, the SECURE Act changes almost nothing. For those looking to use their own IRA in retirement, IRAs are slightly improved due to the new ability to continue to contribute after age 70½ and other small improvements. Therefore, most typical IRA holders will be unaffected or benefit to some degree.
For those who spend their entire IRAs during their retirement, the stretch may not matter that much. However, for those who are using their IRAs to pass wealth to the next generation, it is a real concern.
Reference: Forbes (July 16, 2019) “Are Concerns Over Stretch IRAs And The SECURE Act Justified?”