shot of word retirement plan
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which passed the House in a sweeping 417-3 vote, was incorporated into an end-of-year spending bill and was signed by the President on December 20, 2019. SECURE will vastly change the way savers think about saving for retirement. The Act consists of 29 provisions covering a variety of enhancements to qualified plan rules, including allowing long-term part-time workers to participate in 401(k) plans and letting small employers join together to make it possible to offer their employees 401(k) plans. There are, however, two standout provisions that will affect the way many savers look at retirement.
First, the Required Minimum Distribution (RMD) age is extended to 72. This change grants ‘accumulators’ the ability to delay initiating their RMD, which, in turn, will allow their IRA to continue to grow for an additional 1 ½ years. Second, and far more consequential, is the elimination of the ‘stretch’ provision. Under prior law, IRAs (and qualified plans) that were left to a nonspouse, human beneficiary could be withdrawn over that beneficiary’s life expectancy. For example, if ‘Grandfather A’ left his IRA to his 25-year-old granddaughter, she could, based on her life expectancy, take distributions over 57.2 years. If she inherited a $1 million IRA, her first-year distribution would be $1,000,000/57.2 or about $17,482. Depending on her other income, she could pay federal taxes anywhere from about $548 (if the RMD was her only income) to about $6,468 (if she were in the highest bracket). Her inherited IRA, if it grew at a rate of 7%, would expand to about $1.75 million in ten years, and keep growing for most of her life. The new law completely changes this scenario. All nonspouse beneficiaries must take distributions within 10 years. For the granddaughter in the preceding example, that change would push her into a vastly higher tax bracket and the taxes on the distribution, depending on her other income, could be nearly $300,000-$400,000 more. The Act indicates that it will produce about $15 billion in new tax revenue in the first 10 years, and likely much more.
What to consider: The new law upends a central function 401(k), 403(b) or other saving programs served for many people. The traditional maxim was to use a 401(k) or other qualified plan to lower one’s current tax obligation, defer them in the present, and withdraw them at a lower rate. Many employers (or businesses) offered the benefit of a matching, or employer contribution. A key benefit of these plans was that if the totality of the funds weren’t withdrawn before the owner’s and their spouse’s death, the balance could be left to someone else and be spread over their lifetime. For taxable amounts, this would likely be to decedents’ children in a lower bracket. In the case of Roths, it was possible to delay distribution while accumulating tax-free. This is no longer the case. Consider the following:
· The new 10-year rule applies to all qualified plans; these include 401(k), 403(b), 457(b), ESOPs, Cash Balance plans, 401(a) plans (defined contribution), lump-sum distributions from defined benefit plans, and IRAs. IRAs are usually the rollover recipient vehicle of all these other plans.
· The new 10-year rules do not apply to a spousal rollover. When the owner dies, their spouse may roll over their spouses’ IRA into their own IRA, which is usually a very good idea. This, in turn, creates a larger IRA now owned by a single person, who has a higher tax bracket than a married couple.
· The Tax Cuts and Jobs Act (TCJA) individual tax cuts are scheduled to expire 12/31/25. Unless they are made permanent (which seems unlikely), almost everyone will be in a higher bracket, including the beneficiaries.
In light of all these considerations, we should evaluate Pre-Mortem tax rates versus Post-Mortem tax rates. It is entirely possible that the saver might find themselves in a lower bracket than the eventual beneficiaries who will have to take distribution of the funds within a 10-year period.
Enter the Roth. Many planners see a possible solution in creative Roth strategies. Roths have some interesting features that make them a useful planning tool under the new SECURE rules, especially when coupled with other factors.
· Roths can be IRAs or qualified plan contributions. You can designate a Roth 401(k), Roth 403(b) or Roth 457. Contribution to Roths are on an after-tax basis.
· Roth IRAs (which can, and should be, the recipient vehicle of Roth 401(k) balances) do not have a Required Minimum Distribution age for the owner. An owner can leave their Roth to grow until their death, leave it to their spouse, who can then add it to their own Roth and allow it to grow it until they die. The second spouse can leave it to their children, who can then allow it to continue to accumulate tax-free for another 10 years.
· Contributory Roth IRAs have ‘First-In, First-Out’ (FIFO) rules that allows the contributions to be withdrawn at any time, penalty and tax-free. FIFO does not apply to earnings on contributions.
With the passage of SECURE, Roths become much more attractive as a planning tool. David Demming of Demming Financial in Aurora, OH writes, “As marginal tax rates have declined, our enthusiasm for Roths has increased. We have completed hundreds of Roth conversions and frequently take after tax withdrawals from 401-K’s to Roths…” Similarly, Greg Iacurci, writing for InvestmentNews, posits that “The time is ripe to convert traditional, pretax retirement accounts to Roth-style accounts. Low individual tax rates by historical standards and a pending reversion in 2026 to the higher rates that preceded the new tax law make this an opportune time, according to financial advisers.” With these developments, it makes sense to speak with your financial professional about the planning opportunities presented by Roths as we usher in the age of SECURE.
Here are five ways to capitalize on Roth opportunities:
1. Roth 401(k), 403(b) and 457(b) (DRAC) In these plans, you can contribute out of your paycheck to your employer’s plan. The dollar limits for 2019 are $19,000, and $26,000 if you are 50 or older. Employer match and employer contributions are still pre-tax. Remember to roll your DRAC into a Roth IRA when you separate from your employer to eliminate the RMD rule.
2. Contributory Roth Probably one of the best options is to contribute to a Roth IRA, given the FIFO exception. The limit is $6,000 per spouse ($7,000 if 50 or older). You may only contribute if you have earned income, although only one spouse needs earned income (so if one spouse makes at least $12,000, both can have a Roth). You can have a contributory Roth in addition to an employer savings plan. There are income limits: You are phased out of contributory Roth as your income goes above $122,000 (single) or $193,000 (married).
3. Back-door Roth (if over income level) If you have income over the limits, you might be able to make a nondeductible IRA contribution and convert that to a Roth. Nondeductible IRAs have no income limit. Forbes.com contributor Ashlea Ebeling covers the backdoor in this piece.
4. Roth conversions (including an interesting RMD conversion strategy) A major opportunity to gain Roth accounts is to convert portions of an existing IRA to a Roth in a Roth conversion. The process involves paying the tax on the conversion. The most common use of the Roth conversion is ‘bracket-topping,’ where you convert enough to go to the edge of your tax bracket. For example, a married couple with taxable income of $52,000 could convert $26,950 of their IRA into a Roth (the 12% bracket ends at $78,950) and pay only $3,234 in federal taxes.
5. In-plan after-tax Roth conversions and rollovers (‘Mega Roth’) A newer development is the ‘Mega-Roth,’ where a participant in a qualified plan makes after-tax contributions and converts those to a Roth. These contributions can be large, up to $37,000, but involve some moving parts. See here for a further discussion of this strategy.
Bottom Line: SECURE changes the pre-mortem versus post-mortem tax rates in long-term savings. With this new development, Roth strategies look much more advantageous. These changes merit a conversation with your financial professional for a look at how this will affect your financial plan.