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SECURE Act Changes IRA Rules

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Happy New Year to all!

While most of us were busy this holiday season preparing gifts to exchange with our loved ones, Congress was busy giving us "gifts" by adjusting the tax law late in 2019. They gave us (and the IRS) benefits by way of the passage of the SECURE Act, presenting lots of new rules for IRAs.

One of the high points is that required minimum distributions (RMDs) now must begin by age 72, not 70 ½ , as has been the case for decades. This eliminates the 70 ½ age limit for making retirement contributions as well. This will also affect the use of RMDs for charitable giving, but that's one layer too complex for this cursory discussion.

As Congress giveth, they also take away. One major negative shift in this tax policy is the elimination of the "Stretch IRA." Prior to 2020, this applied when a non-spouse inherited an IRA. Previously, the recipient could use their own age in calculating RMDs and possibly "stretch" the IRA into many more decades of tax-deferred accumulation. The new rules require non-spouse recipients to terminate and distribute the IRA balance within 10 years of the death of the original owner, thus exposing the balance to taxes much sooner than was previously available with proper planning.

This presents some fresh variables on investor tax strategy. I found that this gave my own family reason to accelerate my mother's IRA depletion by doing partial Roth conversions. With her tax bracket being about half that of my brother's and mine, it made me think that lacking a stretch provision, sitting tight would imperil us by forcing mom's deferred taxes into my bracket eventually. The ten-year limit on deferral for beneficiaries must now be weighed against the value of pre-paying taxes at mom's tax rate today. She is 88, so that too is important.

A quick study of the 2020 tax brackets will reveal that one enters the 22% bracket at $40,126 of income and doesn't leave the 24% bracket until $163,301 of earnings. On each side of that 40k-163k range are brackets that are nearly ten points different (12% and 32% respectively). The highest bracket still crowds 40%. With my mom's IRA beneficiaries (my brother and me) both having tax brackets nearly 70% higher than her bracket (as long as her income is below 163k) we decided it was more beneficial to accelerate depletion of mom's IRA.

Now some people would argue for mom to simply take IRA distributions larger than the RMD. Yet, why do that when a Roth conversion accomplishes the same "rinse tax now" outcome while maintaining the tax-free accumulation until death? It's actually better than that, since the Roth can accumulate tax-free for another five years past the death of the original owner. This has always been the rule on depleting Roth's. Yet, with a new ten-year limit on stretching a regular IRA, the Roth choice just got a lot more valuable by comparison. With a 70% lower bracket for mom now, the additional five years of deferral on the new limits with the SECURE Act (10yr IRA depletion vs 5yr for Roth) made the choice clear for us. The larger the income tax rate disparity between first and second generation, the better this works.

There are other high points to be considered with the SECURE Act, but this point alone presents fresh choices for your family to investigate. Because Segment does not give tax advice, we suggest you discuss these possibilities with your tax professional.

Cheers to saving money in 2020.