The SECURE Act: 3 Takeaways for IRA Owners
When it comes to retirement, many Americans do not feel secure. Just one in five Americans is very confident that they'll have enough savings for retirement, according to a recent survey. Almost 50 percent have little to no confidence in their retirement savings ability. Retirement and everything that surrounds it—saving for it, planning for it and figuring out how to afford it—remains a challenge.
That is one reason the House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act—otherwise known as the SECURE Act. Much has been written about the SECURE Act, which was passed in May and is designed to boost retirement savings. I don’t believe it will dramatically change the retirement savings landscape. It is also stalled in the Senate, so its future is uncertain. But if passed, the SECURE Act would represent the first significant piece of retirement legislation since the Pension Protection Act of 2006. The act would also have an impact on retirement savers who hold IRAs. Here’s how:
- Raises the age for required minimum distributions. Currently, retirement savers who use traditional IRAs are required to start taking required minimum distributions (RMDs) from their retirement account at 70½. (RMD rules do not apply to Roth IRAs while the owner is alive.) The SECURE Act would push back the age at which RMDs must begin to 72. Raising the RMD age would give investors another year and a half to enjoy tax-deferred growth of their IRA investments.
That additional time could be significant for IRA owners. Many retirement savers begin taking RMDs at 70½ not because they want to, but because they must. Data from the Employee Benefit Research Institute (EBRI) shows that individuals who own traditional IRAs and are 70½ or older are the primary drivers of IRA withdrawal activity.
At PENSCO, where we custody alternative assets for self-directed IRAs, we’ve seen clients convert from traditional IRAs to Roth IRAs simply to avoid RMDs. But a Roth conversion comes with tax implications and is not always in an investor’s best interest. Given that many retirees are living longer and are not always ready to pull money out of an IRA at 70½, gaining 18 additional months to grow an IRA without needing to make withdrawals could be significant.
- Repeals the age cap for contributing to traditional IRAs. As the law stands today, there is no age limit on making Roth IRA contributions. But retirement savers are not allowed to make regular contributions to a traditional IRA after age 70½. The SECURE Act would change this and allow savers to make contributions to traditional and Roth IRAs regardless of age.
This change—much like the decision to raise the RMD age requirement—acknowledges that Americans are living and working longer, and it provides more time for them to accumulate a bigger nest egg.
- Eliminates “stretch” IRAs. This is one of the more controversial IRA changes in the SECURE Act. Currently, non-spouse beneficiaries who inherit an IRA can “stretch” the RMDs from that account throughout their lifetime, allowing the IRA to continue to compound year after year on a tax-free or tax-deferred basis. Stretching the life of an IRA provides the potential to grow a small IRA into a very large one, allowing it to serve as a substantial inheritance for future generations.
However, under the SECURE Act, non-spouse IRA beneficiaries would have to withdraw all funds from the retirement account within 10 years of the IRA owner’s death—effectively eliminating stretch IRAs. (There would be exceptions for beneficiaries who are minors, disabled, or chronically ill.) This change could require IRA owners to rethink their estate planning strategy and reconsider accumulating a substantial IRA. After all, beneficiaries who inherit a large IRA and must draw down the account within 10 years could face significant tax bills on their yearly distributions.
While this proposal in the SECURE Act has drawn a fair amount of criticism, stretch IRAs are the exception rather than the rule. At PENSCO, most inherited IRAs we encounter are on the smaller side and are liquidated well before hitting the 10-year mark. First and foremost, IRAs are designed to fund an individual’s retirement, not the retirement of children and grandchildren. There are separate estate planning tools that can be used to provide for future generations.
The bottom line is that the SECURE Act, whether or not it becomes law, does not represent groundbreaking new retirement legislation. Instead, it makes it easier for IRA owners to grow traditional IRAs over their lifetime, and that may result in a more secure retirement for certain IRA investors.
This article originally appeared in Forbes.
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