The Secure Act, signed into law on December 20th, 2019 is one of the most comprehensive reforms to retirement legislation since the Pension Protection Act of 2006. As with many bills signed into law, the devil is in the details.
As the title implies, “Setting Every Community Up for Retirement Enhancement Act” this far-reaching bill includes significant provisions aimed at increasing access to tax-advantaged accounts and preventing older Americans from outliving their assets1.
For many, this bill may have hit the mark, but for others, including our clients who have done a great job saving, a couple provisions within this bill could end up costing their family hundreds of thousands or even millions of dollars. The great news is that for those who are well informed surrounding these provisions, many still have time to do something about it. Unfortunately, the problem is, a limited number of individuals even know the consequences of the Secure Act.
The First Provision Of The Secure Act
Historically, for qualified retirement accounts, retiree’s had to begin Required Minimum Distributions (RMD’s) by age 70 ½. The Secure Act increased the RMD age to 72. At first you may be thinking that this is wonderful news! Many Americans who have robust qualified retirement plans like 401(k)’s and IRA’s have been trained to defer taxes as long as possible. After all, why would you pay taxes now if you don’t have a need for that money? This has been a conventional way of thinking for many years. We have a new problem however. And that problem has to do with a second provision within the law.
The Second Provision Of The Secure Act
The second provision requires that a non-spouse beneficiary (with very limited exceptions) who inherits these qualified accounts, distribute them within 10 years from date of death. This is setting up something I have named the “Retirement Tax Squeeze”. Hang with me a minute while I paint the picture. And see if you relate to the descriptions below.
Many individuals with significant qualified funds in vehicles such as IRA’s and 401(k)’s have been able to build these in part due to specific character traits. A common trait we find among this group is they tend to be frugal. They have earned a good living throughout their lifetime and have also been diligent savers. They often live in homes that have been paid off for many years. In addition they may have a defined benefit plan such as a pension and robust monthly social security income due to their solid earnings history.
Other individuals have not been quite as frugal but their earnings have been significant. These individuals often owned small businesses or were highly compensated professionals. They have saved significant amounts in their qualified plans but have also amassed other assets that are quite valuable.
The common theme here is that these individuals are likely to have qualified IRA’s and 401(k)’s that will eventually be left to their children or grandchildren. Their natural instinct is to allow these assets to grow, in a tax-deferred status, until they are required to begin minimum distributions, which is now age 72.
The Secure Act Retirement Tax Squeeze
Now for the “Retirement Tax Squeeze”. The top federal tax bracket is currently 37%. Although for many of us it feels like we pay significant taxes, the reality is that from a historical perspective, top tax brackets have been significantly higher in the past. In 1944 the top federal tax bracket peaked at 94%. In 1980 the top federal tax bracket was 70%. It is not a surprise that this idea of defer, defer, defer taxes to the last possible moment is ingrained in the psyche of many Americans age 60 and beyond. The idea that you would be in a lower tax bracket in retirement is accurate for most Americans.
So imagine this scenario, you are in one of the lowest tax brackets you will ever be in. You are deferring taxes until your Required Minimum Distribution age of 72. Upon your death, and possibly the death of your spouse, your qualified investments have grown to the largest number they have ever been. Your beneficiary is your child or children. They now inherit a significant sum of money that has to be distributed within 10 years of death and is likely inherited at an age when they are at or near peak earning years. If you sprinkle in possible future tax increases, the “retirement tax squeeze” is now complete. Many people will be sorely disappointed when they find out that one of their beneficiaries of their hard earned investments will be the IRS. Now I am being facetious in saying this as the IRS is not named as a beneficiary but depending on your beneficiaries tax bracket, they may end up being a larger beneficiary than those formerly listed on your IRA or other qualified plans.
So What Can You Do?
Hopefully you can now see the challenge that is facing many Americans and the urgency to plan based on recent changes brought about by The Secure Act. The good news is that we have strategies for mitigating these tax risks. I write to educate, but also write to invite you into further conversation. The strategies we utilize depend on each client’s situation. The most effective way to communicate these strategies is to have a zoom, or in person meeting. There is no charge for the initial meeting. If you choose to implement any of our strategies directly with us, the compensation would be discussed well in advance so that you will have the space to make a decision on whether you would choose to further engage with us.
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1. Congress.gov. "H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019." Accessed 09/28/2021
Disclaimer:
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. Conor Boyd is a Registered Representative and Investment Adviser Representative of Equity Services, Inc. Securities, Financial Planning, and Investment Advisory Services are offered solely by Equity Services, Inc., Member FINRA/SIPC, 333 Westchester Avenue, South Building Suite 3302, White Plains, NY 10604 914.428.4000. Thoroughbred Advisors, LLC is independent of Equity Services, Inc. TC123486(1021)1