Who is your primary beneficiary?  If you are a conscientious person, you review your beneficiaries with your financial and legal team every year, but have you ever physically named the IRS as one of your beneficiaries? As of January 1, 2020, new rules that are described in the SECURE Act will impact both beneficiaries and taxes for those people that have a substantial net worth contained in their IRA, and guess what? – the IRS is looking for a raise.

IRAs, and other tax-deferred plans like 401(k)s, 403(b)s, 457s, etc., have always been designed to defer taxes until the monies are withdrawn but that has never meant that taxes are deferred indefinitely. In fact, required minimum distributions (RMDs) have long allowed the IRS a “slow leak” of IRA assets in which tax revenue can be systematically collected. RMD rules can be very complex; in our practice we have witnessed both misinformation and confusion leading to inefficiencies when it comes to overall income planning and income taxes. Although the SECURE Act does much more than two things, two RMD changes are poised to impact thousands and ultimately will create billions in tax revenue from those that don’t actively seek alternatives.

The first change beginning this year is the age at which it is mandatory for you to take your required minimum distribution. The required age for initial minimum distributions has been pushed back to age 72 from a current age of 70.5. For those not needing RMD income for living expenses, this change will allow a further delay of deferring tax implications as well as additional planning opportunities to make changes prior to the RMD age. Conversely, it also truncates the timetable during which RMD’s can be withdrawn, thus forcing RMD tables to have higher withdrawal rates in a shorter period of time. For some individuals, this will result in issues associated with Medicare premiums; but again with extra time to plan there may be other options.

The second change, and the big cost to taxpayers, is the introduction of substantial limitations to what we have affectionately called a “stretch IRA.” If we have a large pool of money that has not been taxed, and that it will continue to grow tax-deferred as long as we’re allowed to leave it alone, then it’s common sense that it will grow faster the longer it is invested due to compounding. In the past, it was allowed to take an inherited IRA and let it compound upon itself, with an individual only being responsible for taking distributions based upon their often longer life expectancy.  Basically, this represented a full bucket that would continue to grow faster and faster due to compounding and we only had to pour out a tiny amount each year. With the SECURE Act, unless the beneficiary is exempt (i.e., the largest exemption being spousal), the whole IRA is required to be liquidated within a ten-year period. So rather than your bucket having a small faucet continually dispensing its contents to allow for growth,within10 years you must dump the entire bucket. This requirement may cause some tax pain to beneficiaries who inherit their parent’s IRAs, especially those beneficiaries that are not yet retired. The years leading up to retirement are typically a person’s highest earnings years and necessarily, higher earnings translate to higher tax brackets. When we take a large sum of untaxed money as an inheritance during these years, it is not unlikely that this may result in elevating someone into a higher tax bracket causing more dollars to go toward taxes and less usable dollars to be passed to the beneficiary. For those wanting to ensure that maximum inheritance is preserved for the use of the beneficiary and not merely creating more tax revenue, it is essential to engage in prior planning. It’s simply a matter of threshold control and the SECURE Act is a bet that those who don’t plan may create the tax revenue needed to support other programs. 

The ultimate question is, do you want the IRS to be your primary beneficiary?  If not, you’ll want to be pre-emptive in financial tax planning.