My take: How the SECURE Act Changes Financial Planning
By now you have probably heard of the Secure Act and may even be familiar with the some of the important provisions. While not as sweeping as the Tax Cuts and Job Act of 2017, the SECURE Act has some noteworthy changes, including pushing the age back to 72 for required minimum distributions and killing the stretch IRA for certain beneficiaries. (For a deeper dive into the SECURE Act, see 10 Ways the SECURE Act Will Impact Your Retirement Savings). From my vantage point, 20 years as a financial planner, the SECURE Act is more of a ripple than a wave of change. Still, I see three ways the new legislation impacts financial planning advice. Here some of my thoughts:
1. Maybe you should consider taking from your IRA earlier?
There is a school of thought in the financial planning profession that says you shouldn't touch the tax-deferred accounts in retirement for as long as possible. The idea is to leave those accounts – think IRA's and 401(k)s – alone and allow them to continue to grow tax-deferred for as long as possible. Investors should instead use up taxable accounts first in retirement. The logic is to take advantage of the power of tax-deferral, allowing all the earnings to accumulate without taxes in an IRA and 401(k) for as long as possible which hopefully will lead to a larger account balance down the road. That logic may have to be adjusted with the SECURE Act.
The SECURE Act now requires certain classes of beneficiaries – namely non-spouses, who are not minors, disabled, chronically ill or more than 10 years younger than the account owner – to withdraw the entire inherited IRA or 401(k) within 10 years of the account owner's death. Before the SECURE Act beneficiaries could "stretch" the withdraws over their lifetime, harnessing the power of tax-deferral over a potentially longer time. If stretching the distribution is no longer allowed, it may make more sense for the account owner to use up the IRA first in retirement then leave whatever is left to a charity. It may be more advantageous to pass taxable assets to the children, since those assets receive a step-up in basis. IRA and 401(k) assets do not receive a step-up in basis and are subject to ordinary income tax rates, which may be higher than the capital gains rates on taxable accounts. Depending on your situation, it may make more sense to use up an IRA in retirement and leave highly appreciated taxable assets which receive a step-up in basis to the kids.
2. Roth conversions may decrease
Affluent retirees who once considered converting a regular IRA to a Roth so their kids can receive a lifetime of tax-free income, may now be putting this strategy on hold. Inherited Roth IRAs have the same 10 year distribution window like regular IRAs, so the advantage of lifetime tax-free withdraws is gone. True, qualified distributions from Roth IRAs are still tax-free, however, the 10-year distribution window on inherited Roth IRAs makes converting IRA assets to Roth's less appealing.
The reason is the tax consequence. If you convert IRA or 401(k) assets to a Roth, the entire balance of the IRA or 401(k) is included in your gross income. Investors used to be able justify this conversion, if they could stretch the withdraws out for their lifetime and their kid's lifetime – the long period of tax-free distributions hopefully made up for the income taxes on the conversion. Now given the 10-year cap on how long a beneficiary may have to distribute the Roth IRA, the time frame may not be long enough to make up for the taxes paid on the conversion. In short, you probably need a financial planner to run a few retirement calculations, to see the impact converting or not converting has on your overall net worth.
3. Life insurance looks pretty good
Permanent life insurance – policies that build cash value, like whole life – have two clear advantages over IRAs and 401(k)s at death. First, all life insurance death benefits are income tax-free (and if in an irrevocable trust, estate-tax free). This is a huge advantage over IRAs and 401(k)s which are taxed at ordinary income rates on distribution. Also, death benefits from whole life can be paid to a trust and distributed over the lifetime of the beneficiary, there is no 10-year cap on trust distributions from life insurance. In effect, beneficiaries can inherit a tax-free death benefit and continue to stretch the distributions out over time.
4. Annuities in 401(k)s?
The SECURE Act will pave the way for more employers to offer an annuity as an investment option in their 401(k). This may or may not be a good thing depending on how good is the annuity? What kind of annuity is it? Does the annuity meet the Qualified Longevity Annuity definition? If not, then is it better to purchase a QLAC annuity inside an IRA? Annuities are complex and individuals should seek help from a qualified professional.