The passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in 2019 changed several aspects of retirement accounts and plans. The law, which went into effect on Jan. 1, 2020, consists of 29 provisions that deal with several aspects of retirement savings plans and accounts including Required Minimum Distributions (RMDs) and inherited IRAs. This discussion will focus on the SECURE Act’s impact on IRAs and Roth IRAs and will touch on some new benefits to account holders and some new regulations on inheritances.
The law raised the age limit for beginning Required Minimum Distributions for qualified and tax-advantaged accounts and plans from 70½ to 72 for individuals who turned 70½ on or after Jan. 1, 2020. Individuals with an IRA can now allow their account to grow tax-deferred for an additional 1½ year before taking their first RMD. The law also removed the age limit to contribute to IRAs, so an individual can continue to contribute to an IRA or Roth IRA (there was not previously an age limit on Roth IRAs) up to the limit allowed by the IRS for as long as he or she has earned income.
For 2020, individuals can make annual contributions of up to $6,000 to an IRA or Roth IRA ($7,000 if the individual is 50 years old or older). There are income phaseouts applicable when contributing to a Roth IRA. For example, single tax filers can contribute up to the limit if their modified Adjusted Growth Income is less than $124,000 per year, they can take a reduced amount if their modified AGI is $124,000 but less than $139,000, and they cannot contribute with a modified AGI that is at or greater than $139,000. Couples who are married and filing jointly can contribute up to the limit with a modified AGI of less than $196,000, they can contribute at a reduced amount with a modified AGI of $196,000 and less than $206,000 and cannot contribute with a modified AGI at $206,000 or greater. (1)
A major change brought on by the SECURE Act is the elimination of what was known as the stretch IRA. This estate planning strategy allowed beneficiaries of inherited IRAs or Roth IRAs to shelter income, potentially for generations, and take advantage of the tax-deferred or tax-free growth within the account. Some beneficiaries of IRAs and Roth IRAs will now have to withdraw inherited assets from the account within 10 years of the death of the original account holder. There are exceptions to this rule that include beneficiaries who are a surviving spouse, a minor child, a disabled or chronically ill individual and beneficiaries who are not more than 10 years younger than the original account owner.
The SECURE Act could make a Roth IRA conversion strategy more appealing to individuals who plan on leaving a significant inheritance to heirs and want to limit the future tax liability on those assets. This conversion is allowed by the IRS within 60 days of a distribution from the IRA. Keep in mind, the distribution from the tax-deferred IRA will be taxed (both on contributions and gains) when the funds are initially rolled over, but once withdrawal requirements are met, future gains in the Roth IRA can be taken sans income tax. Five-year-rules apply to Roth IRA withdrawals, so individuals need to be sure they understand the rules or they could be hit with a penalty on the sum taken out. A back-door Roth conversion can also be used by high-income earners to fund a Roth IRA even if their modified AGI is higher than the phaseout amount. It is worth noting the Tax Cuts and Jobs Act of 2017 eliminated the ability to recharacterize Roth IRA conversions. Previously, account holders could essentially undo the conversion if it ended up saddling the account holder with unfavorable tax consequences. Individuals thinking about a Roth IRA conversion should talk with their tax professional and Financial Planner to make sure they fully understand the ins and outs of a Roth IRA conversion and the potential tax consequences.
An ideal time for a Roth IRA conversion would be in the years just after the individual retires but before the individual starts taking RMDs, because the account holder will generally be in a lower tax bracket during this time period. Since the SECURE Act increased the age for starting RMDs to 72 from 70 ½, individuals have an extra year and a half to take advantage of the strategy. Also, Roth IRAs held by the original owner are not subject to RMDs. There are several moving parts and other potential tax consequences with Roth IRA conversions, and they are not appropriate for everyone. Again, be sure and talk with your tax professional and Financial Planner to discuss whether an IRA to Roth IRA conversion is the best course of action for your situation.