The SECURE Act: Is It Good For You Or Bad For You?

My previous post introduced the potential consequences of the SECURE Act, which is being promoted as an “enhancement” for IRA and retirement plan owners.  This is because it includes provisions allowing some workers to make higher contributions to their workplace retirement plans. I think it is a stinking pig with a pretty bow, so I wanted to give retirement plan owners the good and bad news about it.

I am a fan of Roth IRAs because they allow you to have far more control over your finances in retirement than you might have otherwise had.  You are not required to take distributions from your Roth IRA, but the good news is that they’re not taxable if you do take them.  These tax benefits can be a critical factor for seniors, especially if you are suddenly faced with costly medical or long term care bills.   Saving money in a Roth account can offer financial flexibility to many older Americans – and one good thing about the SECURE Act is that it can help you achieve that flexibility.  Here’s how.

The Good News About The SECURE Act

Under the current law, you are not allowed to contribute to a Traditional IRA after age 70½.  (You can contribute to a Roth IRA at any age as long as you have taxable compensation, but only if your income is below a certain amount.)  The age limitation for making contributions to Traditional IRAs is bad for older workers – and that’s an important point because the Bureau of Labor Statistics estimates that about 19 percent of individuals between the ages of 70 and 74 are still in the workforce.  The SECURE Act eliminates that cutoff and allows workers of any age to continue making contributions to both Traditional and Roth IRAs.

That same provision of the SECURE Act offers a hidden bonus – it means that it will also be easier for older high-income Americans to do “back-door” Roth IRA conversions for a longer period of time.  The back-door Roth IRA conversion, currently blessed by the Tax Cuts and Jobs Act, is a method of bypassing the income limitations for Roth IRA contributions.  The current law prohibits contributions to a Roth IRA if your taxable income exceeds certain amounts.  Those amounts vary depending on your filing status.   But even if you are unable to take a tax deduction for your Traditional IRA contribution, you can still contribute to one because there are no income limitations.  Why bother?  Because, assuming you don’t have any other money in an IRA, you can immediately convert your Traditional IRA to a Roth IRA by doing a back-door conversion.  That’s a good thing because the earnings on the money you contributed can then grow tax-free instead of tax-deferred.

Here’s more good news.  The current law requires Traditional IRA owners to start withdrawing from their accounts by April 1^st of the year after they turn 70 ½.  These Required Minimum Distributions (RMDs) can be bad for retirees because the distributions are taxable.  The increase in your taxable income can cause up to 85 percent of your Social Security benefits to be taxed and can also move you into a higher tax bracket.  And once you begin to take RMDs, you are no longer allowed to make additional contributions to your account, even if you are still working.  The SECURE Act increases the RMD age to 72, a change which will allow Traditional IRA owners to save more for their retirements.

There’s a hidden bonus in this change as well.  Increasing the RMD age to 72 will allow retirees more time to make tax-effective Roth IRA conversions.  What does that mean?  Once you are required to take distributions from your Traditional IRA and your taxable income increases, you may find yourself in such a high tax bracket that it may not be favorable to make Roth IRA conversions at all.

The Bad News About The SECURE Act

Now let’s get down to the stinking pig.

The SECURE Act contains provisions about workplace retirement plans that I’m not convinced will be all that good for employees.  Those provisions pale in comparison, though, when compared to the worst part of the SECURE Act – and believe me, it’s bad. That provision requires Traditional and Roth IRAs that are inherited by a non-spouse beneficiary to be distributed within 10 years.  (There are some exceptions for minors and children with disabilities, and IRAs that you leave to your spouse are not subject to the rule at all.)  Withdrawals from Inherited Roth IRAs are not taxable to your beneficiary, so the cost of the SECURE Act to them will be limited in the sense that they will eventually lose the tax-free earnings on their inheritance.  Roth IRAs, however, haven’t been around that long.  They weren’t established until 1997 (as part of the Taxpayer Relief Act), and the amount that you can contribute to them is limited.  Even if you were smart enough to jump on the Roth bandwagon twenty years ago, the big problem that everyone seems to be overlooking is that most of America’s retirement money still lies in taxable Traditional accounts.

The existing law allows owners of Inherited IRAs to “stretch” their RMDs over their lifetimes.  The SECURE Act requires that Inherited Traditional IRAs be distributed within 10 years of the original owner’s death. The SECURE Act essentially means the Death of the Stretch IRA.   Since your heirs will no longer be able to “stretch” the distributions from your IRA over their lifetimes, there will be a massive income tax acceleration for them.  And the younger your heirs are, the worse that acceleration will be.

I talked about the consequences of that tax acceleration in my earlier post.  This provision in the SECURE Act betrays those conscientious savers who socked money away for years under the assumption that they would be able to pass it on to their children in a tax-efficient manner after their deaths. To me, the SECURE Act is particularly egregious because this change comes very late in the game for many IRA and retirement plan owners.  It will be devastating to people who have worked hard their entire lives, played by the rules, and accumulated significant amounts of money in their IRAs and retirement plans. It will be even more devastating for retirees whose IRA and/or retirement plan constitutes the biggest asset in their estate because it potentially means a difference of millions of dollars for their children and grandchildren.

There are some things that you can do to help mitigate the consequences of this bill, and I will cover those in a later post.  Thank you for reading.

James Lange