In the past, most beneficiaries could stretch out the RMDs of inherited IRAs and 401(k)s over their own life expectancy. This allowed inherited IRAs and 401(k)s to grow tax advantaged for heirs for many years. Additionally, RMDs were relatively small, since they were based off of their longer life expectancy.
Now, these non-spouse beneficiaries must cash out the entire IRA within 10 years. Because the withdrawals will be larger, they will likely force beneficiaries to pay higher tax rates on taxable distributions, and because the time period is limited, the opportunity for tax-deferred growth is also being shortened.
2. Confusion Leading to Possible Missed RMDs (and Penalties)
- If you were born before July 1, 1948, you were already taking RMDs, and that continues unchanged going forward.
- If you were born on July 1, 1948, through June 30, 1949, you turned 70.5 in 2019. Your first RMD is due by April 1, 2020. Your second one is due by Dec. 31, 2020. And then you continue to take RMDs by the end of each year going forward.
- If you were born on July 1, 1949, or later, your first RMD is due by April 1 of the year after which you turn 72. Your second would be due by Dec. 31 of that same year, and then by Dec. 31 of each year thereafter.
3. Conduit or Pass-Through Trust RMD Failure (and a Big Tax Bill If Not Corrected)
In the past, many IRA and 401(k) owners have been encouraged to use conduit or “pass-through” trusts as beneficiaries of their retirement accounts to help qualify for the “stretch” provisions and provide creditor protections for their heirs. However, many of these trusts only gave access to the RMDs each year to the beneficiary of the trust.
With the new 10-year distribution period for many beneficiaries, there is actually no RMD for year one after the year of death of the account owner. In fact, the way the SECURE Act was drafted, the only year that has an RMD is year 10, as the act states all money must be distributed by the end of year 10 after the year of death of the IRA owner.
This means the trust provisions that were drafted prior to the SECURE Act could lock up money for heirs for up to a decade and then cause a full taxable distribution in one tax year for the full retirement account. This has potential for disaster, so trusts need to be reviewed as a consequence of the SECURE Act.
4. More Money Leaking Out of Retirement Accounts
A positive provision was added to the SECURE Act that allows those under the age of 59.5 to take out up to $5,000 from their IRA or 401(k) to cover costs within a year associated with childbirth or adoption and avoid the 10% penalty tax for early withdrawals. If both parents have their own retirement accounts, they could each withdraw $5,000, for a total of $10,000, without a penalty. Of course, they’d have to pay taxes on the money, though.
One issue with these types of additional access points, in regards to retirement money, is that they can encourage leakage — money leaving retirement plans and being used for other needs, instead of retirement.
5. Improper Annuity Ownership in Retirement Plans
A new rule in the SECURE Act lessened the standard of care and review that a retirement plan sponsor must use to vet insurance products going into the plan. As such, there will be a large push to add more annuities into 401(k)s. The reality is, more Americans need access to lifetime income options inside of their retirement plans. Because investment advice and help with financial planning in a 401(k) can be hard to receive, many investors are on their own when picking investment allocations within their employer retirement plans.
By adding more annuities into retirement plans, younger investors who do not yet need to be invested in an annuity might end up with large percentages of their wealth in this strategy. The reality is that annuities can add value, but they will not be the right investment option for all participants … and without quality guidance, education and advice, individuals could have improper ownership and investments in these assets.