The SECURE (“Setting Every Community Up for Retirement Enhancement”) act was passed into law at the start of 2020. While it has many provisions, found here, this article covers 4½ ways that the bill may save you the amount you pay in income taxes during your retirement.
1. Longer time period to contribute to retirement accounts
While the cutoff age for contributing to a retirement account was 70½, this has now been increased to age 72. This helps those employed in a full or part-time capacity continue to save for retirement for a little while longer, defer taxes on a portion of their income, and also leave money in a tax-deferred account for another 18 months. For those working part-time while retired, they can defer earned income they don’t need until a later date.
- Taxes saved on income
- Taxes deferred a little longer on the account balance
2. Delaying RMDs until 72
For those who are currently retired, Required Minimum Distributions (RMDs) were required to be taken at age 70.5. This meant that a formula was applied to your overall retirement account balances, based on your age, and that portion of money had to be taken out of the account. It was taxed and then you could either spend it or save it to another non-retirement account. Even if the money was not needed, it was, and still is, a rule in the IRS code that forced you to withdraw money. This is so that the government can receive tax dollars from money previously deferred from taxation some years earlier.
While this rule is still in place, the government has given an additional 18 months for the first withdrawal to take place.
- Taxes deferred 18 months into the future
- Account balances have a chance to grow a little higher, providing greater income in retirement
3. Taking withdrawals before 72 and paying taxes in lower tax brackets
For some, delaying withdrawals until age 72 isn’t a great idea. For example, they may have multiple streams of income already (pensions, Social Security), and by further delaying withdrawals from tax-deferred accounts, a higher balance can drive up a tax bill later in the future.
For many, withdrawing money out sooner – before it is mandated – allows the spreading out of income over a period of years. While taxes are paid earlier, they can be managed so the total tax bill over one’s lifetime is less. (This is one strategy that Retirement Matters custom-designs for clients with the help of our CPA partners. It can be pain-staking, but is a lot of fun!)
- Less taxes over one’s lifetime
- If money is not needed, re-allocating money to balance the tax “buckets” for retirement income.
4. If receiving an Inherited IRA, retire early and take withdrawals at a lower tax bracket, given the “Stretch IRA” is gone
If you inherited an IRA (that was not from your spouse), you could stretch out the RMD payments over your lifetime. That has now changed to be a maximum of 10 years. The short of it – the government recoups the taxes owed in the span of 10 years or less versus many decades.
For many, this will push them into higher tax brackets as the balances of some inherited IRAs can be large.
But take it one step further – what if the balance of the Inherited IRA was such that you didn’t need it for retirement savings? You could retire earlier than planned and use the money in the Inherited IRA to supplement your income? At this point, you’re taking more out than you are required, but it could be taxed at lower rates because you’re not adding it to your existing income.
- Earlier retirement due to inheriting an IRA
- Pulling out money faster than 10 years to cover living expenses, but at a lower tax rate than expected
4.5. Now stretch IRAs doesn’t exist, take money out of IRA, buy permanent life insurance and use that to give a larger, lifetime benefit for your loved ones
Take the “Stretch IRA” example a little further. What if the plan was to stretch the withdrawals over your lifetime but gift it to a charity or loved one. Now that is no longer the case as the money has to be withdrawn over 10 years.
The money from the Inherited IRA can be leveraged to create a larger legacy gift when you’re gone.
Instead of gifting the money you take out over ten years, use it to buy a life insurance policy that will be paid up over 10 years (meaning no premiums are paid after 10 years). At this point, the life insurance policy will exist until you pass away and the life insurance will pass to your loved ones / heirs / charity tax-free and free of probate. This amplifies the gift you were going to make by leveraging the power of life insurance.
While it’s not an ideal solution for some – who might want to gain joy from seeing loved ones use the money – for those looking to create a family legacy, it can be a great approach.
For the foreseeable future, the changes made by the SECURE act are here to stay. It’s important to not let these changes get in the way of your financial plan, or cause you to pay higher taxes over your lifetime.
If you’re not sure how to adjust your plan given these changes, why not set up an appointment and we can see if we’d be a fit to work together.