The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation, which we recommend reading prior to this series.
We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries. Here is our second of six installments.
In light of the SECURE Act, should I convert my IRA to a Roth IRA, and if so, how much of it should I convert?
The answer is maybe. First, some old Roth conversion strategies may still hold true. If you are in an especially low tax bracket for a few years (e.g. you are retired and no longer bringing in employment income, but you haven’t started taking social security yet), then a Roth conversion may make sense for you. It would likely be a good idea to convert as much as possible during those lower income years without pushing yourself into the next bracket. The idea is to pay the least amount of tax possible on that tax-deferred money so more makes it into your pocket. In light of the SECURE Act, there are now additional considerations due to the elimination of the stretch IRA for most non-spouse beneficiaries. These beneficiaries will now have to withdraw inherited IRAs down completely within 10 years, which could have major tax ramifications for them. A Roth conversion might make sense if all the following criteria are met:
- You will not need your IRA for your own retirement needs.
- You can afford to pay the tax bill out of pocket or with non-retirement assets.
- You want to leave the money to someone other than your spouse, your minor child, someone not more than 10 years younger than you, or someone who is chronically ill.
- The beneficiary will likely be in a higher tax bracket than you are now.
Example: Gertrude dies in 2020 and leaves her IRA to designated beneficiary Suzie, her granddaughter. Suzie is not an eligible designated beneficiary because she is more than 10 years younger than Gertrude and not her minor child. The balance in the inherited IRA must be paid out within 10 years after Gertrude’s death, which means a large tax bill for Suzie as she is in her prime working years. Had Gertrude converted that IRA money to a Roth, the taxes would have been paid at Gertrude’s much lower bracket, and thus Suzie would have received more money when all is said and done. With the Roth IRA, Suzie must still abide by the 10-year withdrawal rule, but now she can let that money grow tax free in the Roth until year 10 and then withdraw it without paying taxes.
I’m still working. Should I be contributing to a Roth IRA / Roth 401(k) / taxable account instead of a pre-tax account now?
It depends, and there are a lot of factors to consider. To start, please see the question and answer directly above and consider whether an IRA or Roth account makes more sense for you today. The analysis will consider your current tax bracket, your estimated future tax bracket, whether or not you will need the money for your own retirement, and who your beneficiaries are.
If you are nearing retirement while in your prime working years, it likely makes sense to contribute to a pre-tax account versus a post-tax account. You are potentially in your highest tax bracket now, so getting the tax break with a pre-tax contribution is generally more valuable. After retirement, when you are in a lower tax bracket, you may decide to make Roth conversions at that time to take advantage of the lower rates.
Taxable accounts are another story completely. Due to their flexibility, having a taxable account is beneficial whether you are also contributing to an IRA or a Roth. If you plan on leaving money to non-spouse heirs, then a taxable account can be a great way to do so. There is no contribution limit on these accounts and there will be a step up in basis upon your death. This will eliminate capital gains as the account passes on to your heirs and they will not have to deal with the forced 10-year withdrawal rule.
Again, this is a loaded question with many moving parts and will be very specific to each individual. It would be best to speak your advisor about which type of account makes the most sense in your situation.
As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.
Second Installment: How to Optimize Your Accounts After the SECURE Act
Third Installment: Must-Know Changes for Your Estate Plan After the SECURE Act
Fifth Installment: The SECURE ACT: Important Estate Planning Considerations
Sixth Installment: Inheriting an IRA? New Rules to Consider
Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.
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Frank joined the Merriman family in 2013 because he’s passionate about helping families get everything they want out of life. He understands firsthand how difficult it is for many people to invest the time that is necessary to maximize wealth assets and enjoys helping busy working families and professionals focuses on intelligent financial decision-making so they can stay focused on doing what they love.
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