For many of us, the Individual Retirement Account (“IRA”) and/or the 401k represent the bulk of our assets. We spend years taking less income than we really earn to set up a nest egg for retirement. Usually this was done with our employers through a company sponsored 401k plan. For those that are self employed they may have started right away with an IRA. Once an individual leaves their employer, they may by choice, or by plan mandate, roll their money out of the company sponsored 401k and into a self-directed IRA. Unfortunately, the Setting Every Community Up for Retirement Enhancement Act (“SECURE Act”) of 2019 is going to be impacting that money we have so diligently set aside for all these years https://www.kiplinger.com/article/retirement/T037-C032-S014-don-t-let-the-secure-act-be-a-windfall-for-the-irs.html.
IRAs and 401k Plans Represent the Bulk of Many Families Assets
With the reduction and almost complete elimination of pensions, more and more families were encouraged by their employers to prepare for retirement using company sponsored 401k plans. By setting money aside you are able to reduce your income and defer taxation until that money is taken out. Even better, the amounts placed into the 401k are allowed to grow tax free until they are taken out. According to St. Charles estate planning attorney Stephen Jones “401ks and IRAs have proven to be tremendous wealth builders for many of our clients at Jones Elder Law.” Employers, Tax Advisors, Financial Advisors etc., did a tremendous job of engraining into our conscious mind that you place money into your retirement account and just leave it there to grow.
The Government Wants Their Money
What was intended to be a retirement tool, for many became an asset that they simply held and did no touch. As St. Peters Estate Planning Attorney, Rosalind Robertson noted, “the IRA is a wonderful accumulator of wealth, where things break down is when that accumulated wealth is being held onto and tried to pass on to the next generation.” In order to make sure that they did get their tax dollars, the Internal Revenue Service included the concept of Required Minimum Distributions (“RMDs”). When an account holder reached age 70 ½ they were required to begin taking distributions from their IRAs whether they wanted them or not. In essence, the IRS was forcing them to recognize a portion of their IRA as income so they could begin receiving tax dollars on them. Even with these forced distributions, the growth on many accounts was keeping up with, or in some cases even outpacing, the distributions. For many, they were holding the accounts until they passed and then the money was being transferred to their beneficiaries.
The IRA Stretch Before the SECURE Act
For beneficiaries, other than the account holders’ spouse, receiving an IRA brings with it a set of tax implications. Each and every dollar the beneficiary takes out of the IRA is taxable as income in the year they receive it. This caused many beneficiaries to take advantage of the “stretch IRA” which allowed them to defer most of the money and in turn most of the income tax consequences. Under the old Stretch IRA rules, the beneficiary could begin to take their own RMDs. The advantage was that the RMD calculation was based upon their life expectancy which at a younger age resulted in much smaller distributions. Thus, the bulk of the IRA remained in tack and the balance was allowed to continue to grow tax free. The amount of tax dollars being missed through these deferrals was not lost upon the IRS nor congress.
The IRA Stretch After the SECURE Act
Under the SECURE Act the benefits of the Stretch have been significantly curtailed. Whereas the original stretch could allow for the distribution to be stretched over decades, under the SECURE Act Stretch IRA, the beneficiary is required to draw down the inherited account within a ten (10 ) year period. That means the entire tax burden associated with the inherited IRA account will be recognized within ten (10) years of the original owner’s death. The tax implications of this change are significant for those us holding an IRA to be passed along to our loved ones. In fact, as noted in Kiplinger, the “accelerated payments will, of course, be a boon for the IRS” and will “generate about $15,7 billion in taxes over the next 10 years” https://www.kiplinger.com/article/retirement/T037-C032-S014-don-t-let-the-secure-act-be-a-windfall-for-the-irs.html.
SECURE Act Implications for You
Each of us should be examining our planning to determine the effect of these changes on our intended beneficiaries. The allocation of assets among our loved ones now needs to take into consideration their earnings. If we have designated someone that will be in their peak earning years as the recipient of our IRA that could mean the IRS gobbles up 30 to 40 percent of that IRA in tax dollars. As Estate Planning Attorney Stephen Jones indicated, “you need to really think about who you want to receive inherited IRAs, more thought needs to be given to which asset should be given to which beneficiary to make sure we limit the reach of the IRS into our life savings.”
If you or your family has question on how to plan with your IRA or 401k, contact the experienced O’ Fallon Estate Planning Attorneys at Jones Elder Law. Get the information you need to make crucial decisions so Uncle Sam doesn’t take your hard work and sacrifice. If we can help guide you, contact our St. Charles Estate Planning law firm at (636) 812-2575 and ask to schedule a call or virtual consultation. For your safety and ours we have develop the Minimal Contact Planning process while the Covid-19 virus remains a concern.
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