Michelle Singletary: Your IRA was never intended to be a vehicle to pass along your wealth

I’ve been hearing from a lot of readers who are concerned about a new rule under the Secure Act that ushers in significant changes to retirement savings starting in 2020.

The Secure Act, which stands for Setting Every Community Up for Retirement Enhancement, is intended to make it easier for people to fund their retirement with their own savings.

However, chief among the changes is a provision that affects IRAs or 401(k) accounts left to beneficiaries. As part of their estate planning, people are allowed to pass along whatever is left in their tax-advantaged retirement accounts.

Under current law, if you inherit an IRA or defined contribution plan such as a 401(k) from a non-spouse, you have to take required minimum distributions, or RMDs, but you can extend the withdrawals over your lifetime to minimize the tax hit. In the financial and estate planning industry, such a strategy is referred to as a “stretch IRA.” It’s called this because the required minimum distributions in some cases can be stretched out for decades, allowing the funds to continue growing tax-deferred.

But starting this year, the Secure Act imposes a 10-year window to draw down the money. There are no required minimum distributions, but beneficiaries must take all the money that’s left and close the account after a decade. This rule – a revenue raiser – would help offset tax losses due to other changes as a result of the Secure Act. For example, the new law increases the age that a required minimum distribution must start from 70½ to 72. Currently, people reaching 70½ must begin taking RMDs from their Individual Retirement Accounts, known as IRAs, and workplace retirement plans.

The Wall Street Journal’s editorial board criticized the change that affects stretch IRAs.

“Favorable tax treatment isn’t a holy writ,” the editorial board wrote. “But before saving money over decades in a special account, people need to have faith that future politicians won’t rewrite the rules willy-nilly.”

Financial adviser Philip DeMuth in a post for the Wall Street Journal in July wrote, “Like grave robbers opening King Tut’s tomb, Congress can’t wait to get its hands on America’s retirement-account assets.”

There is nothing wrong with trying to minimize your taxes or the tax bill for your heirs. That’s a smart money move. However, IRAs and 401(k)s weren’t meant to be used as a way to transfer wealth. They were designed to encourage people to save by giving plan participants and/or account holders – not their children or children’s children – a tax break. The loophole created by the law that has allowed beneficiaries to stretch out their tax burden was a bonus, not an entitlement that should never be touched.

The provision affecting stretch IRAs would generate $15.7 billion of revenue, according to the Congressional Research Service.

Brian Graff, the chief executive of the American Retirement Association, argued as much in a post last summer for the National Association of Plan Advisors.

“We have nothing against estate planning and we certainly don’t have anything against anyone trying to reduce their taxes,” Graff wrote. “However, to get the provisions in the Secure Act, which we believe will help improve the retirement security of millions of Americans, Congress decided it was necessary for the legislation to be revenue-neutral. Ultimately, we have concluded that the enormous potential benefits of the legislation for retirement savings outweigh the ‘pain.’”

In an interview, Graff also pointed out that the stretch IRA estate planning strategy isn’t widely used by most Americans.

“Only a certain class of people have that much money to give to their grandchildren and children,” he said. “The policy basis for why Congress made this change was that we should give a tax benefit to people who are saving for retirement.”

Aron Szapiro, the director of policy research at Morningstar, also doesn’t see a problem with the new rule for inherited IRAs.

“I don’t see this is as an unreasonable thing to do,” Szapiro said. “These accounts were not designed to be large intergenerational tax avoidance vehicles.”

With change often comes confusion. For example, the Secure Act carves out exceptions to the stretch IRAs:

• The surviving spouse of the employee.

• A child of the employee who has not reached the age of majority.

• A disabled individual.

• A chronically ill individual.

• An individual who is not more than 10 years younger than the employee who died.

Here’s a question from a reader about her inherited IRA as it relates to the exceptions.

Q: I’m a 64-year-old woman and have been dealing with advanced, recurrent ovarian cancer. My long-term prognosis is not great. It’s a pretty good bet that my healthy 83-year-old mother, who struggles to get by on Social Security, will outlive me, perhaps by a decade or more. My mother and my boyfriend (age 59) are currently my IRA beneficiaries. With the new law, can my mother and boyfriend still inherit my IRAs, and take RMDs, stretched out over their own life expectancies? Or, must they empty the IRA within 10 years as the new law states?

A: Christine Russell, senior manager of retirement and annuities at TD Ameritrade.

One of the most significant changes resulting from the Secure Act is the elimination of the “stretch” provision for most non-spouse beneficiaries of inherited IRAs. Previously, for non-spouse beneficiaries, the stretch provision meant they could take distributions over their life expectancy. Now, for retirement account owners who pass away in 2020 and later, most non-spouse beneficiaries have 10 years to drain the account. This could be the case for older beneficiaries such as the healthy 83-year old mother unless she meets one of the below exceptions.

There are exceptions to the Secure Act’s new 10-year rule for certain non-spouse “eligible designated beneficiaries” including: a beneficiary no more than 10 years younger than the deceased account owner, and a beneficiary who meets the definition of disabled or chronically ill under the Internal Revenue Code. These eligible designated beneficiaries will still be able to take IRA distributions over their life expectancies. In this situation, it sounds like the 59-year-old boyfriend may be considered an eligible designated beneficiary, based on the information provided. Thus, he may be able to take distributions from the inherited IRA based on his life expectancy.

The exceptions – and the other new provisions of the Secure Act – require careful analysis, so we strongly suggest the reader should consult with a tax professional. This is not intended as tax advice. This answer assumes that the reader’s mother and boyfriend are primary (and not contingent) beneficiaries of her IRA accounts. It also assumes that the beneficiaries claim the IRA account on a timely basis after the death occurs. It is important to note that this information is based on the law as passed Dec. 20, 2019. It is common to get additional regulations from the IRS after a law is passed and these IRS Regulations may further clarify or modify the information provided herein.