New Congressional Bill Punishes IRA Holders
Here’s one of my favorite Washington paradoxes…
On one hand, politicians say they want to help Americans save more for retirement.
On the other, they look for every possible way to punish people who actually succeed in the endeavor.
For proof of this look no further than a new bill that recently passed through the House Ways and
Means Committee with unanimous support. It’s called the SECURE Act and will soon go to a full vote along with a similar companion bill – called the RESA Act – working its way through the Senate.
The basic aims include:
- Letting employers automatically raise employee 401(k) contributions from a maximum of 10% of pay to a new max of 15%
- Increasing tax credits to small businesses that start up retirement plans and/or include automatic enrollment features
- Creating new ways for graduate students and other special categories to participate in retirement savings programs
- Plus, allowing penalty-free account withdrawals for births or adoptions
On the surface, these don’t sound too bad, right?
What You Might be Missing
I mean, perhaps we can argue over the idea of default 401(k) enrollment a bit, but there’s no real debate that all of these things are actually trying to improve access and general participation rates to 401(k) plans, which is positive overall.
Yes. And there are other good things in there, too. Stuff like…
- Creating more transparency and portability regarding lifetime income features of certain retirement plans
- Expanding 529 education plans
- And altering IRA age limits by allowing contributions above 70 ½ and raising the start of mandatory RMDs to age 72
Still sounds good, eh?
Well, it does as long as you don’t already have a solid IRA balance and a well-prepared estate plan.
Reason: One of the ways lawmakers want to pay for the SECURE Act is by forcing non-spousal IRA inheritances to get taxed more quickly.
In short, they want to do away with the “stretch IRA” strategy.
I’ve written about this plenty of times before, including right here in the Roadmap, but here’s the general idea…
Inheriting an IRA
When someone other than your spouse inherits your IRA, they face two basic choices:
A. Withdraw the whole amount by December 31 of the fifth year after your death
B. Begin receiving minimum distributions based on their own life expectancy.
Here’s an example:
Say you die this year and leave your Roth IRA to your son who is 53.
If your son decides to take minimum distributions, the IRS will use its actuarial tables (available in IRS pub. 590) to figure out roughly how long your son is likely to live.
Then the IRS will divide the value of your account by that number (31.4 this year) to arrive at a dollar amount for yearly distribution.
In the case of a $100,000 portfolio, your son would have to withdraw $3,289 next year ($100,000/30.4).
Now, look into the future many years.
While your son is taking those minimum distributions, the value of his inherited investment account can continue to rise!
I’m sure you can see the appeal of this approach, especially since you’re well aware of the effect of compounding.
And this “stretch” approach is especially good if you leave behind a Roth IRA because there’s never any income tax owed on anything for as long as the nest egg keeps growing and kicking off proceeds.
That brings me to another point. While this strategy would be great for a son or daughter, it would be even better for a grandchild or a great-grandchild.
Or at least is under current law.
If Congress Gets Its Way…
The whole opportunity will disappear.
Under the SECURE act, non-spousal beneficiaries would have to take out all the money within ten years. The Senate version forces all distributions to occur over five years if the account is worth more than $400,000. There are just a few small exceptions for minor children of the account owners and disabled beneficiaries.
So basically, if some form of this goes through, a lot of estate plans are going right out the window just like that.
In other words, these changes seek to help some Americans better prepare for retirement but they do it on the backs of plenty of people who have already been saving and planning for their families’ futures.
This is par for the course, and something I’ve predicted for years.
Indeed, three years ago, I sent out an email to hundreds of thousands of Americans with the following warning:
“For the longest time, I liked Roth IRAs for anyone with a long time horizon or for older Americans looking to preserve and grow wealth for future generations.
“But I’ve been changing my tune recently. That’s because I no longer believe lawmakers will honor the promises they’ve made regarding Roth IRAs.
“At the very least, I believe Washington will eventually alter the law so that Roth IRA beneficiaries can no longer withdraw their inheritance over their lifetimes — which was one of the primary reasons I was recommending rolling over assets from a traditional IRA to a Roth.
“Moreover, I believe it is also becoming far more likely that politicians will eventually remove the tax-free benefit on earnings within Roth IRAs… at least for wealthier Americans.
So here we are, and phase one is already happening.
Does phase two seem so outrageous, especially when you listen to some of the things being floated by some far-left politicians?
The Biggest Takeaway
Which brings me to the biggest point I want to make…
No matter how well we plan, lawmakers can completely alter the rules of the game any time they want.
That’s why we also have to continually re-evaluate our own strategies and assumptions.
Moreover, at this point, I suggest you favor approaches and loopholes that give clear, irrevocable benefits instead of relying on some status quo 30 years out… and that you always maintain one or more backup/alternate plans just to further limit your exposure to poor decisions made by politicians.
To a richer life,
— Nilus Mattive
Editor, The Rich Life Roadmap