Hidden Value is a column in ThinkAdvisor where Joe Elsasser, CFP®, answers common questions with insights that advisors and their clients may not have considered. This week, Joe discusses the tax implications of the SECURE Act.
Advisors who specialize in retirement income planning should be aware that some of the changes outlined in the recent SECURE Act could cause eventual tax headaches, particularly those related to the new, later age for required minimum distributions, and the elimination of the “stretch IRA.”
It may appear that increasing the RMD age to 72 would reduce the tax burden since, depending on the client's birthday, withdrawals from IRA accounts could be deferred an extra year or two. However, the larger balances in these accounts can causes the RMD at age 72 to be larger than it would have been at 70 ½. If the client is able to meet their desired lifestyle need with less than the full RMD, then any excess RMD will be taxed at the client’s highest marginal rate, which may be higher than if the client were to spread withdrawals over a longer period of time.
Additionally, prior to the change in legislation, IRA distributions from inherited accounts could be spread over the beneficiary’s lifetime. The tax benefits of a "stretch IRA" could be substantial, since only a small portion of the IRA was required to be distributed each year, allowing additional compounding and the ability to minimize withdrawals during the beneficiaries’ highest earnings years. The SECURE Act added a new 10-year provision that is both positive and negative. It creates more flexibility within the first 10 years after the client’s death, but that flexibility is only available for 10 years.
Trusts established to control IRA distributions have also been impacted by changes in the SECURE Act. In the past, some trusts were written to say that a client’s beneficiary can take only the required distribution. That trust needs to be modified. Otherwise you’re setting the beneficiary up for a bad tax situation. If the trust is not modified, all of the IRA money will be forced out of the IRA in the final year. This would cause the effective tax rate on these funds to be significantly higher than if distributions were spread out, filling lower brackets throughout the 10-year period.
"Most CPAs and accountants who do tax returns for middle-income people want to help their clients pay as little tax now as possible. Yet often that’s not the best choice. Good planning is about understanding the tax burden you’re leaving behind and trying to find a good equilibrium between taxes now and taxes later. Start the conversation now, knowing that you probably won’t close it until later in the year. Tax season is a good time to address the topic since clients have taxes on their minds," said Elsasser.
Read the ThinkAdvisor article in its entirety.
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