The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 significantly changed the landscape of retirement savings for many individuals. Of the key areas the Act targets to help Americans prepare for retirement, many impact a common savings vehicle: Individual Retirement Accounts (IRAs).
Now is a good time to review these changes, as required minimum distributions (RMDs) from the traditional IRA for tax year 2022 must be made prior to December 31, 2022.
Significant Changes to IRAs from the SECURE Act
The SECURE Act:
- Requires IRA owners to begin taking RMDs at age 72 (up from 70 ½)
- Generally requires non-spousal beneficiaries who inherit IRAs to distribute 100% of the account balance over a 10-year period (allowing only minor children, disabled/chronically ill individuals and those within 10 years of the age of the IRA owner to stretch their distributions beyond 10 years). This 10-year period applies to both traditional and Roth IRAs.
- Note that beneficiaries must take RMDs for taxable IRAs during the 10-year period if the IRA owner dies after taking an RMD. These RMDs would be based on the IRS table for beneficiary life expectancy. This does not apply to Roth IRAs.
- If no RMDs have been taken, then there is no annual distribution required during the 10 years.
These changes are important, particularly as heirs will need to pay taxes faster and in many cases at higher tax rates since most will now have to distribute the entire inherited IRA within 10 years. If you are a beneficiary or an owner of a traditional IRA, below are strategies that can help you minimize your tax burden.
Tax Minimizing Strategies for IRA Beneficiaries
Consider Bracket Topping
You can use what’s known as bracket topping to help minimize tax over the 10-year distribution period for inherited taxable IRAs. Bracket topping requires you to review your taxable income each year and take enough IRA distributions to push taxable income up to the edge of the next tax bracket. You can then invest these distributed funds outside the IRA, use them for spending needs and/or to pay the taxes.
Depending on the size of the IRA, you may want to consider using up another tax bracket or two. The current tax brackets are: 10%, 12%, 22%, 24%, 32%, 35% and 37%. The key breakpoints are the increases from 12% to 22%, and then from 24% to 32%. So, for more modest incomes and IRA balances, adding IRA income up to the top of the 12% bracket makes a lot of sense. For higher income and larger IRAs, taking distributions up to the top of the 24% bracket makes sense.
Bracket topping can also be useful for spousal IRA rollovers. Spousal rollover planning is best when done in the final year you are filing your taxes as married filing jointly. For example, in 2022, the 24% tax bracket tops out at $340,100 for those married filing jointly, while this same 24% tax bracket tops out at $170,050 for single taxpayers. In this case, if you had $170,000 of other taxable income, you could distribute an additional $170,000 in the final year of filing married filing jointly, all of which remains taxable at a 24% rate. If you were instead to wait to distribute that same $170,000 when you file as a single taxpayer with $170,000 of other income, the entire amount would be taxed at a 32% tax rate, which creates an additional $13,600 in tax.
Make the Most of Charitable Donations and Other Qualified Plans
When it comes to charitable donations, you can use the related tax deductions to offset inherited IRA distributions to help avoid high income years and fund your charitable goals at the same time. You can:
- Bunch charitable donations in years you take larger RMDs.
- Donate appreciated securities instead of cash (must be long-term capital gain property).
- Set up a more advanced method of giving, such as a donor advisor fund, family foundation or a specialized charitable trust.
You may also want to contribute the maximum allowable amounts into each of the retirement plans available to you during the 10-year IRA drawdown period, to reduce your total income. These include plans such as 401(k)s, 403(b)s, IRAs and HSAs.
Tax Minimizing Strategies for IRA Owners
If you are the owner of a large traditional IRA, you can minimize the tax associated with passing a large balance onto your beneficiaries in a few different ways.
Move IRA Assets to ROTH IRAs
In general, Roth IRAs are better assets to pass onto your heirs. Not only are distributions tax-free, but the entire balance can grow tax-free and be distributed at the end of the 10-year distribution period since there are no tax implications to manage. Of course, the downside is paying the tax to convert IRA assets from a traditional IRA to a Roth IRA.
If you are over 72 and do not need the funds from your RMD, one strategy is to use the distributions to fund a Roth IRA conversion. For this strategy, you take your RMD, and then use part of the distribution to pay tax on the RMD, and use the rest of it to pay the tax on converting a portion of the remaining IRA balance to a Roth IRA account. If you do this over a period of time, you can move a significant amount of assets over to the Roth IRA in a tax-efficient manner.
Use Qualified Charitable Distributions (QCDs)
IRA owners can also look to qualified charitable distributions (QCD) as a tax savings tool. These distributions are directly transferred from taxable IRA assets to public charities. The maximum QCD amount is $100,000, per spouse if married, but you must be over the age of 70 ½ to make these types of distributions. QCDs not only allow you to satisfy the RMD requirements, but the distribution is also excluded from your adjusted gross income such that it does not affect your itemized deductions and is non-taxable for state tax purposes.
Use a Living Trust as the IRA Beneficiary
Finally, you can use a living trust as the IRA beneficiary, so when you pass away the trustee can assist your heirs in making tax-efficient distributions. The trustee can implement bracket topping and time distributions to minimize taxes over the full 10-year period. A living trust makes more sense if there is a large IRA balance, there are multiple beneficiaries with different tax situations or in situations where the beneficiaries will need oversight in managing the distributions. The trustee can be given a great deal of flexibility in allocating the distributions to the heirs, but these intentions should be well documented within the living trust document.
There are many other areas of impact to consider when looking at the tax savings provided by any of the options above. State taxes, net investment income tax, Medicare premiums, qualified business deductions, phase outs of certain tax credits or itemized deductions, and taxability of Social Security can all be impacted by IRA planning strategies.
Regardless of whether you are the owner or beneficiary of traditional or Roth IRAs, you will want to work with your tax team, attorneys and financial planners to implement any of these strategies as you plan for your retirement.
Contact Christina Roman at firstname.lastname@example.org, Scott Swain at email@example.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.