The Government’s New Interest In Your IRA

USA Government

Its tax time again so today I want to briefly comment on two aspects of taxation.

The first is about how a new rule, The SECURE Act, will put a higher tax burden on your IRA.  The second is about the emotional taxes now being paid as a result of the current market dip.

If you don’t have any form of a qualified plan like an IRA or a 401(k), you might choose to skip the first section.  But if you do have a qualified plan and have any intention of passing it along to your next generation, you need to pay very close attention to that first section.

Move Over Kids, Your Uncle Needs More Room

The federal government has been very busy this past year.  There has been no shortage of measures put into place to navigate the pandemic.  Rather than wade too deeply into the philosophical end of that pool, my work requires me to be very specific about the things that will unquestionably impact my clients.  While it would be correct to say that a lot of the Washington reactions will be meaningful to the economic landscape and the ways it might matter to portfolios, there is no need for interpretation or curiosity about how the SECURE Act will rewrite rules that absolutely matter regardless of what the economy and markets do in the future.

From my perspective, the SECURE Act is a very big deal.  I’ve worked in this field for nearly three decades and in that time I’ve seen countless pieces of legislation and rule changes.  Many of them were initially thought to have major influence; in the end, they really didn’t.  But this SECURE Act is different.  Without question, and in every way, it assures one guaranteed outcome – that less of your IRA’s value will be going to your beneficiaries.  I suppose I should say there are two guaranteed outcomes because this also means that more of your IRA will be headed to the federal government.

Note that this rule doesn’t impact your surviving spouse, but it is a game changer for non-spouse beneficiaries.  Ultimately, whether it is upon your death or the death of your surviving spouse, if you have an IRA of any sort, this rule will impact you, your money, and your legacy.

I could waste a lot of time explaining why I dislike this rule.  But the summary would be that it is shameful why this had to be enacted, which is because the US government is broke and it needs more revenue.  And it is misguided in the way it impacts virtually every household in middle-America, a far cry from just our nation’s wealthiest.  In a world where politicians claim to be looking out for the interests of the every-man, this is a rule that hits that class of our society right in the wallet.  But it seems to be going largely unnoticed for being harmful to not just middle-Americans of today, but also to their kids.  It’s simply bad policy filled with deception, in my personal opinion. There are just enough token ‘pros’ to the Act to obfuscate the far larger ‘cons’.  The ways in which the typical American family will benefit from the Act pales in comparison to the ways in which they and their families will be harmed – to the benefit of Uncle Sam.

But I digress. Let me explain why this is a big deal as well as some potential ways to address it. I should also say that, as with all regulations, there are various pieces of and exceptions to the rules.  In this piece I’ll only refer to the issue that will be by far the most common.

The crux of my problem with the SECURE Act is that is abolishes the “Stretch” IRA.  This is the provision that allows for beneficiaries to take only modest required minimum distributions each year from IRA assets they inherit.  This allows them to pay only modest taxes on these assets each year; but more importantly it allows them to compound the value of those assets in a tax-deferred IRA account for their lifetimes.  This creates a very valuable long term asset to help beneficiaries prepare for their own eventual retirements.

The loss of this benefit will cost Americans dearly.  The benefits that used to accrue to your loved ones now accrue to the government.

No longer can a non-spouse beneficiary spread their taxable distributions over their life expectancy.  The new rule requires that an inherited IRA has to be emptied out entirely within just 10 years.  Gone are the days of you, the IRA owner, passing along a multi-decade tax advantaged growth engine to your next generation.  Surely it is still nice to pass along these assets in any way possible.  But the lost power of time and tax savings is huge.

You now need to tell your kids to move over because their Uncle needs more room at the table.  Is that why you saved your money all these years and laid out plans for how to use those assets both in your lifetime as well as part of your legacy?  I highly doubt it.

The money in your IRA can be withdrawn by your beneficiaries in any way they wish over that 10 year period.  They could take it all in year 1, wait to take it all in year 10, or vary their withdrawal rates throughout that period.  They can manage their taxable exposure each year along the way, but they need to keep in mind that if they don’t have a zero balance of that inherited IRA at the end of the tenth year they’ll pay a penalty of 50% of the amount that was supposed to be distributed that wasn’t.

The SECURE Act applies to all qualified plans, so both Traditional and Roth plans are impacted.  Though a distribution from a Roth still isn’t taxable, the government is clearly hoping those distributions will be put into taxable investments that generate more future revenue for itself.  No matter where your qualified retirement assets live, your broke Uncle found the address.

There are strategies for how to mitigate these taxes.  Depending on your situation, some are of no use and some are ideal.  An overview like this one doesn’t lend itself to detailed advice, but do be aware that past planning might now be far less effective and some changes to your income and legacy planning may be in order.

We all know that tax rates on all things will likely be changing soon.  Depending on how things shake out with taxes related to income, dividends, and capital gains, the notion of merely taking the minimum annual requirements from your IRA could be challenged.  Especially when seen through the lens of your legacy.  We want to be sure to pass along whatever we don’t use in our lifetimes the most efficiently as possible.  We don’t want to be overly generous to the government at the expense of our families.

Perhaps we want to look at the best ways to reduce the amount of qualified assets we pass along since they won’t go as far as they would have prior to this Act.    Perhaps we should be considering different gifting strategies to endow things like education funds for grandkids while reducing both current and future taxation.  Perhaps rearranging beneficiary assignments on our qualified plans to include whatever charities we wanted to benefit in our legacy can now not only benefit the charity, but also be how we pass along the most tax efficient assets to our family.  And now could also be the time to consider using life insurance as the most efficient legacy enhancer.  I’ve actually joked about how this Act seems to have been written by the life insurance industry’s lobbyists.  As much as this Act downgrades IRAs, it even moreso upgrades life insurance largely due to its tax-free status.  There are lots of ways to use life insurance and its versatility to combat this Act’s adverse impacts, but again, this isn’t the forum for that deeper dive.

Suffice it to say, this Act shifts the paradigm on how to value and prioritize our qualified assets.  It’s a new world in qualified plans and as the facts have changed, we need to correspondingly change our strategies.

A Purposeful Pause

The markets are in a downdraft at the moment.  Times like these are always stressful and we all wonder if this is merely a pothole we bounce over or if the road ahead is more perilous.  To avoid any needless suspense, I think this is a purposeful pause in the markets.  I know I’ve voiced my desire for a pause in the markets on a lot of phone calls in recent months.  We have seen a lot of movement this past year and a rest to consolidate the upward move is well warranted; and again, in my view is a welcome rest to keep the market healthy and able to continue higher in the years ahead.

As time goes by it feels almost like a game of Trivial Pursuit trying to remember just when and why stock prices may have dipped for a while at any particular time in years past.  But what isn’t at all trivial is the pursuit of our longer term goals.  And those goals are met through the patience and endurance we have to show through periods of lower markets.  This current phase seems to be another in the long line of productive pauses and not a new downward trend.

At the moment we have pipelines shutdown because of cyberattacks, fears about the return of inflation, heightened tensions in the Middle East, and Tesla playing ping-pong with Bitcoin. All are perfectly legitimate scapegoats for a temporary setback. This setback will be felt in all assets temporarily – time tested assets like stocks and bonds, and also the newer more speculative assets like cryptocurrencies. But we must remember that, ironically, these set-backs are part of the natural progress of all markets.

Remember, too, that in times of market stress, all assets first become highly correlated before they inevitably return to their own fundamental characteristics.  In other words, all things are painted with the same brush initially; but they do indeed decouple and provide their diversification benefits over time.  This is why seemingly all assets, things that shouldn’t all do the same thing at the same time, at first will actually all suffer before getting back to being themselves, so to speak.At the moment we have pipelines shutdown because of cyberattacks, fears about the return of inflation, heightened tensions in the Middle East, and Tesla playing ping-pong with Bitcoin.  All are perfectly legitimate scapegoats for a temporary setback.  This setback will be felt in all assets temporarily – time tested assets like stocks and bonds, and also the newer more speculative assets like cryptocurrencies.   But we must remember that, ironically, these set-backs are part of the natural progress of all markets.

It’s a funny thing about human nature that dips like these are always welcomed in advance, but then we feel awful when they actually arrive.  These dips are common and they are healthy, yet they still always seem to have a way of upsetting our stomachs.  Intellectually we all know that asset prices go up and down.  We know that trying to time market gyrations has led to more rags than riches.  And yet we still just humanly hate the feeling of a market dip.  The emotions overpower the brain.  It’s just how we’re wired.  So feeling nervous or even a bit frightened is, unfortunately, natural.  I refer to this as the emotional tax we must pay to outperform bank accounts over time.

A good way to defend against those emotions becoming overpowering is to remember that corrections are far better than bubbles!  When it comes to wealth creation in the years ahead, a bubble presents an infinitely larger risk than a correction.  Bubbles take years to recover from.  The average correction is typically here and gone in a handful of months and we typically have to endure at least one such event every year.  Bubbles, when they burst, are destructive.  Corrections like these help prevent those bubbles from growing.  So while they are never enjoyable, they are truly productive.

We all know markets experience volatile periods, and we even envision ourselves taking advantage of those types of opportunities.  But when they inevitably arrive, our resolve is tested.  We are more likely to worry about the correction leading to a genuine problem rather than seeing them as important stops on the journey.  Any thoughts of being opportunistic are challenged by the paralysis that comes from fear.  This is natural.  But this is also when mistakes might be made that could jeopardize the longer term goals we each have.

I’d love to say this particular bout of volatility is done, but I don’t believe that’s the case.  But let me say that this season of weakness doesn’t change my view of higher values in the not too distant future.  If anything, it’s what reassures that view.


The Takeaways:

  • Taxes, in all forms, are genuine enemies. We must control the taxes we pay on our income and on our investments, as we must make our peace with the taxes we pay through our emotions. The SECURE Act requires your beneficiaries to pay both income taxes and capital gains taxes sooner rather than later.   And now the downdraft in the market is charging its customary emotional tax.
  • If you intend to use your qualified assets (IRA, Roth IRA, 401k, 403b, etc.) as part of your legacy, please let me know so we can talk more about how to best accomplish that goal for you.
  • If you are feeling nerve-wracked by this market dip, please don’t hesitate to reach out so we can discuss it in more detail.
  • Remember that corrections are productive while bubbles are destructive. Nobody likes lower prices in real-time.  But we need to keep perspective on how they are more our ally than our enemy.



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