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Retirement Perspectives

If the SECURE Act is passed by the Senate, certain beneficiaries who inherit retirement accounts will have less time to “stretch” post-death payouts.

Wouldn’t it be nice if your retirement accounts provide income that could last for years, and possibly decades covering multiple generations? Now, investors are able to do this through a “stretch” IRA, which facilitates a potential multiyear intergenerational wealth transfer after an account owner dies.

The “stretch” strategy allows a named beneficiary upon the account owner’s death to control payouts from IRAs, 401(k)s, and other defined contribution plans over their lifetimes. The beneficiary effectively inherits a tax-deferred account—or if it’s a Roth, a potentially tax-free account—from which payments can be spread over a significant number of years, thus offering tax-deferred compounding to continue and taxes on the payments may be minimized or at least defrayed for a considerable period.

However, we believe the “stretch” strategy is on life support due to a bill making its way through Congress. As part of the Setting Every Community Up for Retirement Enhancement (SECURE) Act that was passed in late May by the U.S House of Representatives, Congress would essentially eliminate the “stretch” and instead require some (but not all) beneficiaries to exhaust the payouts from inherited IRAs (including SEP and SIMPLE), 401k plans and Roth accounts in 10 years.

For example, under current rules, a 40 year old non-spouse beneficiary could stretch post death payouts (and therefore taxes) over his/her 43.6 year life expectancy, according to IRS tables. The SECURE Act, if passed, would shorten the maximum payout period to 10 years, or 33.6 less years!

Notably, a separate bill drafted by the Senate (who has as of this writing has yet to vote on the SECURE Act) proposes to limit the “stretch” payout to certain beneficiaries to a maximum of five years.

Why is Congress looking to (almost) eliminate the “stretch” strategy?

Revenue.  Congress is looking for money to offset the cost of taxpayer friendly provisions (e.g. removing the 70½ age barrier prohibiting traditional IRA contributions, increasing required minimum distributions (RMD) age, etc.) included in the SECURE Act. The second reason is Congress does not consider retirement accounts as a vehicle for estate planning. In other words, Congress believes retirement accounts were created for retirement income only.

Who would (and would not) be impacted?

As mentioned, the SECURE Act would change post-death (“stretch”) minimum distribution rules for defined contribution plans (e.g. IRA, 401(k), 403(b) etc.). The maximum payout period would be 10 years—specifically, all post-death distributions must be made by the end of the 10th calendar year following the year of the account owner’s death.

The proposed 10-year payout does not affect all designated beneficiaries. The 10-year payout rule would not apply if, upon death, the named beneficiary is the surviving spouse, disabled, chronically ill, is a child (who has not reached the age of majority), or an individual who is not more than 10 years younger than the deceased.

If the SECURE Act becomes law, retirement account owners should consult with their financial advisor and/or accountant about tax-efficient estate planning strategies. 

 

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results and are not indicative of any particular client situation.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

GLOSSARY OF TERMS

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees' accounts.

A defined contribution plan is a retirement plan that's typically tax-deferred, e.g. a 401(k), at employers. An employee contributes a percentage of his/her paycheck in an account to fund retirement. The sponsor company will generally match a portion of employee contributions.

A required minimum distribution (RMD) is the minimum amount an account owner must withdraw from a retirement account each year. An owner generally has to start taking withdrawals from a retirement plan account at age 70½. Roth IRAs do not require withdrawals until after the death of the owner.

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