cancel
Showing results for 
Search instead for 
Did you mean: 
     
Highlighted
Frequent Contributor

Tax impact of the SECURE Act

There's a lot written out there about how the SECURE act, affecting TIRA and employer retirement plan beneficiaries when  death of the retirement plan owner occuring in 2020, can have a profound effect on how much of the inherited plan will be lost to Federal and State income tax. So I thought it might be timely to actually do a couple of calculations on this.

This new maximum 10 year distribution requirement for all non-Eligible Designated Beneficiaries (NEDBs) will have the most pronounced negative tax effect on those NEDBs who are:

  • Only Children
  • Only Children of widow/widower with large TIRA + Employer retirement plan balances
  • Young
  • Single tax filer
  • Not needing the RMD for income
  • In a high Fed tax bracket
  • Resident of a high income tax state

So let's look at an example.

Sue, single and age 40 in 2020, is a surgeon and resident of Oregon and the only child of her mother, a widow age 70, who dies February 2020. Her father died two years ago, leaving $800,000 from his self-employed 401(k) that was rolled over and combined with the mother's TIRA. The balance of the mother's TIRA is $1,000,000 after her 2020 RMD withdrawal. The $1,000,000 balance was recently rolled over into Sue's inherited IRA she recently had set up to receive it. Sue's AGI for 2020 is expected to be about $220,000, putting her in the 35% Federal tax bracket and the 9.9% State tax bracket. She will remain in the 35% and 9.9% tax brackets, combined 44.9%, after reporting the inherited IRA RMDs for the next 10 years.

Sue is a conservative investors, so for this calculation, we'll assume her annual average return on a 50% equity/50% bond portfolio is 7% in her inherited IRA and 5% after-tax return on investments held in a taxable account.

The following is the chart comparing the RMD schedule under SECURE to what would have been the RMD schedule for 2019 and before.

SECURE tax effect.jpg

Note that Sue elected to take a withdrawal in 2020 thus drawing down the inherited TIRA over 11 years rather than 10. Due to the 10 year rule, with the assumptions given, she will have to add another $133,357 to her AGI each year, which over 11 years results in adding $1,466,927 of ordinary income to her AGI, which will be $1,114,473 more than the $352,454 she would have included had the SECURE Act not passed. Had Sue waited until 2021 to take her first RMD under SECURE, the annual RMD amount would have increased to $142,378. But with 11 years of withdrawals, the ultimate tax effect to Sue of this is as follows:

SECURE net tax diff.jpg

Sue's Fed + State income tax bill over the 10 year period will go up by $658,650 under the SECURE act, which will be $500,399 over the $158,251 she would have had under the old inherited RMD rules.

But the 'bottom line' effect of the SECURE act must take into account the values of the TIRA AND the value of the taxable accounts holding the after tax RMD amounts that will include investment returns. This chart shows this effect

SECURE bottom line.jpg

The TIRA after 10 or 11 years (depending on when the first withdrawal is made) will have $0 value as all of the pretax dollars have been withdrawn, while the TIRA under pre-SECURE Act rules, still has a balance of $1,499,128, given these conditions. Hence, the 'bottom line' effect after the mandatory full withdrawal period for Sue is a reduction in value of $692,594, due to the much higher taxes being taken out so quickly. And to show the value of that extra year of withdrawal in the year of death, had Sue's mother died in December and not allowed sufficient time to set up the inherited IRA and make a withdrawal in 2020, or had Sue simply not known she could do this, the 'Bottom Line' effect to her would have been a reduction in value of $749,769. But the loss of $692,594 represents 69.3% of the value of the inherited IRA.

This comparison is not completely accurate, as the future tax on the withdrawal of the inherited TIRA under pre-SECURE rules is not taken into account, net of earnings. This shows the financial effect to the household at the end of the mandatory 10 year withdrawal period, beginning with the first year following the year of death.

Now, without showing all the supporting graphics again, let's look at a case where the RMDs will be much less.

Jake is married and one of 4 siblings named equally in his father's TIRA as beneficiaries. His widowed father died at age 85 in February 2020 with a TIRA balance of $200,000, directing it be divided equally, or $50,000 each to his adult children. Jake is 60, with an AGI of $110,000 (about half of Sue's) his marginal tax rate is 22% Federal which he expects to drop to 12% in retirement at age 62 and he lives in a state with no income tax. His expected investment returns are the same as Sue's. And like Sue, he takes his first distribution in 2020.

His additional ordinary income reported over the 10 years following the year of death of his father is $43,028. Over this period, he'll pay $4,361 more in tax than what he would have paid under the old RMD rules.  Bottom line, the SECURE Act cost him $9,468 at the end of the 10 year mandatory withdrawal period over RMDs under the pre-SECURE rules, or 18.9% of Jake's inherited $50,000 value.

Just some interesting new numbers on the SECURE Act.

Anyone who'd like a copy of this Excel SS to try your own numbers, e-mail me at incomeonly at comcast dot net and I'll reply with it attached.

BruceM

 

8 Replies
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act

Bruce,

You have already done a lot of work, but may I ask: how, if at all, does the Secure Act impact disclaiming an inherited IRA?

As you know, there are instances where inherited IRAs are disclaimed (unlikely to happen with my beneficiaries!).

Thanks.

Bob

0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act

Bob

I didn't see anything in the new act showing a change to disclaiming, so I'd assume it can still be done. But then you've got to think where the disclaimed $$ would be going.

BruceM

0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act

Thanks, Bruce.

Bob

0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act


@BruceM wrote:

Bob

I didn't see anything in the new act showing a change to disclaiming, so I'd assume it can still be done. But then you've got to think where the disclaimed $$ would be going.

BruceM


Under rules for disclaimers beneficiary who disclaims is deemed to have predeceased the owner of the property and forfeited all rights to disclaimed property which means that successor beneficiary who inherits gets all tax benefits/liabilities of disclaimed property such as stepped up basis of decedent owner. Valid Disclaimer is not deemed to be a gift by disclaimant. Best recipient for disclaimed taxable income, e.g., TIRA, is taxpayer in lower bracket than designated beneficiary, e.g., grandchild, relative or a non profit org. Or person who could use the money the improve their life with increased income , e.g., pay off mortgage. Under rules for disclaimers, party who disclaims part or all of an inherited asset, e.g., TIRA, cannot direct who will receive it. Disclaimed property must be transferred to next party or parties in succession under beneficiary designation executed by deceased owner which is why owner must select successor beneficiaries carefully. Generally Disclaimer must be executed within 9 months after death of owner of property although there are different rules for minors who inherit. There is no limit to number of successor beneficiaries or how many can be co beneficiaries of the same successor level.

some states have similar laws which are sometimes called renunciation which may have different requirements. A beneficiary who wants to disclaim an inheritance should consult counsel before executing a disclaimer.

0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act


@BruceM wrote:

Bob

I didn't see anything in the new act showing a change to disclaiming, so I'd assume it can still be done. But then you've got to think where the disclaimed $$ would be going.

BruceM


My wife and I received three identical letters (for our three accounts) from Vanguard that the dormant accounts - disclaimed probably - warning us that it would send the money to the state. There was a problem in Vanguard last year that an employee stole from such accounts and passed it to his brother-in-law's account. In any case, both were caught and prosecuted. So, Vanguard sent these warning letters to us.

 

0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act


@ECEPROF wrote:

@BruceM wrote:

Bob

I didn't see anything in the new act showing a change to disclaiming, so I'd assume it can still be done. But then you've got to think where the disclaimed $$ would be going.

BruceM


My wife and I received three identical letters (for our three accounts) from Vanguard that the dormant accounts - disclaimed probably - warning us that it would send the money to the state. There was a problem in Vanguard last year that an employee stole from such accounts and passed it to his brother-in-law's account. In any case, both were caught and prosecuted. So, Vanguard sent these warning letters to us.

 


In the context of inheriting, disclaiming by a beneficiary allows the funds to go to the next beneficiaries mentioned.

The dormant/inactive accounts are something else. To avoid dormant account situation, one should make a small transaction [deposit or withdrawal] - interest/dividend reinvestments don't count. Don't ignore such a notice. State laws require that banks/brokers send dormant account funds to State. There is a dispute going on between States and the Fed about who should get dormant/unclaimed Savings Bonds - the Feds hold on to them but some States say they they should get those funds. 

YBB
0 Kudos
Highlighted
Frequent Contributor

Re: Tax impact of the SECURE Act


@yogibearbull wrote:

@ECEPROF wrote:

@BruceM wrote:

Bob

I didn't see anything in the new act showing a change to disclaiming, so I'd assume it can still be done. But then you've got to think where the disclaimed $$ would be going.

BruceM


My wife and I received three identical letters (for our three accounts) from Vanguard that the dormant accounts - disclaimed probably - warning us that it would send the money to the state. There was a problem in Vanguard last year that an employee stole from such accounts and passed it to his brother-in-law's account. In any case, both were caught and prosecuted. So, Vanguard sent these warning letters to us.

 


In the context of inheriting, disclaiming by a beneficiary allows the funds to go to the next beneficiaries mentioned.

The dormant/inactive accounts are something else. To avoid dormant account situation, one should make a small transaction [deposit or withdrawal] - interest/dividend reinvestments don't count. Don't ignore such a notice. State laws require that banks/brokers send dormant account funds to State. There is a dispute going on between States and the Fed about who should get dormant/unclaimed Savings Bonds - the Feds hold on to them but some States say they they should get those funds. 


Yogi

That is interesting. Thanks. Don't worry. I sent money to the taxable account. There is already one in the pipe line. I submitted 6 trades but 5 were executed in all.  Wait for another day.

0 Kudos
Highlighted
Participant ○○○

Re: Tax impact of the SECURE Act

Disclaiming might be quite helpful, depending on the RMD circumstances.  

In the past, when lifetime gifting caps (without tax consequence) were low, it was a useful tool to limit the size of someone's estate.  Say the wealthy brother left the wealthier brother some assets that would be taxed at 40+% at the Federal level (let alone the state level) ... disclaiming could move that to the wealthier brother's heirs.  

In some cases, it might not be worth it, depending on state and probate fees for a specific state.  Don't know.

I do know that probate in the lovely state of Connecticut takes 1% of all assets, whether part of probate or not.  So that trust or CD gets taxed in my state.  Supposedly, there is a lawsuit against the state for charging probate fees for items that should not be a probate matter, but I haven't heard where that lawsuit stands.  

ctyankee

0 Kudos
Announcements