The SECURE Act 2.0 which passed towards the end of 2022 ushered in a great many changes to the retirement planning landscape, too many to catalog in one short article. Thankfully, not all of these provisions become effective immediately, which gives Americans time to digest them. One of the most momentous of these changes appears not to take effect for some time, but actually impacts how many should plan for the future, starting today.
Specifically, I have in mind the change to the age at which Americans must begin taking Required Minimum Distributions (RMDs) from 401ks, 403bs and IRAs, which among them hold by far the largest pool of retirement assets held by Americans, rubbing up against $20 trillion. The first SECURE Act—passed at the end of 2020—raised the age at which RMDs must begin from 70.5 to 72. The SECURE Act 2.0 raises the age first to 73 beginning in 2023, then to 75 beginning in 2033.
Right about now some of you may be thinking: “Big deal, 2033 is a long time in the future.” But actually, this changes things for lots of people right now, because this changes the horizon of their retirement income planning for anyone born after 1960.
Similarly, you might be thinking: “This is great, because starting RMDs later allows me to hold onto my hard-earned dollars for longer before having to give them up to the consarned government.” Which is true, but right about here the plot thickens. Because what we need to be thinking about is less when the government at long last gets to tax this long-deferred income, but how much in taxes will ultimately be paid on it.
Very commonly people with decent-sized retirement accounts pass away with reasonable chunks of change in them. Indeed, that’s a goal for most of us: both to leave something to our loved ones and, more importantly, to hedge against longevity risk, making sure we never run out of money. Up until the passage of the first SECURE Act, IRAs inherited by heirs could be “stretched” over the heirs’ lifetimes, with beneficiaries taking RMDs based on their own life expectancies. The SECURE Act eliminated the Stretch IRA, as it had come to be known, for most non-spouse beneficiaries, i.e., the children who most often inherit them upon the death of their second parent.
Instead of being able to stretch distributions from IRAs over their lifetimes, next-generation beneficiaries who inherit IRAs now have just 10 years to empty them. Combined with a later start to RMDs for the parents, this dramatically compresses the timetable over which IRAs need to be emptied.
The top quintile income groups this impacts continue to live longer—despite the “deaths of despair” trend which has hit U.S. life expectancy generally. Affluent U.S. males have a median life expectancy around 85 while top quintile women can generally expect to live to 87 or so. So, on average, given the new tax laws, the IRA of someone born after 1959 will need to be emptied over the course of 20 to 25 years, as opposed to 40-and-change for someone who died in 2019 before the law changed.
Therefore, these two changes—the deferral of the mandated beginning of RMDs and the disappearance of the Stretch IRA—mean that people now need to think intergenerationally about tax rates: Will your money get taxed more during your lifetime or during your child’s? Even with the age of child-bearing having risen over the last couple of decades, by the time those with sufficient means to retire do so somewhere in their 60s or 70s, parents often have reasonable insight into their children’s professional arc and, therefore, their income prospects.
Most retirees will fund their retirements using a mix of Social Security, cash flow from tax-deferred asset pools (401ks, IRAs and even perhaps traditional defined benefit pensions), Roth IRAs and 401ks, and taxable assets such as homes and brokerage accounts, most of which will have unrealized capital gains. For most people, the taxable income sustainably derivable from these asset pools will be lower than what they earned during their working years and therefore will be taxed at lower rates.
The financial planning community has historically recommended that people should fund retirement by first emptying taxable accounts, then tax-deferred accounts like IRAs and 401ks while taking RMDs, and lastly Roth accounts. It is no longer clear that this order of operations makes sense for everyone.
In many cases, it might make sense for people to start taking distributions from 401ks and IRAs before RMDs kick in and force them to in order to smooth their income over time and manage exposure to higher tax brackets. Also, depending on one’s kids’ income, leaving assets in taxable accounts to take advantage of basis step-up at death could make sense. There’s even a plausible argument for higher earners to overweight deferrals into Roth 401ks or forego 401ks altogether and invest in taxable assets, depending on what their kids’ tax brackets are and how large they expect their tax-preferred assets to be at death.
Certainly, this all argues for maintaining open lines of communication about money and careers between parents and kids. These conversations are not always easy because they can be loaded with the baggage of parental agendas and expectations and their fraught echoes in kids’ perceptions of what their parents want and expect and how they have lived up to expectations.
Tax planning is further complicated by the possibility of change: the daughter or son seemingly on a high-powered career trajectory might be unhappy in it and leave, say, corporate law or the like, at the age of 38 for something less remunerative but more fulfilling. Or the opposite might happen as a child finds her money-making groove. The parents and kids who can work through this stuff best and communicate openly and non-judgmentally about money and goals are those who have the best chance at optimizing tax rates across generations.
Then there are the macro considerations. On the one hand, the U.S. fiscal situation implies that taxes are likely to go up in the future. Our national debt is large and our situation towards the tail end of the wave of baby boomer retirement does indeed challenge the fiscal soundness of Social Security and Medicare.
The politics of this are hard, with Republicans unrealistically resisting tax rises and Democrats equally unrealistically insisting that entitlement benefits are sacrosanct. In any case, the tax cuts ushered in by the TCJA (Tax Cuts and Jobs Act) in 2017 are scheduled to sunset at the end of 2025, which would return us to marginally higher rates, albeit ones that are unlikely to be enough to fill the hole we’ve dug for ourselves.
In an ideal political world, these conditions would set the stage for a grand bargain in which each political party would recognize that compromise was necessary and each would yield. But we don’t live in an ideal world.
One way or another, tax rates will likely rise in the future. The two Secure Acts have complicated how we need to think about taxes. We are blessed to live in interesting times.
