In the final days of 2017, President Trump signed into law a major overhaul of the U.S. tax code, the so-called Tax Cuts and Jobs Act, that contained major, life-changing elements for many American expat small business owners in particular.
Two years on, as December drew to a close and Washington was once more preparing to close down for the annual end-of-year Christmas/New Year break, President Trump signed another piece of legislation that was again set to take effect on the first day of the New Year.
And once again, although it affects all U.S. taxpayers who save for their retirement, it’s causing questions to be asked by tax experts and wealth planners who specialize in looking after expats, as well as those of their clients who have learned of it over the last few weeks.
The legislation in question has been dubbed “the SECURE Act”, which stands for “Setting Every Community Up for Retirement Enhancement”.
As the name implies, the emphasis is meant to be on the bill’s stated role of introducing various provisions aimed at boosting retirement payouts for Americans who otherwise might not be well provided-for in this area.
Among its wide-ranging features, the act seeks to make it easier for smaller employers to join open, multiple-employer retirement plans; ease non-discrimination rules for frozen defined benefit plans; and add a safe harbor for selecting lifetime income providers in defined contribution plans.
It also increases the automatic-enrollment safe harbor cap to 15% from 10%.
However, as a number of experts have been pointing out over the last few days, certain of the changes appear likely to hit many savers who actually had gone to the trouble of saving for their retirements – specifically with respect to eliminating a rule that until now has allowed certain beneficiaries of individual retirement accounts (IRAs) to “stretch” the distributions across their lifetimes.
“The stretch IRA is dead” is how InvestmentNews, a New York-based advisory industry trade publication, headlined an article on the subject on Dec. 27.
Among those who’ve been calling attention to the changes being introduced by the SECURE Act over the two weeks since Trump signed it into law (on Dec. 20) has been John Richardson, the Toronto-based lawyer and expat rights campaigner.
According to Richardson, the removal of the “stretch IRA provision” is among the tricks the SECURE Act’s drafters evidently relied on to provide the funding needed to accomplish the legislation’s undeniably-laudable objectives.
Specifically, he explains, the SECURE Act means that as of now, the named, non-spouse beneficiaries of IRA account-holders who happen to die anytime after Jan. 1, 2020 will need to have the full amount of the deceased’s IRA paid out to them within 10 years of the deceased’s death.
Until now – and typically, more tax-advantageously, Richardson says – these non-spousal beneficiaries normally had the option of being able to “stretch out the disbursements over their lifetimes”.
The limitation to ten years, he explains, is an “anti-deferral provision” that Washington lawmakers who drafted the Act are using to pay for the legislation.
In other words, certain taxpayers are having their savings tapped to provide better opportunities to other taxpayers who, for whatever reason, have been less disciplined or successful in providing for their retirements.
The fact that the new rules have been forecast to raise an estimated US$15.7bn in funding, Richardson adds, reveals the scale of money that’s expected to come from somewhere else – evidently including the pockets of future IRA beneficiaries.
Writing in InvestmentNews, journalist Mark Schoeff Jr. quoted a number of Stateside experts who predicted that the elimination of the stretch provision would prompt investors to convert their schemes to “Roth IRAs”, a type of IRA which applies the tax on contributions rather than on the withdrawals.
This, Schoeff noted, could help to ease what otherwise could be “a substantial tax bill for IRA inheritors after a decade”.
Schoeff quoted Woodlands, Texas-based Justin Brownlee, owner of Brownlee Wealth Management, as saying it would now be “critical” for investors “to execute Roth conversions on the highest scale possible”.
“Prior to the SECURE Act, the difference between doing Roth conversions from ages 60 to 70 and not doing them could be millions of dollars over a few decades,” Brownlee added.
“Now it’s even more extreme. A Roth conversion is going to be more powerful than taking Social Security at an early age.”
Schoeff quoted another adviser, Rob Greenman of Portland, Oregon-based Vista Capital Partners, as adding: “Now that the rules of the game have changed, it could change the math in terms of how much to convert and in what time frame.”
As for how much this change will affect expat taxpayers, an individual’s country of residence could be a factor, as it often is when it comes to cross-border tax matters, Richardson points out.
Roth IRAs ‘still advantageous
for Americans in Canada, but..’
For example, American expats resident in Canada may be able to take advantage of the fact that if they convert their IRAs into a Roth IRA, they should be able to benefit from the special treatment ROTH IRAs are accorded under the existing U.S./Canada tax treaty, Richardson says.
In the past, for example, he notes, Americans moving to Canada with existing Roth IRAs have found them to be attractive, as long as they made no new contributions to them, as this has meant that these savings products would, under the current Canada/U.S. tax treaty, be treated as a pension and thus enjoy tax deferral in Canada, (so long as they were not taxable in the U.S.)
While Roth IRAs are expected to continue to enjoy this treatment, Richardson notes that the SECURE Act shortens the period of tax-deferred growth to ten years.
Said Richardson: "Tax treaties giveth, and tax treaties taxeth."
Other features of
the SECURE Act
While the ending of the “stretch IRA” seems to be the aspect of the Secure Act that’s getting the most attention at the moment, it’s not the only change the act is introducing.
It also looks to expand the use of annuities by 401(k) plan investors, for example – a fact which is being met by a few raised eyebrows, as annuities tend to be more popular among economists and insurance industry brokers than consumers, who typically prefer to have more control over their savings than annuities give them.
Annuities provide a guaranteed income over the course of a retiree’s lifetime, and thus can be a sensible option, proponents say, at a time when people are living longer. However, experience has shown in the U.S. and elsewhere that people often prefer to maintain more control over their own retirement savings than the annuity structure typically offers.
As set out in the SECURE Act, U.S. insurance product providers, which market 401(k)-plan compliant annuities, take over (from employers) the responsibility for ensuring that the products being offered to 401(k) plan investors are suitable for the individuals involved.
Another change being introduced by the SECURE Act sees the elimination of the maximum age for traditional IRA contributions, which until now had been capped at age 70.5 years. This is said to be a response to an increase in the number of Americans who are working beyond the traditional retirement age (currently 67 in the U.S.)
That said, experts in the U.S. have warned that Americans who turned 70.5 years old in 2019 still would have needed to withdraw their “required minimum distributions” (RMDs) by the end of 2019, to avoid being hit with a penalty – even though those turning 70.5 years old in 2020 aren’t being required to withdraw their RMDs until they’re 72.
In general the SECURE Act features wide-ranging provisions, including ones that make it easier for smaller employers to join open multiple employer plans, ease non-discrimination rules for frozen defined benefit plans and add a safe harbor for selecting lifetime income providers in defined contribution plans. It also increases the automatic-enrollment safe harbor cap to 15% from 10%.
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