Legislation attached to the year-end Spending Bill included some major tax and retirement reforms. With the Spending Bill now passed and signed by the President, the Setting Every Community Up for Retirement Enhancement or SECURE Act also became law.
The SECURE Act brings a number of sweeping changes to retirement planning both of which present new opportunities and also new challenges which are highlighted here.
Age Limit to Make Traditional IRA Contributions Eliminated
Beginning in 2020, the age limitation on making contributions to your Traditional IRA is eliminated. Regardless of age, as long as you have "compensation" or earned income from wages or self-employment, you may contribute to your traditional IRA which expands opportunities for contributions for older clients. Previously, the year in which you reached age 70.5 you were prohibited from making additional contributions to your traditional IRA.
Age to Begin Required Minimum Distributions Raised to 72
The SECURE Act also raises the age in which required minimum distributions (RMD's) begin from age 70.5 to age 72. This applies to IRA owners who reach age 70.5 in 2020 or later with RMD's now to begin when they reach age 72. An additional time delay in taking forced IRA distributions makes tax management strategies to fill lower tax bracket years pre age 72 more valuable. In other situations where IRA resources are not needed, the new law allows retirees to keep IRA resources growing a little longer tax deferred.
Qualified Charitable Distributions Still Begin at Age 70.5
The qualified charitable distributions (QCD's) age of 70.5 did not change with this legislation. Thus, QCD's can still be made beginning at age 70.5 using the traditional IRA account even though RMD's will not be required to be taken until age 72. If you are charitably inclined, you can use your IRA to make a QCD up to $100,000 for the year direct to the charity beginning at age 70.5. Using IRA resources in this way helps avoid the income tax consequences on the charitable gift with IRA funds sent pre-tax to the charity. Beginning at age 72, a QCD can be used to offset the IRA required minimum distribution up to $100,000 for the year.
Ability to Stretch Traditional IRA Distribution Period is Now Restricted
With Congress looking for revenue sources, the stretch IRA provisions were eliminated. Under the SECURE Act, for most non-spouse IRA beneficiaries beginning with deaths after December 31,2019, the inherited IRA account will now be required to be paid out by the end of the 10th year following the year of the IRA account owner's death, which means beneficiaries will be paying more taxes sooner. Previously, the inherited IRA account would be paid out over the life expectancy of the beneficiary thus stretching out the payout period. There will not be annual required minimum distributions for inherited IRA's but only a requirement for the account to be emptied by the end of the 10th year following the year of death.
Eligible Beneficiaries Not Subject to the New 10-Year Rule
The loss of tax deferral and the stretch IRA may create more opportunities for Roth conversions with the SECURE Act aiming to push non-spouse beneficiaries into higher tax brackets in the future. Roth conversion of traditional IRA money today, when tax rates are relatively low and pre-age 72 for the IRA owner may be a very efficient tax strategy especially for families with wishes to pass resources on to the next generation.
Trusts as Beneficiaries of IRA's Impacted
Those with conduit trusts listed as primary beneficiaries for IRA's may be faced with challenges without required annual distributions and only one RMD at the end of ten years, which could result in a very large tax bill all in one year. In addition, at the end of ten years all inherited IRA funds are released to trust beneficiaries which voids any further trust protection; likely the opposite objective of the IRA owner's intent. Beneficiary designations should be reviewed and updated to avoid unintended consequences from the change in inherited IRA rules. For deaths in years prior to 2020, the old rules remain.
Two New Exceptions Added to the 10% Early Distribution Penalty
The SECURE Act adds a 10% early distribution penalty exception for birth or adoption up to $5,000 which applies to a distribution from a retirement account within one year from date of birth or legal adoption. The amount withdrawn would still be subject to income tax.
Employer Liability Protection for Annuities in Plans
Retirement plan fiduciaries now have a safe harbor for employer liability protection for offering annuities within employer retirement and 401K plans. Section 404(e) was created within ERISA to help employers meet fiduciary requirements when selecting an annuity provider. This change is expected to open the door for more annuity and lifetime income products to be available as investment choices within employer retirement plans.
Other SECURE Act Notable Non Retirement Change
Qualified Education Expenses for 529 Plan Funds Expanded for Student Loans and Apprenticeships
Now expenses related to apprenticeship programs that include books, fees, supplies and required equipment are considered qualified education expenses if the program is registered and certified by the Department of Labor. Also, distributions for "Qualified Education Loan Repayments" of the 529 Plan beneficiary are now considered a qualified education expense up to a lifetime amount of $10,000 per person. This change further extends how 529 Plan resources can be used.
Realizing the full impact of the sweeping changes from the SECURE Act will likely not occur for decades. Because many of the changes involve complex long-term tax and retirement planning it is important to consider how the act will impact your overall plan. Reviewing your plan with your trusted financial advisor and tax professional can help you determine what is best for your overall situation.