Over the past 20 to 30 years, more and more companies have eliminated pension plans. This has shifted more responsibility of saving for retirement to employees. As a result, lacking pension income to supplement other retirement income and savings, working people have to more closely manage their finances, ensuring they contribute to their 401(k) plans and put additional monies into personal investment accounts.
To enhance people’s ability to prepare for retirement, Congress passed the SECURE Act in December 2019, which the President has signed it into law. The law is designed to lead to an increase both in the number of people saving for retirement and in the amount saved. The new law creates both new opportunities and new challenges in retirement planning. This blog outlines the key provisions of the SECURE Act to consider in your retirement planning, as well as some additional tax implications of the new law.
Changes that Impact Retirement Planning
The SECURE Act has made significant changes related to retirement planning.
Elimination of Maximum Age for IRA Contribution
Previously, you could contribute to an IRA only up to the maximum age of 70½. Under the SECURE Act, the maximum age has been eliminated. As long as you have earned income and meet other income thresholds, you can continue contributing to an IRA. This provision benefits the increasing number of people who are working into their 70s and creates more opportunities for tax planning initiatives such as Backdoor Roth IRAs at older ages.
Change in Age for Required Minimum Distributions (RMDs)
The age at which minimum distributions are required to be taken from retirement accounts has been increased from 70½ to 72. The first distribution from an IRA, 401(k), or 403(b) can now be delayed until December 31st of the year you turn 72. Delaying the initial distribution until April 1st of the following year is still an option. This change benefits retirees who do not need to take distributions from their IRAs to fund retirement spending. IRA investments can continue to grow tax deferred for a longer period of time.
A twist to this change is that people born in the first half of the year will have two additional years before they need to start distributions, whereas people born in the second half of the year will get one additional year.
In conjunction with the RMD age change, the IRS will also be issuing updates on the Uniform Life Tables and the life expectancy used to determine RMD amounts. The changes will extend the period for retirement account distributions.
Qualified Charitable Distributions (QCDs) Still Allowed at 70½
Even though RMDs do not begin until age 72, you may still use an IRA to make a qualified charitable distribution (QCD) for up to $100,000 for the year after turning age 70½. The SECURE Act also requires that any QCD be reduced by the total post–70½ IRA contributions. The post–70½ IRA contributions amount will be reported as income, and the amount can also be claimed as an itemized deduction.
Elimination of the Stretch Provision for Inherited IRAs
The most significant unfavorable change of the SECURE Act is the elimination of the “stretch” distribution period for inherited IRAs. An inherited IRA distribution period is now 10 years, whereas previous law allowed distributions over the life expectancy of the beneficiary. Some specifics of this change include the following:
- The 10-year rule will not apply to Eligible Designated Beneficiaries, which include spouses, disabled beneficiaries, chronically ill individuals, beneficiaries who are not more than 10 years younger than the decedent, and minor children.
- IRAs inherited prior to January 1, 2020 are grandfathered. The provision applies to situations where the decedent passes after December 31, 2019.
- While 100% of the IRA must be distributed by the end of year 10, the beneficiary has flexibility on how much is distributed each year. For example, no RMDs could be made during the first 9 years and 100% distributed by the end of year 10.
The new 10-year rule may result in higher taxes for heirs since larger RMDs will result in higher income. The 10-year rule may also have negative tax implications in instances a trust serves as the beneficiary of an inherited IRA. The language of a trust agreement should be reviewed to ensure the most favorable tax treatment is achieved under the provisions of the new law.
The implications of the new law for inherited IRAs should be taken into account in retirement and estate planning. For example, transacting more strategic Roth conversions over the life of the IRA owner may prove to be a beneficial tax strategy.
More Favorable Terms to Encourage Adoption of Retirement Plans by Small Businesses
Multi-Employer Plans (MEPs) are retirement plans where multiple businesses are pooled together into one plan. The new law makes it less burdensome for smaller companies to establish a retirement plan for their employees by easing a number of restrictive criteria for MEPs.
Provisions in the Act also make establishing a retirement plan more affordable. The tax credit for a small owner was changed to 50% of plan start-up costs up to a maximum of $5,000 from a previous maximum of $500.
A $500 credit is now available for new 401(k) or Simple IRA plans that include automatic enrollment. Under an automatic enrollment feature, participants are automatically enrolled by the employer to contribute to the plan. The participant then has the option to notify the employer to cease the contribution. The credit can be claimed for 3 years by the employer, assuming the feature remains in place. The automatic enrollment is expected to increase participation by employees in 401(k) plans.
Increase in the 401(k) Automatic Enrollment Contribution Percentages
With the intent of increasing participants’ contribution amounts to their retirement savings, the SECURE Act increases the amount of an employee’s compensation that an employer can automatically elect for contribution. Previously, the maximum default for automatic enrollment was 10% of an employee’s compensation. Beginning in 2020, 15% can now be set as the default percentage, with the exception of the first year of enrollment, which is still 10%.
More Access to Retirement Plan for Part-Timers
New rules of the SECURE Act guarantee 401(k) eligibility for employees who have worked at least 500 hours per year for at least three consecutive years. The employee must be 21 years old by the end of the three-year period. This provision does not apply, however, to collectively bargained employees.
Annuity Products in 401(k) Plans
You may begin seeing more annuity products offered in your 401(k). In the past, annuity products were not usually offered in 401(k) plans because plan sponsors had fiduciary responsibilities concerning the financial viability of the insurance companies offering the annuity product. The SECURE Act has eased fiduciary responsibilities for plan sponsors, allowing plan sponsors to rely on insurer ratings issued by state insurance commissioners. Basically, the plan sponsor is no long responsible if the insurer issuing the annuity product goes bankrupt.
This provision likely provides a mixed benefit. On the one hand, annuities as an investment option in a retirement account may be suitable as a tool to mitigate the risk of living longer than expected. On the other hand, the availability of annuity products creates a greater potential for abuse by insurers providing annuities that have excessive fees and commissions.
A beneficial change in the law is that if you selected an annuity option in your 401(k) and then the employer decided to drop the annuity as an investment option, you will be allowed to maintain the annuity by transferring it out of the plan rather than having to liquidate it as was required under the previous law.
No Credit Card Loans for 401(k)s
No longer can a 401(k) loan be provided through a credit card or a debit card. The elimination of these forms of loans prevents easy access to retirement funds to pay for routine spending needs.
Lifetime Income Disclosure Statement for 401(k) Plans
You’ll now begin receiving information on the expected annual income that you may receive in retirement for your 401(k) savings. The disclosure must represent how much income the lump sum balance in your retirement account could generate and must be provided at a minimum of once every 12 months. The plan must disclose to participants the assumptions used in making this projection. How the expected income will be measured still needs to be determined, so the reporting will likely not start until well into 2020.
Additional Qualified Distributions from IRA/401(k)
A person can take a distribution of $5,000 per year from their IRA or 401(k) to financially support the birth of a child or an adoption. The distribution will not incur the 10% early withdrawal penalty, and it is exempt from a mandatory 20% withholding. Distributions can be taken within one year of a child’s birth date or of the date that adoption is finalized. Distributions are even allowed prior to the birth date. A taxpayer identification (TIN) must be established for the child. Each parent can take the $5,000 distribution, for a total distribution of $10,000.
More Lenient Guidelines to Qualify for Making IRA Contribution
One requirement for making an IRA contribution is having “earned income” for the contribution amount. In the past, graduate students and post-doctoral students who received certain forms of compensation were not able to make IRA contributions because the compensation did not qualify as earned income. Under the new Act, stipends, fellowships, or other payments received by these students will now be treated as compensation for purposes of making an IRA contribution. This will make saving for retirement more feasible for students who have earned these types of payments.
Non-Retirement Changes
The SECURE Act has also made some changes unrelated to retirement that have an impact on financial planning.
Use of 529 Plan Funds to Pay Student Loans
The Act has added to the list of qualified higher education expenses. Qualified education loan repayments are now considered a qualified expense. A 529 distribution may now be used to pay the principal and interest of a qualified education loan, limited to a lifetime amount of $10,000. If funds are used to pay loan interest, the interest cannot be taken as a student loan interest deduction. The $10,000 lifetime amount applies to each person. As such, a $10,000 distribution to pay off an education loan can be made for each sibling of a 529 plan beneficiary.
Update to the Kiddie Tax Rules
The Tax Cuts and Jobs Act of 2017 taxed income subject to the Kiddie Tax at trust tax rates. As a result, children with significant unearned income paid high taxes. The SECURE Act has reverted to the former tax guideline, which taxed income subject to the Kiddie Tax at the child’s parents’ marginal tax rate. This is a favorable change for most, as the parents’ rate is often less than the trust rates. While the change is effective for 2020, taxpayers can elect to apply the new rule to 2018 and/or 2019 tax returns. Those who benefit from this change may want to consider filing an amended 2018 return.
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As you can see, the SECURE Act adds a number of provisions to assist the working individual in saving more successfully for retirement. However, individuals continue to bear a significant responsibility for retirement planning. Participating in retirement plans offered by an employer, managing spending within a budget, and performing effective tax and financial planning continue to be important disciplines in creating a successful retirement. The SECURE Act now creates several new opportunities to consider to optimize your savings. If we can assist with planning related to the SECURE Act or with your retirement planning in general, please feel free to reach out to us to discuss.