Among the tumult of other happenings in Washington DC during the last two weeks of December, a significant update of retirement laws passed the Senate and was signed into law.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was passed overwhelmingly by the House of Representatives in May but was stuck in the Senate until it was wrapped into the year-end spending package. This is the largest set of retirement law changes in over a decade and it touches many areas of savings. Changes that may impact you include:
Elimination of the “Stretch” IRA
“Stretch” IRA refers to the ability to take minimum distributions from an inherited IRA over the lifetime of a beneficiary. Congress never set out to create the “Stretch”, it came about through persistent beneficiaries and favorable IRS rulings. Prior to 2020, a child beneficiary could stretch distributions out 70+ years. Even with a million-dollar IRA, much of the income distributed would be at a relatively low tax rate. Now the entire IRA must be distributed within 10 years, increasing the annual income distribution and hence the taxes owed. (Note that there are exceptions including for spouses; for minor children; for disabled and chronically ill beneficiaries; and for anyone else who is not more than 10 years younger than the deceased IRA owner).
This impacts you especially if: you have a large (million-dollar plus) IRA. If you have a large IRA, then it is worth investigating tactics to reduce the potential tax hit. Depending on your charitable intent and the income bracket of your beneficiaries, these tactics range from Roth Conversions, to Qualified Charitable Distributions, to increasing your number of beneficiaries, to creating a charitable trust. Analysis of the best strategy is an exercise in projections and calculations. It is impossible to predict the future, and no one wants to pay taxes sooner than necessary, but sometimes paying some taxes now creates a significant potential for tax savings in the long term.
This impacts you especially if: a Trust is a beneficiary of your IRA. The issue above is magnified for a Trust because tax rates are significantly higher for Trusts (37% for income over $12,950 in 2020). This problem is solved by distributing all income to the Trust beneficiaries in the year received (often called a “Conduit Trust”), but often the trust is in place to protect the beneficiaries from too much income. As a result, either the income is distributed to the unprepared beneficiary (conduit) or it is retained in the Trust for the protection of the beneficiary but is taxed exorbitantly. It is critically important to review your beneficiaries and your Trust language if the Trust is a potential beneficiary of your retirement plan.
New Age for Required Minimum Distributions (RMDs)
There are several rule changes regarding contributing to and distributing from IRAs. The biggest by far is that the age for RMDs has now been increased from 70½ to 72. This allows IRA owners to defer taxes from IRA distributions for several more years. For those who will benefit by deferring income, this adds significant flexibility. (Note that due to the elimination of the “Stretch”, it now may be less advantageous to defer those taxes.)
Qualified Charitable Distributions (QCDs) which are distributions from IRAs directly to charities (thereby avoiding the taxable income associated with distributions) are still allowable after the IRA owner turns 70½. For those with charitable intent, this is often the most tax efficient way to gift to a charity.
Prior to the SECURE Act, a contribution to a traditional IRA was not allowed past age 70½. Now, if an older taxpayer has earned income, money can still be contributed to an IRA. In addition, amounts paid to grad students and care providers (which previously was not counted as compensation by the IRS) now will be included as compensation, allowing those workers to contribute to an IRA.
The SECURE Act also introduces the ability to withdraw up to $5,000 from an IRA for childbirth or adoption without penalty and the ability to withdraw up to $10,000 (over a lifetime) from a 529 plan to pay qualified student loan payments.
Enhancements for Small Business Employee Sponsored Retirement Plans
Some of the most significant changes introduced by the SECURE Act relate to employee sponsored retirement plans such as 401(k)s. The Act changes several rules to make it much easier for the creation of Multiple Employer Plans (MEPs). MEPs as the name implies are retirement plans for multiple employers under one umbrella.
In the past, there have been restrictions that made them challenging to create and administer. The updated rules enable small businesses to create 401(k) plans for their employees without the overhead normally associated with running a plan. Also new tax credits are available to encourage plans to implement automatic enrollment for plan participants.
The hope is that more small business employees will be able to take advantage of employer-sponsored plans.
This impacts you especially if: you are a small business owner and have hesitated to implement a retirement plan because of the hassle. Be on the lookout for new alternatives over the next year or two.
The text of the SECURE Act stretches over 120 pages so there are certainly areas beyond these which will impact you and your family. Armor will continue to monitor the implementation of this Act and other legislative changes.
Please let us know if there are questions or concerns on the topics covered here or other items related to the Act that we can investigate for you.