SECURE Act: What Does It Mean To You?
In the final weeks of 2019, the Senate passed the SECURE Act (it was passed by the House in the Summer) and was signed into law by the President. This legislation will have a major impact on your retirement accounts and your ability to create a legacy with them for your children and grandchildren. Many of the other parts of the Act will probably have minimal impact to you but I’ll go over them anyway.
No More Stretching...
The stated goal of the SECURE Act, which stands for “Setting Every Community Up for Retirement Enhancement” is to strengthen retirement security across the country. From my perspective it does very little to accomplish that. It increases taxes on inherited retirement accounts and prevents them from creating multi-generational wealth for the beneficiary. It does this through the elimination of the so called “stretch IRA” for non-spousal beneficiary inheritors. Under the current law if a non-spousal beneficiary such your son or daughter where to inherit your IRA (or any non-Roth retirement account) they had choices with how they paid the tax on your IRA. They could take it all out at once and pay the tax in one year or take it out over their lifetime to spread out the tax. With the SECURE Act, a non-spousal beneficiary who inherits your IRA must cash in the entire account within 10 years of your death. There are a few exceptions to this such as disabled beneficiaries (as defined by the IRS) , chronically ill (as defined by the IRS with limited exception) beneficiaries, individuals who are not more than 10 years younger than you, certain minor children (of the original account owner) but only until they reach the age of majority (18 in most states).These beneficiaries can still take out distributions over their lifetime rather than over 10 years. However, once minor children reach the age of majority in their state, they must empty the account within 10 years.
This is potentially problematic for a beneficiary who inherits your IRA in their 50s or 60s while they’re still working as this extra annual IRA income could push them into much higher tax brackets. This maximum 10-year distribution period also means that the distributions will be much larger than the previous rules required as distributions could be taken over their lifetime. As before there is still the option to withdraw the entire IRA in one tax year or they can also wait until the 10th year to withdraw it all. For people who are still working when they inherit your IRA and plan to retire in 10 years or less, a strategy could be to wait and withdrawing it all in 10th year. The 10-year period begins the year following the IRA owner’s death. Making tax projections over the next 10 years will become a lot more important for anyone inheriting a retirement account in 2020 and beyond. It is also important to note that if you inherited a retirement prior to 2020 the previous beneficiary rules will apply. If you decided to take distributions over your lifetime you may continue to do that.
Spouses still can roll the money into their own IRA and take distributions based on their life expectancy. I’ve used the term IRA throughout this article, but this applies to all retirement accounts, including Roth’s. The only difference with Roth’s is that the income is currently not taxable(if the Roth has been open for 5 years). I say currently because Congress could always decide to tax Roth’s. We all forget that Social Security wasn’t taxable until Congress decided to begin taxing it. Hopefully Roth’s don’t ever become taxable. That is why I recommend not relying only on Roth’s to fund your retirement. However, if you have a long retirement ahead of you with children and/or grandchildren, getting some of your money into Roth’s still makes sense. The Roth money will grow tax deferred and your children or grandchildren will inherit it tax free (if the Roth has been open 5 years or more). Also, if you’re in a lower federal tax bracket you possibly could convert some of your retirement account to a Roth at a lower tax rate than your child or grandchild might pay when inheriting it.
72 Is The New 70 and 1/2 ...
Another change was an increase in the age that required minimum distributions (RMD’s) must begin. The prior rule required you to begin taking RMD’s by December 31st of the year after you turned 70 and ½. Beginning 2020, you must take your first RMD by December 31st of the year you turn 72.
Beware if you turned 70 and ½ years old in 2019 and didn’t take your RMD by the end of the year. If you forgot to take your RMD, you still have until April 1st, 2020 to take your first RMD. Otherwise a 50% penalty will apply in addition to the taxes. You don’t want to pay that penalty. You will still need to take your 2020 distribution by the end of 2020 and a distribution each year after. Keeping in mind you can always take more than the minimum.
Interestingly this change favors you if you were born in the first half of the year as this allows you 2 years of non-RMDs as compared to the previous rules.
New Factors...
The IRS also recently released proposed changes in November to the table that is used to calculate your RMD’s. These changes would go into effect in 2021 and reduce the annual RMD percentage that you must take. For example, it would reduce the required distribution percentage by roughly .24% for a 72-year-old. Assuming an IRA value of $500,000 for the same 72-year-old the current table would require a distribution of $19,531 and the new table a distribution of $18,315. A reduction of $1,216. If you’re someone who only takes the minimum distribution this could allow your IRA to last a little bit longer.
Age is Not a Factor...
Previously once you reached RMD age (70.5) you could no longer contribute to an IRA. That restriction has been eliminated and now you can make an IRA contribution at any age. However, same as before you must have earned income to make the contribution. Pensions, Annuities, Dividends, Interest, Social Security, and IRA distributions don’t count towards earned income. You must perform some work in order make this contribution. Either collect a W-2, 1099, or be self-employed.
Fox in the Hen House...
The SECURE Act opens the gates for more employers to offer annuities as investment options within 401K plans. Currently the employers (as the fiduciary) are responsible for making sure these annuity products are appropriate for employee’s portfolios but under the new law the responsibility falls on the insurance company (who also sell the annuities). These seems like a major issue to me as these are tremendous issues with many annuities. Annuities can be extremely complex, can have high fees, can have possible surrender schedules (periods where your money is locked up), and may offer minimal benefits for employees compared to the existing investment options. Buying the wrong annuity can be devastating to one’s portfolio as this can create lower than expected and below normal returns. This is a major win for the insurance lobbyists and the insurance industry. Even though this was a bipartisan bill it seems like many of our politicians are in the insurance companies’ pocket.
Can’t Trust This...
There are new planning challenges if a trust is listed as the beneficiary of your IRA. Especially if the purpose of that trust is to maintain the IRA and the tax deferral benefits that it provides. These trusts are generally meant to comply with the “See-Through Trust” rules which allow the trust to stretch distributions over beneficiary’s lifetimes (based on the age of the oldest beneficiary). These trusts are usually Conduit Trusts and Discretionary Trusts. Both could now be harmed by the SECURE Act. These trusts may be prevented from making any distributions until the 10th year following the IRA owner’s death, or the distribution may be subject to the trust tax rates (which are higher in many cases than individual tax rates). We’ll have to wait and see if the IRS comes up with any guidance to address these issues. I would check back on this.
Childbirth and Adoption Exemption...
There is a new exemption to withdraw $5,000 penalty fee from your IRA or retirement plan as a “Qualified Birth or Adoption Distribution”. To qualify for this exemption, you must take a distribution from your retirement account at any point during the one-year period beginning on either the date of birth of your new child, or the date on which your adoption of a child under the age of 18 is finalized. The rules stipulate that the distribution must occur after the qualifying event. However, the $5,000 limit appears to be per each new child birth or adoption and applies on an individual basis. Meaning you and your spouse could each take money from your retirement account up to the $5,000 for each child born or adopted. It also states each parent who took a Qualified Birth or Adoption Distribution can repay such amount. This would be over and above the standard contribution limits. Though the Treasury hasn’t come out with the rules that explain the timing of such contributions.
Small Business Incentives...
The 3 year $500 tax credit that was previously available for small businesses(less than 100 employees) to set up a retirement plan(401(k), 403(b), SEP IRA or SIMPLE IRA) is still available but you could qualify for a greater tax credit of up to $5,000 per year(for 3 years). Instead of receiving the $500 credit you could receive the lesser of$250 per non highly compensated employee covered by the plan or $5,000. You can also qualify for a $500 tax credit (separate from the other tax credits) if you include auto-enrollment in your retirement plan. In order to qualify your plan must adopt an “Eligible Automatic Enrollment Arrangement” as defined by IRC Section 414(w)(3). This arrangement auto enrolls employees in the plan once they reach plan eligibility unless they opt out. Auto-enrollment has show to be extremely effective in getting employees to contribute to a retirement plan. As such plans now have the option to increase the maximum allowable auto-enrollment percentage from 10% to 15%.This is available in any year after the first full plan year in which the employee was automatically enrolled in the plan. There is also a requirement that employers begin counting workers who worked at least 500 hours in the past 3 years as plan eligible. Previously you could exclude employees that worked less than 1000 hours in a plan year. However, this change isn’t required until 2021 and you don’t begin counting these part time workers until 2021. This means the earliest they will be eligible for the plan is 2024.You also don’t need to count them for plan testing to determine discrimination and to determine “top-heavy” testing. Beginning this year businesses also have the option of adopting stock bonus plans, pension plans, profit sharing plans, and qualified annuity plans up to the due date (including extensions) of the employers return. Previously all plans had to be adopted by December 31st of that year (or the employers fiscal year end).
Multiple Employer Plans For Small Business...
The bill also increases access to multiple employer plans for small business. These are single retirement plans that are maintained for multiple employers to benefit from economies of scale and to lower plan costs. Companies in the past stayed away from multiple employer plans because of the so-called “one bad apple” rule and the “nexus” rule. The “one bad apple” rule stated that if one employer did not meet the plan obligations then the plan would fail for all those involved. Due to Section 101 of the SECURE act the IRS can now disqualify the just portion of an employer’s plan allowing the master plan to maintain its qualified status. The “nexus” rule requires employers participating to have significant common interests such as belonging to the same trade association. These rules were loosened via Department of Labor (DOL) Guidance earlier this year. They still do require employers to reside in the same geographic area or common businesses. These plan changes are not effective until 2021.
