While no one was watching – right before Christmas – Congress folded an essential piece of legislation into a must-sign funding bill. It was the SECURE Act (or the ‘Setting Every Community Up for Retirement Enhancement’ Act) of 2019.
Its employer-related provisions may not affect you. Its changes to some tax calculations may apply only marginally. But the most significant changes for you are likely to be those that impact inherited IRAs and other retirement accounts.
Retirement Issues. The SECURE Act directly affects three separate aspects of retirement accounts (IRAs and others): a popular estate-planning tool and two ‘trigger’ age changes related to your IRAs. Let’s look at the planning strategy first.
The Stretch Provision. The SECURE Act has taken away a good part of the stretch provision. This retirement-and-estate-planning strategy will affect you most if you have named non-spouse beneficiaries or if you are a non-spouse beneficiary of a defined-contribution plan or IRA account.
For anyone who passed away before December 31, 2019, their designated beneficiaries (defined as living human beings) could stretch the distributions from inherited accounts over the beneficiaries’ life expectancy, based on an IRS-defined formula.
But now, if the original IRA owner dies after January 1, 2020, the new distribution standard for those same beneficiaries under the SECURE Act will be the ’10-Year Rule.′ You must empty the entire retirement account by the end of the tenth year following the year of inheritance.
One positive: there will be no Required Minimum Distributions (RMDs) during the ten years, as long as all funds are out of the account by the end of the tenth year after death. That allows you the flexibility to take distributions in the most tax-efficient way.
Do You Need to Worry? If you think the stretch provision could be part of your estate planning, you might want to confer with your advisor. More specifically, if:
• You plan to leave an IRA to younger non-spouse beneficiaries as part of your retirement strategy; you may want to look for a better way to provide for your heirs.
• You are the future beneficiary of an IRA, and part of your planning counts on certain distributions over the long term; you may want to recalculate that benefit over the new 10-year window and make other adjustments.
• You have some IRA beneficiaries you have protected with trusts; you may want to confirm that the protection continues to exist.
Who Doesn’t Need to Worry? Besides not being affected if your inherited IRA came from someone who died before December 31, 2019, you also don’t have to worry if you are a future beneficiary and you are:
• The IRA owner’s spouse,
• Younger than the IRA owner by ten years or less,
• Disabled or chronically ill, or
• A minor child (which exempts you until you become a legal adult at age 18).
Age Changes. The age-related changes brought on by the SECURE Act will affect you if you are:
• Still generating qualified income and thinking you will have to stop contributing to traditional IRAs at age 70½.
• Approaching age 70½ and expecting to have to start taking RMDs.
The IRA Maximum Contribution Age. The traditional retirement age of 65 is rapidly losing popularity. Many Americans are living longer, so they are also working longer to finance those extra years.
Whether you are working because you love what you do or because you are still building a comfortable nest egg, before the SECURE Act you couldn’t keep contributing to a traditional IRA after age 70½.
The SECURE Act does away with that age limitation. The one condition is that your contributions must come from earned income, which the IRS defines as:
• Wages, salaries, tips, and taxable employee pay,
• Long-term disability benefits received before minimum retirement age,
• Union strike benefits, and
• Net earnings from self-employment.
Social Security, retirement income, alimony, interest and dividends do not count as earned income.
The RMD Onset Age. Annual RMDs exist so that the IRS can finally access the taxes on the income you deferred in the past. Before the SECURE Act, you had to start taking RMDs by April 1 of the year after you reached age 70½.
The SECURE Act extends the age from 70½ to age 72. This 18-month period means you can save longer before having to start taking RMDs and implement a Roth conversion strategy if it makes sense. Your IRA savings may last longer into your retirement. Check with your advisor if this makes sense for you.
Now that the age limit for contributing is gone, can you find yourself withdrawing RMDs from an IRA you are still adding to? Yes, you may find yourself in a money-in/money-out situation with your IRA.
Other IRA-Related Changes. The SECURE Act allows you to take up to $5,000 for each qualified birth or adoption and $100,000 for each qualified disaster, with no 10% penalty for early withdrawal, although you will still need to pay income tax.
Non-Retirement Issues. Not all provisions of the SECURE Act relate to retirement. Some related to taxes might affect you, such as:
• Returning the applicable tax on children’s income (the Kiddie Tax) to the parents’ top marginal tax bracket,
• Changing the medical expense deduction threshold back to 7.5% of adjusted gross income,
• Letting you use 529 college savings plans for qualified apprenticeship and student loan expenses, and
• Changing the deductions for mortgage insurance premiums and higher education tuition and fees.
Actions You Will Want to Take. Some of the tax and IRA changes may merit attention as you go forward, but the changes in stretch provisions leave you the most exposed. All are important but checking and updating your beneficiary strategy should be your top priority. You may not want to leave that one to ‘someday.’ Act today, to ensure a financially smooth tomorrow.
