In the last weeks of December, the Senate voted 71 to 23 to pass the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The Act was originally passed by the House of Representatives in July, and was subsequently passed by the Senate in December and signed into law by President Trump on December 20, effective January 1, 2020.
Some of the highlights of the Act include the following:[i]
Repeals the maximum age for making traditional IRA contributions (previously 70½)
Increases the age at which Required Minimum Distributions (RMDs) must start from 70½ to 72
Limits the life of an Inherited IRA for non-spousal beneficiaries
Allows a $5,000 penalty-free withdrawal from a retirement account related to the birth or adoption of a child
Expands the types of qualified education costs allowed by 529 College Savings Plans
No Age Restriction on IRA Contributions
Prior to the SECURE Act, working individuals could not make contributions to a Traditional IRA after age 70½. Now, individuals can make IRA contributions so long as they have earned income, with no age restrictions. The new law allows workers to save more for retirement and increase tax-advantaged savings.
Prior to the SECURE Act, a working individual could make Roth IRA contributions past age 70½ and that is unchanged under the new law.
RMD age limit increased from 70 ½ to age 72
Prior to the SECURE Act, individuals had to take a Required Minimum Distribution upon reaching age 70 ½. For those who were already age 70 ½ before 12/31/2019, the old rules still apply. However, individuals who turn age 70 ½ in 2020 and thereafter are not required to take their initial RMD until age 72. In line with the prior tax code, if a person is working past the RMD age (now age 72) and that employee is not a 5%+ owner of the company they work for, they can defer taking an RMD from their employer sponsored retirement plan until the year in which they retire.
Also unchanged, the individual’s first RMD can be taken as late as April 1st of the year following the required beginning date. For example, if a person turns age 72 in 2021, they must take their first RMD by April 1, 2022. Every year thereafter, the annual RMD must be taken by 12/31.
Death of the Stretch IRA
One coveted estate planning tool was the Inherited IRA, also known as the Stretch IRA. For example, under the old rules, when mom passed away, her daughter could receive her mom’s IRA as an Inherited IRA. The daughter would be subject to taking annual RMDs on the Inherited IRA over her lifetime, but the daughter could continue to benefit from the tax-deferral treatment her mom had, stretching the life and tax-deferral benefit over two+ generations. The Stretch IRA was a powerful tax management strategy. Using the same example as above, under the SECURE Act, mom could still pass her IRA to her daughter upon her passing. However, under the new tax rules, her daughter would have to withdraw the Inherited IRA balance, in full, by the 10th anniversary of mom’s passing, eliminating the use of Stretch IRAs over multiple generations and accelerating the taxation of the IRA funds, to the benefit of the IRS. According to the Congressional Research Service, the new tax-deferral limit on the Stretch IRA strategy has the potential to generate about $15.7 billion in tax revenue over the next decade.[ii]
As a result of the new Inherited IRA rules, careful income tax planning will be more essential than ever. Short-sided IRA distributions could have long-lasting ramifications to the recipient such as being pushed into a higher income tax bracket, subject to higher Medicare premiums, and potentially assessed a higher taxation rate of SSI benefits and so forth.
Additionally, anyone who has listed a Trust as the beneficiary of their IRA should meet with an advisor right away to ensure that decision is still appropriate. Listing a Trust as an IRA beneficiary could restrict access to the beneficiaries of the Trust over the 10-year distribution window. This could cause the beneficiaries to receive the entire IRA balance in full at the 10th year and inadvertently subject them to massive taxes.
The new 10-year IRA withdrawal rule does not apply to spouses and other eligible designated beneficiaries who can continue to inherit the deceased owners IRA into their own name (versus an Inherited IRA titling) and are not held to a 10-year withdrawal timeline.
Birth or Adoption of a Child
Under the SECURE Act, a retirement account holder under the age of 59 ½ can now make a penalty-free withdrawal of up to $5,000 from their retirement account, including a 401(K) or IRA, for expenses relating to the birth or adoption of a child after the child has joined the family. A couple can potentially withdraw a total of $10,000 penalty-free, if they each had separate retirement accounts. This flexibility allows young individuals to save more, with the peace of mind they have a back-up to pay for bills associated with a new child during a busy time.
Expanded Definition of 529 Qualified Education Expenses
As of 2019, student debt in the U.S. totaled more than $1.5 trillion.[iii] A benefit of the SECURE Act is you can now use up to $10,000 from a 529 College Savings Plans over your lifetime to directly pay-off outstanding student debt. This is a lifetime, and not an annual limit.
The SECURE Act will dramatically change the financial planning and estate planning strategies utilized going forward. Be sure to meet with your Certified Financial Planner™, CPA or attorney early to develop strategies to take advantage of the benefits available and circumvent pitfalls. Incorporating the new tax law into your Comprehensive Financial Plan can ensure your long-term goals are still on track.