The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was added to a year-end spending bill in the Senate and passed after being on life support since the House passed H.R. 1994 in May. Its passage by the Senate represents the most significant retirement tax reform in decades, adding to the period of tax volatility kicked off by the TCJA of 2017. Now, consumers and financial professionals need to understand the law’s impact and what it means for 2020 and beyond. The act includes changes that could both help and hinder individual retirees and small businesses. And, like many bills, the SECURE Act contains several smaller tax changes that are not retirement related.
Increases age for required minimum distributions to 72.
Beginning in 2020, the SECURE Act raises the age at which retirees must start required minimum distributions (RMDs) from 70.5 to 72. While 18 months might not seem like a lot, it does provide some tax flexibility for people who work into their early 70s and it eliminates the headache of calculating your “70 and a half” birthday.
Removal of “stretch” provisions for non-spouse heirs.
When an individual inherits a Traditional IRA, they also inherit the deferred tax obligation that goes with it, which can be a sizable tax bill depending on the amount inherited. One way to manage that tax liability is to “stretch” distributions, and taxes owed, over the beneficiaries’ lifetime. Unfortunately, the SECURE Act eliminates these “stretch” provisions for non-spouse beneficiaries who inherit a qualified account (IRA, 401k, Roth, etc.) where the account owner passes in 2020 or later.
These non-spouse beneficiaries of an inherited account must take distributions of the full amount within 10 years. There is no “account minimum” exempt from this rule, however, spouses, minor children of the deceased, disabled and chronically ill individuals are exempt. Individuals who inherited an account prior to 2020 do not lose the “stretch” and will remain subject to the pre-SECURE Act laws and regulations.
This will have important implications for your tax and estate planning. Before the SECURE Act, if an individual inherited an IRA worth $1,000,000 at age 40, they could spread distributions over their lifetime. Under the SECURE Act, an individual who inherits a Traditional IRA worth $1,000,000, has 10 years to take the full distribution amount. If a significant portion of your wealth is in tax-deferred IRAs, you’ll want to talk with your advisor who can recommend smart beneficiary selection strategies, conduct a Roth conversion analysis or make other recommendations to help ensure your heirs keep more of what you leave them.
Eliminates the age cap for IRA contributions.
Today, people are living longer than they used to—which means that in some cases they are also working longer than they used to. To better match these changing demographics, the SECURE Act eliminates the age limit on traditional IRA contributions which is currently set at 70.5. This means if you continue working into your 70s, you can contribute to a Traditional IRA as long as you have earned income.
As we discussed, IRAs come with tax liability later in life, or for your heirs—working with an advisor can help you weigh the trade-off between lower taxable income now versus paying taxes later. Depending on your situation, a Roth IRA, taxable brokerage account or even an HSA might be better places for your investment dollars.
Expands 401k access to more small businesses.
The SECURE Act would make it easier for small businesses to offer 401ks by creating the potential for multiple employer plans. This would allow small businesses to group together into a single 401k while offering lower cost plans with better investment options. The SECURE Act also includes a $500 tax credit for small employers to encourage automatic enrollment into their retirement plans.
The act also requires employers to provide a “lifetime income disclosure” on their 401k statements. This disclosure would include the amount of sustainable monthly income the employee’s balance could support at retirement. The SECURE Act provides for increased availability of lifetime annuity options in employer retirement plans and, because retirement planning is complicated, employees will also be able to use pre-tax dollars to pay for investment advice to help them sort through their options.
Non-retirement related SECURE Act provisions.
The SECURE Act repeals changes to the kiddie tax that were put in place by the TCJA of 2017, which made investment income taxable at trust rates. Going forward, the old kiddie tax laws will apply, where taxes on investment income is based on the parent’s income. Another change from the SECURE Act is that 529s can now be used to repay student loan debt. Parents can now withdraw up to $10,000 per 529 plan beneficiary to repay student loans. This offers additional planning opportunities by expanding what qualifies for a tax-free distribution for 529 plans.
While most tax changes appear simple, complexity will inevitable arise when applied to specific individual situations. In the coming year, it’s important to review your situation to understand what these changes mean for you and your financial plan. Markets change, laws change, and your circumstances change. And it’s important that you continue to evaluate your plan to see if it also needs to change in order to keep you on track to meet your goals. Fortunately, you don’t have to do it alone; we’re here to help guide you through whatever changes come your way.
Brian Vnak has been helping clients create intricate financial, tax and estate strategies that are in line with their goals and values for more than 10 years. His popular column for Kiplinger.com is published monthly.