The SECURE Act – What It Means for the US Retirement Landscape

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20, 2019 by President Donald Trump. The SECURE Act, which largely aims to add flexibility for investors, marks the most significant update to the US retirement system in over a decade. Here are some of the main highlights of the proposed bill:

Required Minimum Distributions (RMD) from Retirement Accounts Will Now Begin at Age 72

Under the previous law, IRA owners were required to begin making mandatory minimum annual distributions from their IRAs and other retirement accounts, once they reach age 70.5.  The SECURE ACT delays the start of these mandatory distributions to age 72.  Account owners born in the first half of the calendar year will enjoy a full two-year extension while those born in the latter half of the year only get a one-year respite.  Under the new rules the first RMD is due no later than April 1st of the year following the year the IRA owner turns 72.  While waiting to take the first RMD (the age 72 RMD) until 4/1 may make sense in some cases, the account owner will also have to take her age 73 RMD by December 31s of the same year resulting in two RMDs recorded in the same tax year.  Finally, anyone turning 70.5 in 2019 is not eligible for the new RMD rules and must make the mandatory distribution according to the old rules.

The extension to age 72 provides IRA owners a little more time to gradually convert traditional IRA assets to Roth IRA assets.  Roth IRAs are not subject to mandatory distributions because income taxes have already been paid on contributions.  Partial Roth conversions, done on an annual basis, in retirement when taxable income may be suppressed can be an effective way to move dollars to a Roth IRA at a lower marginal tax bracket.

Qualified Charitable Distributions (QCD) from IRAs

While the SECURE Act pushed the RMD age out from 70.5 to 72 it did not make any changes to the age when IRA owners can make Qualified Charitable Distributions.  That minimum age remains at 70.5.  Thus, while mandatory distributions are not due until age 72, IRA owners can use their IRAs to make charitable contributions on a pretax basis on or after the date they turn 70.5.

The SECURE Act also includes a provision to deal with the fact that some IRA owners implementing QCDs may also be making Traditional IRA contributions now that the law has eliminated the age restriction.  The IRS added a new anti-abuse rule that will not allow IRA owners to take both a tax deduction for the value of the IRA contribution AND have the ability to eliminate the value of the QCD from taxable income when implemented.  Recall that tax payers are not eligible to record the dollar value of a QCD as an itemized charitable deduction.  Precisely because the QCD comes from a tax-deferred IRA, the IRS states the dollar value of the distribution can simply be excluded from gross income.  The new anti-abuse rule states that QCDs will be reduced by the cumulative amount of post-70.5 tax-deductible IRA contributions.  For example, David is 71 and still working and decides to max out his IRA with $7,000 contributions annually for the next 3 years.  If he decides to make a $30,000 QCD at age 76 it will be reduced by $21,000 ($7k x three years) for a final QCD of just $9,000.  It appears the remaining $21,000 can be taken as an itemized deduction.  It is important to consult with your tax advisor for further guidance.

Removing the Maximum Age for Traditional IRA Contributions

The SECURE Act eliminates the age restriction of 70.5 for making traditional IRA contributions.  Elimination of the age restriction will help American workers who continue to work into their seventies save for retirement.  Additionally, the new legislation will treat stipends and non-tuition fellowships paid to students as eligible income for IRA contributions.  Traditional IRAs were the only retirement account type that used to impose this age-based restriction.  It should be noted that even though contributions are now allowed for those with earned income after age 70.5, IRA owners are still required to take their RMD at age 72.

Changes to the Distribution Rules for Inherited IRAs

One of the primary revenue generators in the SECURE Act comes from changes in the treatment of mandatory minimum distributions for inherited IRAs.  Under the old rules, a non-spouse beneficiary of an IRA or retirement account had to take annual required minimum distributions (RMDs) from the inherited IRA over the course of his/her life expectancy.  For someone who inherits an IRA in her thirties or forties, distributions could have been stretched over several decades, hence the term “Stretch IRA”.  The SECURE Act changes this in a significant way.  Specifically, non-spouse beneficiaries would be required to empty the inherited IRA within ten years of the date of death of the original account owner.  A change like this will accelerate tax revenues owed to the government and increase the tax burden on beneficiaries.  There are some beneficiaries exempt from the new rules and they include: spouses, beneficiaries not more than 10 years younger than the original account owner, those that are disabled and chronically ill (as defined by the IRS) and certain minor children although only until they reach the age of majority and then the ten-year rule would apply.

The SECURE Act states that beneficiaries of an inherited IRA subject to the new ten-year distribution rule are not required to make distributions on an annual basis.  The inherited IRA must be fully emptied by the end of the tenth year following the original account owner’s death.  Essentially, beneficiaries could choose to wait until year ten and make a full account distribution, but this would cause the full market value of the distribution to be included in taxable income in the year of distribution.  Depending on the size of the inherited IRA, the market value could be taxed at the highest federal tax bracket (currently 37%) plus state taxes if applicable.  It may make more sense for the beneficiary to establish a plan to make distributions over more than one year to help reduce the tax impact.

In situations where trusts are named as IRA beneficiaries the new ten-year rule may require making some adjustments to the language of the trust.  Typically, these “see-through” trusts allow RMDs to be taken and stretched over the life of the oldest named beneficiary (specifically a natural person who has a measurable life expectancy) of the trust.  The new distribution rules for inherited IRAs technically only have one RMD year – year ten.  Trusts with language that only allow required minimum distributions to be distributed from the inherited IRA to the named beneficiaries would effectively only make one final lump sum distribution in year ten.  This could result a substantial income tax bill that could have been spread out over many tax years if the trust language had been amended.  We encourage those IRA owners with trust beneficiaries to consult with their attorney for the appropriate legal guidance.

Increased Access to 401ks for Part-time Workers

Under the old law, employers were generally able to exclude part-time employees (typically those that work less than 1,000 hours per year) from a defined-contribution plan such as a 401k.  The SECURE Act now allows plan access to workers with at least 500 hours of service per year over a period of three consecutive years.  Essentially, the new law provides access for long-term part-time employees who would otherwise not be allowed to participate in a 401k plan.  This could be especially helpful for workers with reduced hours who are raising a family or assisting with elderly relatives.

Addition of Annuities to 401k Plans

The SECURE Act opens the door to make it easier for employers to include annuities in 401k plans.  The legislation provides employers a safe harbor for selecting an insurer that would provide annuity products to the plan.  This change offers participants a potential income option upon retirement which would be subject to the financial strength and claims-paying ability of the insurer.  On its face, adding an annuity income option for retirement plan participants can be an effective way to plan for future cash flow needs.  As with anything, participants will need to pay close attention to the fine print.

Defined contribution plan statements need to disclose lifetime income estimates at least annually to participants.  These disclosures would allow participants to see what their account value would translate to if converted to a stream of monthly lifetime payments.  The SECURE Act aims to help workers visualize the task of replacing the monthly paycheck from their employer during retirement.

Expansion of 529 Plan Benefits

The SECURE Act expands the use of section 529 savings plans to pay for costs associated with apprenticeships and up to $10,000 of qualified student loan repayments.  The student loan repayment provision is capped at a lifetime amount of $10,000 per beneficiary.  In addition, there is a separate $10,000 limit on the qualified student loan debt of the beneficiary’s siblings (includes brother, sister, step-brother and step-sister).

It remains to be seen how much the provisions of the SECURE Act will ultimately benefit the retirement equation in America.  Some of the new rules will have a larger impact than others depending on the unique circumstances of each person.  Consequently, this will create planning opportunities which can be used to develop an optimized retirement.  As always please consult with your wealth advisor regarding any questions you may have on how the SECURE Act could impact your personal situation.

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