(Fiduciary Trust International) The end of the year always has its surprises. This year, in the realm of financial and tax planning, the surprise is the passage of the SECURE Act.
Heralded as the first major retirement savings law in the past 10 years, the Act was passed by the House over the Summer but has languished in Washington ever since despite bipartisan support. Then, last week, word came that it’d been tacked onto the year-end appropriation bill being approved by Congress. Now, it’s been signed by the President and is set to become law effective January 1, 2020.
The law affects many aspects of retirement savings, including when contributions can be made, when distributions must and can be taken, and what happens to your retirement accounts after you die. It also serves as a timely reminder to review the status of your retirement accounts and your financial plan in general as we head into the new year.
The SECURE Act in Brief
From a policy perspective, the goal of the SECURE Act is to encourage savings. Many of its provisions are aimed at making retirement accounts and plans available to a wider range of individuals. These include provisions designed to increase availability of participation in company 401(k) plans, encouragement for small employers to offer plans and a new class of so-called “Multi-Employer Plans.”
For individuals who already have retirement accounts, the most relevant changes center around the new rules related to contributions and distributions, including distributions after you die.
Contributions at Any Age: There’s No Stopping You Now
Under current rules, you cannot contribute to a traditional IRA after you’ve hit the date when you’re required to take distributions (currently the year you turn 70½). Under the new law, that age limit is off the table. Whether you’re 70 ½ or 90 ½, you can continue contributing to your traditional IRAs. The normal limits apply. That means the maximum you can contribute for 2020 will be $7,000 for individuals over 50. If you are under 50, the limit for 2020 is $6,000.
Contributions are also limited by the amount of your taxable compensation. This means if you are fully retired you won’t be able to contribute. But for individuals who continue to earn a paycheck, whether through full-time work or part-time jobs like consulting, the freedom to continue contributing to your IRA can offer a meaningful impact in terms of both the tax-deferred savings and the potential to deduct your contributions.
It may not seem intuitive to continue contributing to your retirement accounts in your 70s and beyond, but deferring taxes is beneficial at any age. Assuming you’re able to deduct your contributions, you can avoid income taxes on the compensation you contribute. The contribution is also then able to grow tax-free, with taxes deferred until you eventually withdraw the funds out of your IRA.
Of course, it doesn’t make sense to continue contributing to a traditional IRA if you effectively withdraw those funds immediately or not long thereafter. If you’re already withdrawing more than required from your IRA, or additional contributions would require you to increase your IRA withdrawal, you’re likely better off holding on to your compensation and instead limiting the amount you withdraw from the IRA.
Distributions: A Nod to Longevity and Other Realities
Under current rules, you are required to begin taking your required minimum distributions (RMDs) from your traditional IRAs, 401(k)s and other retirement accounts by April 1 of the year following the year in which you reach the age of 70½. Under the new rules, the relevant year is now the year you turn 72.
This may seem like a subtle change, but it can have major significance for someone who is about to turn 70½ or is planning ahead for when they start taking RMDs. For someone who turns 70½ in 2020, the need to liquidate investments in their IRAs to start taking distributions is no longer quite so imminent. If you are thinking about retiring completely and your decision is based in part on how much you pay in taxes, you may decide to continue working another year while your taxable income isn’t bumped up due to your RMDs. Depending on your circumstances, a delay in taking distributions from your retirement accounts might also trigger the need to adjust your distribution and investment strategy across your non-retirement accounts to align with your newly calibrated financial plan.
The new law also eliminates the 10% penalty for early withdrawals from a retirement account in the case of the birth or adoption of a child. In these cases, you can withdraw up to $5,000 within a year of the birth or adoption date and you can also transfer those funds back into your retirement account at a later date if you want to.
In addition, under the new law, you can use 529 college savings accounts for registered apprenticeship programs or qualified student loans. The ability to pay off student debt with funds in a 529 account is a welcome relief for many individuals who have completed their educations but haven’t exhausted their 529 savings, which often occurs when someone plans for more education than they ultimately pursue. If you do not have student debt, it may be possible to transfer your 529 account and its leftover funds to a beneficiary who does.
Inherited IRAs: A Gift That Can No Longer be Stretched
Each holiday season has its Cabbage Patch doll or Tickle Me Elmo – the gift that flies off the shelves, until suddenly it doesn’t. This year, we may be adding the Inherited IRA to that list.
Under current rules, a key planning technique for individuals with large IRAs is to leave them to their children or other beneficiaries in a manner that allows distributions to be stretched over the beneficiary’s life expectancy. In effect, the tax deferral of the IRA is enabled to last over two lifespans rather than one. While this planning technique is not without its complications, it is generally incorporated into most estate plans.
Under the new law, the so called “Stretch IRA” becomes a thing of the past. Generally, all funds in an IRA you pass down as an inheritance will have to be distributed to beneficiaries within 10 years of your death, along with the resulting tax burden. Spouses are still excluded from this requirement and still have the option of stretching distributions over their remaining life expectancies. Minor children also can defer the 10-year distribution period until they reach the age of majority. In addition, the new rules exclude disabled beneficiaries and qualified special-needs trusts.
These new requirements don’t apply to IRAs that have already been inherited but will apply to IRAs handed down by anyone who dies after December 31, 2019. For individuals with significant retirement accounts, the rules are an important and timely reminder to take a close and regular look at your beneficiary designations.
If a trust is named as a beneficiary, you should review the terms of the trust since it was likely drafted to account for the expiring laws and may include provisions that are no longer appropriate or, at minimum, no longer reflect your intentions when you account for the new law. If you haven’t used trusts for the beneficiaries of your retirement accounts, possibly due to the complications it can involve for stretching out an IRA, now might be a good time to reconsider it.
Last but not least, the new law adds an exclamation point to the wisdom of leaving your retirement accounts to charity. Often, when you leave your traditional IRA to an individual, they ultimately may receive less than 50% of the value of the IRA after estate and income taxes are paid. In contrast, when you name a charity as beneficiary, the charity pays no taxes and receives 100% of the account. Since beneficiaries will no longer be able to mitigate taxes by stretching IRA distributions over their lifetimes, leaving your IRAs to charity could make even more sense.
A Year-End Bonus: Tax Extensions
It’s also important to note that there was a package of tax provisions included in the new law as well. The “kiddie tax,” which changed in 2018 to apply the estate and trust tax rates to the unearned income of minors, was adjusted back to apply the rates of the minor’s parents. This generally should result in tax savings because estates and trusts pay federal income taxes at the highest rates.
Other tax provisions have been extended, including deductions for medical and dental expenses (allowed when expenses reach 7.5% of your adjusted gross income, down from 10%), the ability to deduct mortgage insurance premiums as qualified residence interest, and above-the-line deductions for qualified tuition and related expenses. Finally, the law extended multiple energy credits and included disaster relief for federally declared disaster areas in 2018 and 2019.
