In December 2019, the SECURE Act was passed to change some of the longstanding rules that govern retirement plans. In a previous post we touched on a few of these changes, but with the end of 2020 already quickly approaching, let’s review some of the Act’s significant changes that likely could affect you or your family in future years.
Much of the SECURE Act or (Setting Every Community Up for Retirement Enhancement) Act focuses on retirement plans in the form of adjustments to rules, expanded eligibility and options, among others. While many of the SECURE Act items are geared towards businesses, in this article we will highlight the changes that can substantially affect individuals.
Perhaps the most impactful change comes in the form of changes to rules affecting inherited retirement assets for beneficiaries. The SECURE Act removed the ability to ‘stretch’ inherited retirement assets for many beneficiaries and likely may result in a review of many individual's estate plans and current beneficiary designations so that account owners are familiar with how this change could impact their overall estate plan. These changes will apply to any qualified retirement assets, including IRAs, traditional 401(k)s or Roth 401(k)s, 403(b)s, Roth IRAs, SARSEPs, SIMPLEs and SEP IRAs. Considering if Roth conversions are applicable or appropriate for an investor is even more important given these changes. We will be covering this topic in more detail in future articles. If you have questions about your particular situation please contact your legal, tax or financial professional. While we while highlight possible estate implications of the SECURE Act, individuals should consult with their licensed estate attorney about their situation and before making any changes.
The SECURE Act removed the Stretch IRA provisions which benefited so many individuals in decades past. Prior to 2020, many related beneficiaries could take their required minimum distribution (RMD) each year based on their own life expectancy. For example, someone in their 40’s inheriting an account from a parent would be able to have a lower required amount they had to withdraw each year from an inherited IRA than would someone in their 70’s. Instead of having to use the age of the person who passed away, an eligible beneficiary could have used their own age in order to ‘stretch’ out how much of the account they had to deplete each year, allowing the account to stay invested and typically last much longer. Now, many beneficiaries will be required to distribute all of the funds in an inherited account within 5 or 10 years of the owner of the account’s passing with a few exceptions.
As of January 1, 2020, there are essentially 3 tiers of how inherited retirement assets will be treated by the IRS.
Depending on which category your intended beneficiaries fall into, they may be required to deplete the accounts within the 5-year or 10-year window. Within those timeframes, a beneficiary can choose to distribute the funds whenever they choose. All funds from the inherited retirement account can be taken out in year 1, or year 10, or any combination within that window. Tax planning will likely become essential for beneficiaries inheriting larger retirement accounts. Beneficiaries are taxed at their Ordinary Income tax rate in the year(s) of withdrawal. Even if a spouse initially inherits the retirement account and uses their own life expectancy to stretch the account, the next beneficiary, or ‘successor beneficiary’, will be subject to the 10-year (or 5-year) payout rule. This is true for previously inherited ‘stretch’ accounts even if the original owner died prior to 2020 and the passing of the SECURE Act.
Another point to note relates to minor children inheriting a retirement account. For example, if a minor child inherits an account at age 15, they are able to use their current age and life expectancy table until they reach the age of majority in their state, generally 18, 19, 21 or 26 (if in school) depending on state law. For example, let’s assume the age of majority is 18 like in California. At age 18 the child may be required to fully deplete the retirement account within 10 years. By age 28 the child will have withdrawn all funds. This can be a concern for parents for a number of reasons.
A key part of the changes related to what happens to your trust if your trust is listed as the beneficiary of your retirement account. The type of trust and the controls of the trust impact how it is categorized, but almost all trusts are expected to be subject to the 10 or 5-year rules. In general, the SECURE Act removed some of the tax-deferred benefits for retirement assets when it comes to estate planning.
Eliminating the stretch provisions was purported to be the way our elected officials were able to increase changing the starting RMD age from 70.5 to 72 which is covered below. Pushing back the starting RMD age is so expensive to the government from a tax perspective based on current demographics that the removal of the Stretch IRA provisions was a way to compensate for the initial loss in tax revenue. Regardless, with these changes to stretch provisions the government will receive their share of deferred tax revenue sooner than under the previous rules.
The SECURE Act will likely result in a massive shift affecting tax planning, retirement planning and estate planning for years to come. Estate and tax attorney experts are exploring how to efficiently navigate this substantial overhaul with certain trust vehicles. There will be continued developments in estate planning as these changes are worked through. Contact us with questions and stay tuned.
The Required Minimum Distribution starting age is changed from the year in which someone turns 70.5 to the year they turn 72. Starting in 2020 anyone turning 70.5 on or after January 1st, 2020 is not required to start their initial RMD until age 72.
The SECURE Act removes the prior age cap where once individuals reached age 70.5, they could not contribute to an IRA even if they were still working. The removal of the age cap allows anyone, regardless of age to contribute to an IRA if they have qualifying income. Congress recognized the reality that many individuals are still working and will continue to work into their 70s. These changes could allow for some planning opportunities depending on an individual’s situation. One thing to keep in mind of course, is that RMDs will still be required once hitting age 72 regardless. Removing the age cap can be significant for those who would still prefer a tax-deferred way to save for retirement, or for those who prefer more options for how their money can be invested when compared to a company retirement plan such as a 401(k) or 403(b) plan.
The IRS’s upcoming change is actually not a part of the SECURE Act, but we are including it here for its relevance. Prior to the changes with the SECURE Act, the IRS already had a proposed change to their Life Expectancy Tables slated for 2021. Realizing that many individuals alive today could outlive the current 115-year life expectancy, the IRS expanded the maximum age for inclusion in RMDs to 120 years old.
This change, if it passes the final regulatory stages to be implemented, should lower the annual RMD amount required for everyone subject to RMDs. By increasing the maximum age, the IRS Table effectively lowers the multiplier factor for a given year, reducing the amount required to be withdrawn, and as a result lowering expected tax liability. The updated tables were slated to be implemented by 2021, before the SECURE Act’s December 2019 upheaval which requires substantial changes to parts of the tax code. If approved on schedule, the updated tables are expected to apply to RMDs starting in 2021.
As a reminder, the Tax Cuts and Jobs Acts in 2017 expanded 529 Plan rules to be able to be used up to $10K per year towards private tuition before a child reaches college. The SECURE Act made another tweak to 529 plan rules. 529 plans, the most popular tax-advantaged savings vehicle for saving for college, will now allow 529 plan savings to be applied, up to a maximum of $10K, towards homeschooling, apprenticeship programs and qualified student loan repayments for primary, secondary and religious schools.
Parents can take a penalty-free early distribution up to $5K from a retirement plan to help cover costs related to the birth or adoption of a child. This change will not eliminate the tax liability an individual will need to pay if the withdrawal is from a tax-deferred plan.