How does the SECURE Act change your retirement plans?

Editors Note: Please see a newer article on the current status of the SECURE ACT 2.0

In the summer of 2019, a tantalizing new bill that made substantial changes to the retirement system for Americans was passed in the House of Representatives.  It languished for a few months, until finally, just a few days before Christmas, the SECURE Act (Setting Every Community Up for Retirement Enhancement) was attached to an appropriations bill that “had to pass” in the Senate to keep the government running.  So, the SECURE act is now law, and there are many changes for Americans that are actively using an IRA, college savings plan, inherited IRA, making charitable donations and more.  Surprisingly, the act is mostly filled with provisions that help Americans, though in some instances they also raise additional funding for the government at the expense of the general public.  At Arrow, we think these changes are extremely important, and we want to communicate how these revisions affect our clients and everyone across Oklahoma.

Please note that the following are only the major changes in the act, there are other more subtle changes that are best discussed with your financial adviser.  I organized these in the order that I think they will impact Arrow clients:

Required minimum distributions (RMD’s) now begin at age 72.

One of the major changes provided by the SECURE Act is the shift backwards of the mandatory age for taking required mandatory distributions to 72 from 70.5.  Making this a nice whole number is going to make life easier for everyone, and provide all investors an extra year and half to allow their assets to grow before drawing down their retirement accounts.  Importantly, the new starting age for RMD’s only applies to those individuals who turn 70 ½ in 2020 or later. So even though an individual turning 70.5 on December of this year will not yet be 72 in 2020, they will still be required to continue RMDs under the existing rules, and to take an RMD for 2020 and all subsequent years.  Similar to existing law, individuals of 72 years of age will still be able to delay their first RMD until April of the year AFTER they turn 72.

Traditional IRA contributions are now allowed after the age of 70.5 (similar to a ROTH IRA).

Section 107 of the SECURE Act finally makes the Traditional IRA consistent with the ROTH IRA and other retirement accounts.  Starting in 2020, investors of any age can now make contributions to their Traditional IRA.  However, the provision that individuals have compensation from wages or self-employment at least equal to the amount they contribute still remains.  So, this option is really only available for folks that either are still working, or have a spouse that is still working after the age of 70.5.

The SECURE act also coordinates the new Traditional IRA rules with the pre-existing Qualified Charitable Distribution (QCD) rules.  A QCD is a distribution made from an individual’s IRA to a qualifying charity, which can satisfy their RMD’s for the year.  Under the new requirements, any QCD is reduced by the cumulative amount of post-70.5 IRA contributions that have not already been used to offset an earlier QCD.

The “Stretch” provision for retirement accounts is now dead.

Under previous rules, non-spouse beneficiaries of retirement accounts had several options for drawing down their accounts.  Most notably, they needed to draw-down the account completely within five years (even as a lump sum), or alternatively, “stretch out” their withdrawals over their life expectancy, based on a formula that considered both age and life expectancy.  Starting in 2020 and forward, all beneficiaries will need to utilize the “10-year rule”.  Under the new 10-Year Rule, the inherited retirement account must be completely drawn down by the end of the 10th year AFTER the year of inheritance. Similar to the pre-existing 5-year rule for non-spouse beneficiaries, there is no distribution requirements within those 10-years, so the beneficiaries will have flexibility when it comes to timing distributions from their inherited accounts.  This at least allows the beneficiaries some options for controlling when they take their distributions for tax purposes, as long as the account is emptied in the year after the 10th year of inheritance.

The 10-year rule does NOT apply to “designated beneficiaries”, who remain part of the pre-existing beneficiary rules.  Designated beneficiaries include spouses, disabled beneficiaries, minor children, and chronically ill beneficiaries.  Spouses may still transfer their inherited accounts to their own accounts, and other designated beneficiaries can utilize the pre-existing stretch rules.

The elimination of the stretch provisions for retirement accounts has been cited as the primary negative update to the retirement system.  Since people (and Trust beneficiaries) have to speed up their timeframe to withdraw inherited accounts, they will pay more taxes, and the U.S. government stands to raise a large amount of additional funding each tax year.

Small businesses can now get a larger tax credit for starting a retirement plan.

Under current rules, small business (those with under 100 employees making >$5000 per year) are eligible to receive a $500 tax credit for opening a qualified retirement plan, such as a 401k, 403(b), SIMPLE IRA, or SEP IRA.  Section 104 of the SECURE act now increases that amount to the highest of the following:

-$500

-The lesser of:

                -$5,000

                -$250 x the # of highly compensated employees that are plan-eligible.

Student loan debt and apprenticeships can now counts as a qualified expense for 529 College Savings Plans

The SECURE act adds expenses like books, fees, and supplies related to apprenticeships to the qualified expense list, on the condition that the apprenticeship is properly registered with the Department of Labor.  More importantly, the SECURE act allows up to $10,000 (lifetime limit) in educated related loan principal or interest payments to be paid using a 529 plan.  Notably, that payment is then not eligible to be deducted as student loan interest when filing your taxes.

The $10,000 is a lifetime limit per individual, however, funds from a 529 plan can also be used to fund the beneficiaries’ siblings, up to the same $10,000 limit.  So, one 529 plan can allow multiple children to be covered for the $10,000 loan repayment with only one account.  Unlike many other provisions of the SECURE act, these changes are applied retroactively to all of 2019.

Other Changes

The updates I described here are only some of the changes coming to the retirement and tax system as a result of the new SECURE act.  There are additional rules for using annuities in retirement plans, qualified adoption distributions, maximum 401k contributions for automatic enrollment and a host of other categories.  Please feel free to ask for an appointment if you would like to discuss any of these changes.