Amidst the rancor of impeachment, it may be hard to believe but Congress did actually pass a bill shortly before Christmas – and a significant one at that. You may have already seen or heard details about the SECURE Act. You’re forgiven if you haven’t or if you are confused by what you’ve seen. After all, paying attention to anything in the other Washington these days can be hazardous for your health!
Regardless of whether you’re hearing about it for the first time right now or whether you have read the actual bill three times over, we hope today’s blog post will help you understand some of the key considerations coming from this long-anticipated and very significant piece of legislation. We’ll focus on the provisions that impact individuals, while also briefly touching on those impacting business owners and retirement plan sponsors. This is meant to simply be an introduction. By no means will every provision impact you. Where we see these new laws impacting your financial plan, we’ll be reaching out personally to you in the coming days and weeks. So without further ado, let’s get started.
Required Minimum Distributions
For those of you turning 70-1/2 after this year, your required minimum distributions (RMDs) will now be delayed to age 72. This won’t preclude you from taking withdrawals at anytime after 59-1/2 but does enable you to further delay withdrawals and reap the tax benefits of doing so if you so choose. This will have a significant impact on financial planning, and we’ll be adjusting plans accordingly in order to maximize the value of this new rule for you.
It is important to note that if you are already subject to RMDs, that will not change. You will need to continue your RMDs uninterrupted in the new year.
End of the “Stretch IRA”
Under current law, a non-spouse beneficiary of an IRA could take distributions from that inherited account based on their own life expectancy. For those that inherited such assets at a young age, this meant low RMDs and thus significant tax savings over the life of the account. For example, this would often prompt wealthy IRA owners to leave their IRA accounts to grandchildren. To help make up for the lost tax revenue resulting from the delay in the RMD start date, the SECURE Act effectively removed the stretch IRA from the lexicon of financial planning. Instead, non-spouse beneficiaries (with some specific exceptions) will now be required to completely drain the inherited account within 10 years of receiving it. Given that RMDs from pre-tax accounts are subject to ordinary income tax rates, this could mean very significant tax bills resulting from these withdrawals, especially if the account is received by someone in the prime of their career when their own income is at its peak.
It is important to note that spouses can continue to inherit IRAs and treat them as their own, meaning distributions remain subject to the inheriting spouse’s life expectancy. It’s when that second spouse dies and leave the assets to the next generation that this new rule really comes into play. That said, there is no formula for how and when you will have to take distributions during that 10-year window, just so long as the account has a $0 balance at the end of Year 10. This will open up plenty of planning discussions!
Qualified Charitable Distributions
We’ll interrupt our previously scheduled program with a news alert – lawmakers missed a few things in drafting and passing this legislation. Now that you’re over your shock, we’ll discuss one such item – Qualified Charitable Distributions (QCDs). These are a way for charitably minded IRA account owners to give from their IRA in a significantly tax-advantaged way. Under current law, these can be done when the account owner reaches 70-1/2, which you’ll note is the same as the current onset of RMDs. The SECURE Act did not explicitly change this age, meaning there is now an awkward disconnect between the RMD and QCD starting ages. We expect that this will be cleaned up at a later date, and we advise you to check with us or with our tax advisor before doing a QCD in 2020 if you aren’t already subject to RMDs. Note that QCDs were not eliminated and will remain a powerful tax-savings tool for those that have philanthropy in mind.
Max age for Traditional IRA contributions
Previously, once you reached 70-1/2 you were unable to make a tax-deductible contribution to a Traditional IRA (you could continue contributing to a ROTH IRA or a 401(k), assuming you had earned income). Under the SECURE Act, you will now be able to continue making contributions to your Traditional IRA (and a spousal IRA) so long as you have earned income, irrespective of your age (yes, you can make a contribution while also taking required distributions). With people working longer – either full-time or part-time – this may provide substantial tax savings to many of you.
Penalty-free withdrawals when you have a kid
There are currently a handful of scenarios where you can tap into your retirement accounts penalty-free before the age of 59-1/2. The SECURE Act adds one more such circumstance to that list – the birth or adoption of a child. You can now withdraw $5,000 in this case, though the withdrawal is still subject to taxation, so we don’t recommend it as the first avenue for funding this joyful expense
529 Distributions for Student Loans
Guess what, not everything in this retirement bill is directly about retirement! A random provision is also included that will allow you to use up to $10k (lifetime) from a 529 account (college savings account) to pay back student loans. This is currently prohibited. It may seem like a useless exercise, but it could be a helpful provision under certain circumstances, especially if you live in a state where you can get a tax deduction for contributing to a 529 account (not yet the case in the Evergreen State).
And now for those 401(k) plans
While all of the aforementioned provisions were an important part of this Act, the meat of the bill actually regarded workplace retirement plans. Those provisions included:
- Expansion of Multiple Employer Plans (effective 2021). This is designed to encourage smaller employers to offer 401(k) plans by banding together with other employers to offer more robust, lower-cost Plans to their employees. Currently, these “MEPs” are permitted but under more limited scenarios. These new “open” MEPs will build on this concept. We’ll be diving deep into the proposed mechanics to see how these might benefit the 401(k) plans we currently service, and how they might make a 401(k) a viable option for other business owners that we know and serve.
- Lifetime income options. Perhaps the most heralded, and most controversial, part of this bill is the provision to encourage more annuity products to be offered within a 401(k) plan. With the slow death of the defined benefit plan (aka, pension), some retirees are looking for more guaranteed income streams in retirement, and some have found that their 401(k) is not meeting that need. This bill provides “safe harbor” provisions designed to encourage Plan Sponsors (employers) to consider offering guaranteed lifetime income products within their Plans. Note, this is not a mandate to offer these products, so a lot remains to be seen as to the actual impact of this provision. Also, our own commentary here – no annuity will save the day for those who have not saved enough. The value of any annuity is directly tied to how much you have available in your account.
- Tax credit enhancements. To help further encourage employers to launch new 401(k) plans, the SECURE Act significantly expands on the tax credits available to help offset the upfront costs of initiating such a Plan. With up to $5,500 now available, this should motivate many employers to take the leap.
- Expansion of eligibility. Those that work very limited hours are currently prohibited from contributing to a 401(k) in most cases. Under the new law, those working at least 500 hours each year for three consecutive year will now be eligible to contribute (though their employer will not have to provide the same matching funds that other eligible employees receive). With more people working multiple jobs in the “gig economy,” this could serve to further enhance retirement savings options for those workers.
Wow! That was a lot. I hope you stuck with us and learned a thing or two. Perhaps the most important thing to take from all of it is what we said at the beginning, and that is that we’ll be reaching out to you personally where we see opportunities or needs to adjust your financial plan in light of this new law. We often say that “a good guide is better than the best map.” It’s when sweeping new changes come at you that the good guide becomes even more valuable – and we thank you for allowing us the privilege of being that guide for you.
Happy New Year! May 2020 be a year filled with great relationships, adventures, and learning.