Over the past few years, we have seen some of the greatest shifts in tax legislation. And just as we are finally digesting the unprecedented tax reform changes of 2018, we now turn our attention to one of the most extensive pieces of retirement legislation to become law in over 13 years.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) was signed into law on December 20, 2019, making sweeping changes to retirement planning as we know it.
The new law covers three main areas of retirement, including: 1) changing the required minimum distribution (RMD) rules for retirement plans; 2) broadening retirement plan access and 3) eliminating the “stretch” provision from inherited retirement accounts.
Changes to Required Minimum Distribution Rules
If you didn’t yet celebrate your 70 ½ birthday before the end of 2019, you have more time to let your nest egg grow in a retirement account because now, under the new law, your money in an employer-sponsored retirement plan or a traditional IRA does not have to be withdrawn until you’re 72!
Before the SECURE Act, you were required to make withdrawals at 70 ½ on your money whether you wanted to or not. Since many people are working well into their 70s these days, it’s a much better strategy to let your funds grow and then take them out when you’re in a lower tax bracket in retirement.
On the flip side, if you’re retired and are experiencing a dip in income, you may consider converting your traditional IRA into a Roth IRA, a retirement account that allows tax-free withdrawals under certain requirements and does not require RMDs. For those who haven’t reached retirement age yet, you have an extra two years to plan for these conversions.
These RMD changes also translate into additional tax saving opportunities through continued contributions in a tax-deductible IRA. The new law removed the age restriction on IRAs, so if you work beyond your 70s, you can still contribute.
Broad Retirement Plan Access
One of the main goals in creating this bill was to expand the access to retirement plans, making it more affordable for businesses to offer plans and more accessible for part-time employees to be part of them.
The Act incentivizes small businesses to set up employer-sponsored retirement plans by offering an increased tax credit to make setting up 401(k) plans more reasonably priced. The tax credit will go from a cap of $500 to up to $5,000 in some cases.
Separate and unrelated small business owners will also be able to organize themselves into an “open” 401(k) multiple-employer plan (MEP), also referred to as “pooled” employer plans (PEPs). The purpose is to reduce costs and share in the administrative duties to set up the plans so small businesses do not have to take on the burden alone.
For employees, the Act broadens a number of key aspects of retirement plans. It makes it easier for part-time employees to join employer-sponsored 401(k) plans. It also allows automatic-enrollment safe harbor plans to raise the default savings cap on payroll contributions from 10 percent to 15 percent. While employees have the option to opt out of the increase, it may come in handy for employees who are looking to escalate their contributions because they may not have adequate retirement funds.
Both employees and businesses alike benefit from the annuity safe harbor rules embedded in the Act. While annuities have the ability to provide lifetime income during retirement, they also present an “annuity conundrum.” Businesses worried that they could get sued for breaching fiduciary duties if annuity providers faced problems years down the road. The Act aims to fix these employer concerns by protecting them from liability if they choose a provider that fulfills certain requirements.
Lastly, in regards to expanding access, parents have the option to take out up to $5,000 of their retirement funds penalty free to pay for costs associated with a birth or adoption of a child. Since starting a family happens long before retirement, the opportunity to withdrawal funds earlier may encourage younger employees to see the value of contributing much sooner.
Inherited Retirement Accounts
On the not-so-bright side, the Act also imposes stricter rules on non-spouse IRA beneficiaries by eliminating the “stretch” provision. Prior to the SECURE Act, a child, grandchild, or any non-spouse had the option to stretch out required distributions of the IRA over their lifetime (and potentially over decades). But now (with a few exceptions), those who inherit IRAs must take the full disbursement by the end of 10 years. Depending on the stage of life, this could have serious tax implications, and much less of the inheritance going to the intended recipient and rather to the government. This new provision only applies to IRA beneficiaries of people passing away after Jan. 1, 2020.
One strategy to circumvent this new rule is to potentially split the primary beneficiaries to extend the life of the inheritance. Take for example, a surviving spouse and a surviving adult child. Assuming the surviving spouse has enough money to thrive in retirement, you may consider splitting the inheritance and naming both the surviving spouse and adult child as IRA recipients. The adult child would start taking distributions immediately on half of the inheritance, greatly reducing the tax burden. Upon the passing of the surviving spouse, the other half of the inheritance would start a new 10-year period of disbursements. This strategy has the ability to increase the distribution of funds over a longer period of time, thus reducing the overall tax bill.
The SECURE Act also imposed the same legislation onto trust accounts, often established to help manage the inherited retirement account. You should review the trust’s language to ensure compliance and alignment with intended goals.
Other Important Changes
In addition to the key takeaways, there are a few other significant changes—some extended, some temporary—included in the SECURE Act to note. They are:
- The tax-favored 529 plan savings account can now be used to pay back student loan debt.
- The medical expense deduction is now subject to a 7.5% AGI threshold instead of 10%.
- The non-business energy property credit was extended from tax year 2018 through 2020.
- The employer tax credit for paid family and medical leave was extended through tax year 2020.
- The Cadillac tax on high-end health plans has been repealed.
- The work opportunity credit was extended from tax year 2018 through 2020.
- The exclusion from gross income for discharge of debt income from qualified principal residence debt.
Start Planning Now
Many of these changes will require proactive steps to ensure the best outcome for retirement and beyond. This article only touches upon key aspects of the bill and will require a deeper dive. Please contact us at (781) 247-5569 or text the office line at (781) 790-4504.
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About Stu: With more than 30 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.