In December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act). The COVID-19 pandemic has brought our attention to many other pressing issues that affect our lives including more recent legislation called the CARES Act.
In this article, we’ll go over the major provisions in the SECURE Act regarding retirement, and summarize some of the other changes implemented in both the SECURE and CARES Acts. For the major retirement changes, we’ll give you some useful planning tips.
The Big 3 Changes in the SECURE Act
It extends the age you can contribute to an IRA
Now you may contribute to an IRA, or an IRA for your spouse, for as long as you have earned income. The rule used to be that you were precluded from making IRA contributions once you reached age 70 ½.
Planning tip: This extends the period of time that earners may accumulate wealth on a tax-deferred basis. Or you might be able to do back-door or regular Roth IRA contributions to save on a tax-free basis.
It raises the age for Required Minimum Distributions, or RMDs
Previously, RMDs from retirement accounts generally had to begin upon turning age of 70 ½. The age is now 72. Some additional notes about changes to RMDs are:
The CARES Act in 2020 has waived RMDs for 2020. RMDs will start up again in 2021.
Those who turned age 70 ½ prior to 12/31/2019 must follow the old rule.
Planning tip: Delaying RMDs presents the opportunity to have further tax-deferred growth should you not need the income. Also, it potentially pushes the income out to years when you expect to be in a lower tax bracket.
It eliminates the “stretch IRA” in certain instances
When someone inherits an IRA, they must follow RMD rules as well. For children inheriting an IRA, RMDs were calculated to spread distributions across one’s lifetime – the so-called “stretch IRA.” For inherited IRAs for which the original owner’s death falls after Jan. 1, 2020, the payout period is shortened from lifetime to 10 years.
There are several types of beneficiaries that are excluded from this rule: spouses, disabled individuals, beneficiaries who are no more than 10 years younger than the decedent, certain minor children until they reach the age of majority, and chronically ill beneficiaries.
Planning tip: It is always a good idea to periodically review the beneficiary designations and bequests in your Will. You might have named a Trust as the beneficiary of your IRA. We can review with your attorney the impact that this ruling may have on your estate plan. Also, due to this loss of a “stretch,” the income-tax hit on inheritances from a retirement plan is potentially accelerated. If charitably inclined, naming charities as beneficiaries of your retirement accounts while directing your taxable accounts to your heirs might warrant greater consideration.
Summary of key changes from the SECURE Act
IRA contributions must stop
Age 70 ½
No more age restriction
RMDs must start
Age 70 ½
Inherited IRA RMDs timeline for most children
Could “stretch” distributions over their lifetime
Must distribute no later than year 10
Other Ways SECURE Can Affect Retirement
It gives part-time employees more access to retirement plans
In order to qualify for an employer retirement plan, part time employees had to work at least 1,000 hours a year. Now, an employee can also qualify if they work 500 hours or more for three consecutive years. The earliest an employee can be eligible, though, would be 2024, as this applies to plan years starting in 2021.
It waives the 10% early withdrawal penalty for utilizing retirement accounts to fund birth or adoption expenses
There are several ways to take money out of your retirement account before you are 59½ and not pay a penalty. Another exception has been added whereby one can take up to $5,000 for qualified expenses related to birth or adoption (incurred within one year of the event) and not incur the 10% early withdrawal penalty. You may also re-contribute the money back into your account should the expense be a short-term cash flow issue.
It creates tax incentives for companies to establish retirement plans
Businesses can get a bigger tax credit for establishing new small business retirement plans and a further credit for setting up automatic default contributions on behalf of their employees. Default contribution rates can go as high as 15% starting after the first full plan year in which the employee’s compensation is automatically deferred into the plan.
It allows companies to set up certain retirement plans after year’s end
Previously the deadline to set up most retirement plans was December 31st. It has been extended until the tax filing deadline for the business (including extensions) providing the plan’s only contributions are from the employer. This would apply for profit sharing plans, stock bonus plans and pension plans.
Other Changes to Consider
It enhances the medical expense tax deduction
The hurdle to deduct medical expenses was 10% of your adjusted gross income (AGI). This percentage has been changed recently, going from 7.5% to 10% and now has reverted back to 7.5%. The catch is that it applies only to 2019 and 2020 tax years.
It rolls back kiddie tax rules
Children under the age of 18 (with exceptions for dependent college students), who have unearned income above $2,200 are taxed at their parents’ marginal tax rate. In 2018 and 2019, the rule had changed such that the tax was imposed using trust tax rates. Depending on the tax bracket of the parents, this could mean either higher or lower taxes on their children’s unearned income. This rule is effective in 2020 but taxpayers can go back and amend 2018 and 2019 returns using the new rules if more advantageous.
It allows withdrawals from 529 plans to pay off student loan debt
In addition to being able to use 529 plans to fund some of a beneficiary’s primary schooling, withdrawals can now be made for repayment of qualified student loans up to $10,000 for lifetime. Additionally, they can be made for siblings up to $10,000 each. Note this provision is retroactive to 2019. Be careful, though – while such a withdrawal is deemed to be “qualified” at the Federal level, some states such as New York have deemed them to be “nonqualified” and subject to a recapture of the state tax deduction.
It increases penalties for failing to file returns
Penalties for failing to file both regular income tax returns and for reporting employee benefit plans are significantly increased.
The most significant changes in the SECURE Act are the loosening of age restrictions and the elimination of the stretch IRA. Consider how each of these major changes affects your personal financial situation. While being aware of current laws is the best way to ensure you have the best plan moving forward, it can also help to consult your financial advisor.