So now you may be able to delay Required Minimum Distributions (RMDs) until age 72 instead of 70 ½. And now you may be able to contribute to an IRA after age 70. However, an inherited IRA can no longer be “stretched” over a beneficiary’s life expectancy; now it must be taken and taxed within 10 years of the original account owner’s death.
What’s the net result for you? To answer that question, we suggest that you do two things: (1) learn a bit about the SECURE (Setting Every Community Up for Retirement Enhancement) Act, and (2) consult with a financial advisor to determine its impact on you. Some of these impacts may not be so obvious, because they may be derivatives from primary impacts. Therefore, the suggestion for professional guidance.
On December 20, 2019, President Trump signed the SECURE Act. This new law is the largest legislative change in retirement rules since the Pension Protection Act of 2006.1 It makes sweeping changes to key provisions in most defined contribution plans, including 401(k)s, 403(b)s, 457(b)s, ESOPs, cash balance plans, IRAs and rollover IRA’s.
Although there are 30 provisions in this law,2 some provisions will have a greater impact on clients’ lives than other provisions. Following are some of the more impactful sections of the law.
Required Minimum Distributions Starting at Age 72
Prior to the passage of the SECURE act, seniors were generally required to start taking required minimum distributions (RMDs) from IRA’s and qualified plans in the year they turned age 70½. RMDs from current employers aren’t required until after you leave your job, unless you are at least a 5% owner of a company. The SECURE Act pushes the age that triggers RMDs from 70½ to 72. More specifically, effective January 1, 2020, the starting date for RMDs are delayed to age 72 for everyone born on July 1, 1949 or later.3
Anyone who turned age 70½ in 2019 falls under the old rules. These individuals must take their RMDs this year, and failure to do so may result in a 50% penalty of their RMD amount. To be sure, the first year’s withdrawal doesn’t need to be made until the following April 1st, which means people who turned 70½ in 2019 can wait to withdraw their first RMD until April 1, 2020. They must take another RMD by December 31, 2020, and every December 31 thereafter.
Increasing the start date to age 72 adds another 1½ years before RMDs must begin. Mirroring current law, individuals reaching age 72 will still be able to delay their first RMD until April 1 of the year following the year for which must take their first RMD. Thus, an individual turning 72 on February 2, 2021 can timely take their first RMD until as late as April 1, 2022.4
Qualified Charitable Distributions (QCDs) Still Allowed at 70½
Under prior law, an individual over 70 could use their IRA to make a qualified charitable distribution (up to $100,000) and not pay income tax on the distributions. The SECURE Act makes no changes to the date at which individuals may begin to use their IRAs (and inherited IRAs) to make QCDs. Even though an individual turning 70 ½ in 2020 will not have to take an RMD for 2020, they may still use their IRA to make a QCD (up to $100,000) for the year (after actually turning 70½ or later).5
Death of the “Stretch” Rules
One of the most significant changes made by the SECURE Act is the elimination of the ‘Stretch’ provisions for most non-spouse beneficiaries of defined contribution plans and IRA accounts.
Under current law, non-spouse beneficiaries of IRAs for individuals who pass away before 2020 are eligible to stretch distributions over their life expectancy. Under the SECURE Act most designated beneficiaries who inherit in 2020 or beyond (where the retirement account owner dies in 2020 and beyond) will be subject to the new ’10-Year Rule.’ This rule states that the entire inherited account must be emptied by the end of the 10th year following the year of inheritance. Within the 10-year period there are no distributions requirements, as long as the entire account balance has been taken by the end of the 10th year after death.6
There are certain Eligible Designated Beneficiaries who are exempt from the 10-year rule. These include the following people:7
- Spousal beneficiaries
- Disabled beneficiaries within the meaning of IRC 72(m)(7)8
- Chronically ill beneficiaries within the meaning of IRC 7702B(C)(2)9
- Individuals who are not more than 10 years younger than the decedent
- Minor children, but only until they reach the age of majority
For these individuals, the same rules that applied before the SECURE Act will continue to apply after the SECURE Act.
The SECURE Act also provides that trusts be treated as an Eligible Designated Beneficiary when the trust beneficiary is a disabled or chronically ill individual.10
For the most part, the changes in the ‘stretch’ rules will impact beneficiaries beginning in 2020. However, Congress did carve out a few exceptions. Plans pursuant to a collective bargaining agreement are effective January 1, 2022. Likewise, for governmental plans, such as 403(b) plans sponsored by state and local governments, and the Thrift Savings Plan sponsored by the Federal government. The ‘stretch’ rules for these plans also become effective January 1, 2022.11
No Age Restrictions on IRA Contributions
Under prior law, individuals who turned age 70½ could no longer make traditional IRA contributions (although they could make Roth contributions). Under the SECURE Act beginning in 2020, there will be no maximum age for allowable contributions to a traditional IRA. The requirement that the individual must have earned income to make the contribution still remains, however.12
There is a curious provision in the law that coordinates post-70½ IRA contributions with QCDs. Under this rule, any QCD will be reduced by the cumulative amount of total post-70 ½ IRA contributions (but not below $0) that have not already been used to offset an earlier QCD. For example, let’s assume that Abe, who is working part-time, contributes a total of $15,000 to an IRA and retires after three years. He then decides to make a $20,000 QCD, his first contribution to charity. Abe will only be allowed to claim a QCD of $20,000-$15,000 or $5,000. The remaining $15,000 may be claimed as an itemized deduction, if he so itemizes.13
Exception to the 10% Early Distribution Penalty for Childbirth and Adoption
The SECURE Act introduces a new exception to the 10% early distribution penalty from a qualified plan or IRA. This new rule, found in Section 113, allows an aggregate amount of $5,000 to be distributed from the plan or IRA without penalty. The distribution would need to occur within one year of the adoption becoming final or the child being born. As with other exceptions, income taxes must still be paid on the distribution.
********************************************
Other SECURE ACT Provisions for Retirement Plans and IRAs:
Treat “Difficulty of Care” Payments as Compensation for Purposes of Contributing to an IRA
Effective upon enactment, individuals who receive “difficulty of care” payments (under IRC Sec. 131) which may be excluded from gross income, can use such amounts to make nondeductible IRA contributions (subject to IRA contribution limits).14
Taxable Non-Tuition Fellowship Payments Treated as Compensation for IRA Purposes
Stipends and non-tuition fellowship payments received by graduate students are currently not treated as compensation and cannot be used for IRA contributions. Section 106 removes this obstacle and allows such amounts that are includible in income to be used for IRA contribution purposes.
Small Employers Get Bigger Tax Credit for Establishing a Retirement Plan
Under current law, small business are eligible for a tax credit of up to $500 for up to three years for startup costs related to establishing a retirement plan, including a SEP IRA or SIMPLE IRA. Small businesses are defined as businesses with 100 or fewer employees receiving $5,000 or more in compensation. Section 104 of the SECURE ACT increases the potential tax credit amount available. Depending upon individual circumstance, the credit may be as much as $5,000.15
Small Employers Get Tax Credit for Automatic Enrollment
Section 105 of the SECURE Act creates a new tax credit of up to $500 per year to small employers to defray startup costs for new retirement plans (including SEP or SIMPLE IRAs) that include automatic enrollment. This credit is separate and apart from other credits, such as the one mentioned above, and is available for three years. This new provision is designed to incentivize small employers to automate enrollment in retirement plans. Research shows that automatic enrollment is likely to increase an employee’s contribution amount to a retirement plan.
Increase in the Maximum Contribution Percentages for 401(k) for Automatic Enrollment
Employers are currently limited to the amount they can automatically defer for them in the employer’s retirement plan. The maximum current amount is 10% of compensation. Section 102 of the SECURE Act allow employers to defer as much as 15% in any year after the first full plan year.
Allow More Part-Time Workers to Participate in Employer Retirement Plans
Under current law, employers may exclude employees from participating in a 401(k) if they have not worked at least 1,000 hours in a year. Under Section 112 of the SECURE Act, part-time employees must also be eligible to enroll if they worked at least 500 hours in three consecutive years.
Barriers Reduced for Multiple Employer Retirement Plans (MEPs)
Multiple Employer Retirement Plans are single retirement plans maintained for the benefit of two or more unrelated employers. The development of MEPs has been underutilized due to the “One Bad Apple” rule. This rule states that a disqualifying act by any single employer disqualifies the whole plan. Section 1010 of the SECURE Act removes the “One Bad Apple” rule.
Qualified Plans Prohibited From Making Loans Through Credit Cards
Loans may be available from the employee’s 401(k) plan under certain circumstances. Oddly enough, employers were allowed to make these loans through the use of credit cards. Section 108 of the SECURE Act now prohibits this option.
Fiduciary Safe Harbor for the Selection of an Annuity Provider
Section 204 of the SECURE Act seeks to update the safe harbor provision for plan sponsors to select annuity providers in order to offer in-plan annuities inside of a 401(k). Today, many 401(k) plans avoid annuities, in part because of concerns about liability in picking an annuity provider for the plan. These new rules ease these liability concerns somewhat, potentially opening up the path for more annuities to be offered inside of a 401(k).
Portability of Annuities
Section 108 permits qualified defined contribution plans, 403(b) plans, and 457(b) plans to make a direct trustee-to-trustee transfer of an annuity if the annuity is no longer authorized to be held as an investment option under the plan. This transfer may be to another employer-sponsored retirement plan or to an IRA.
********************************************
Miscellaneous Provisions
Extending the Timeframe for Establishing a Qualified Retirement Plan
Under current law, an employer must generally establish a qualified retirement plan by the end of the tax year. Section 201 of the SECURE Act amends this requirement so that employers may adopt plans that are entirely employer funded up to the due date of the employer’s return. Entirely employer funded plans may include stock bonus plans, pension plans, and profit-sharing plans.
Increase Penalty for Failing to File Returns
Section 402 of the SECURE Act increases the penalties for failing to file income-tax returns, including Form 1040s, and Section 403 increases penalties for failure to file retirement plan returns.16
Expanding Qualified Education Expenses for 529 Plans
Section 302 of the SECURE Act expands qualified educational expenses to include expenses for apprenticeship programs. More important, though, is the inclusion of “Qualified Education Loan Repayments” as qualified higher education expenses payable potentially without tax and penalty. Distributions for the latter expenses may be used to pay both principal and/or interest of education loans and are limited to a lifetime amount of $10,000. Section 302 is effective retroactive to the beginning of 2019.17
Reversal of Kiddie-Tax Rules
Prior to the Tax Cuts and Jobs Act passed just two years ago, any income subject to the Kiddie Tax was taxable at the child’s parents’ marginal tax rate. The Tax Cuts and Jobs Act made that income subject to potentially much higher trust tax rates. Under Section 501 of the SECURE Act, any income subject to the Kiddie Tax is once again taxable at the child’s parents marginal tax rate. Although this change is effective 2020, taxpayers may elect to have these new rules apply to income for 2018 and 2019 as well.
Conclusion
As you can see, the SECURE Act represents a sea change in retirement legislation. The rules changes can have dramatic and possibly unintended consequences to both retirement and estate plans already in place. For example, reducing the lifetime stretch of an inherited IRA to a “10-Year Rule” may result in significant added taxes to your children during their peak earnings years. To deal with these and other potential new issues posed, planning should begin now. That’s why we suggested at the beginning of this article that learning about the rules changes is important … as is consulting an advisor to think through how they may impact your current and future planning.
Please feel free to contact us if you would like to begin a discussion about the impact of the SECURE ACT on your planning. Remember, we are here to help.
Doug Lemons, CFP®
This material is for general use with the public and is designed for informational or educational purposes only. It is not intended as investment advice and is not a recommendation for your retirement savings. Lincoln Financial Advisors does not offer legal or tax advice.
Registered Associates of Family Wealth Decisions Group are registered representatives of Lincoln Financial Advisors Corp. Securities and investment advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. Family Wealth Decisions Group is not an affiliate of Lincoln Financial Advisors Corp. CRN-2893322-010620
2H.R. 1865, Division O, Table of Contents, https://www.congress.gov/bill/116th-congress/house-bill/1865/text, p. 657
3H.R. 1865, Division O, Sec 114, Op. Cit.
4Ibid
5https://www.kitces.com/blog/secure-act-2019-stretch-ira-rmd-effective-date-mep-auto-enrollment/
6Sec 401(a)(1)(H)(i), H.R. 1994 https://www.congress.gov/bill/116th-congress/house-bill/1994/text#toc-H084B5EBD76DF47C0B895121999E2270E
7Sec 401(a)(2), H.R. 1994, Op. Cit.
8Per IRC 72(m)(7), “an individual shall be considered disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.”
9Per IRC 7702B(C)(2), “chronically ill individual means any individual who has been certified by a licensed health care practitioner as (i) being unable to perform…at least 2 activities of daily living… or…requiring substantial supervision to protect such individual from threats to health and safety due to sever cognitive impairment.”
10Sec 401(a)(1)(H)(iv), H.R. 1994, Op. Cit.
11Sec 401(b), H.R. 1994, Op. Cit.
12Sec 107(a), H.R. 1994, Op. Cit.
13Sec 107(b), H.R. 1994, Op. Cit.
14Sec 116, H.R. 1994, Op Cit.
15Kitces, Op. Cit. and Sec 104(a)(1), H.R. 1994, Op. Cit.
16Applies to all tax returns under IRC 6651(a), Sec 402(a), H.R. 1994, Op. Cit.
17Section 302(c), H.R. 1994, Op. Cit.