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SECURE ACT - What it Means to You

In an era of extreme political division, it would have been easy to miss the bipartisan legislation recently enacted by Congress. On December 20th, and without much fanfare, President Trump signed into law the SECURE ACT, which is an acronym for “Setting Every Community Up for Retirement Enhancement.”

 Here are the main provisions and what this could mean for you: 

  • Required Minimum Distributions (RMDs) from IRAs/401(k)s pushed back to age 72. This new law will only apply to those turning 70 ½ AFTER December 31st, 2019. Thus, someone turning 70 ½ in 2019 will be under the old rules and must take an RMD for 2019 and beyond. This change is good for savers as it allows an extra 1 ½ years of additional compound growth and tax deferral on pre-tax retirement funds. 
  • Contributions to Traditional IRAs can be made beyond age 70 ½. Under the old rules, those working beyond 70 ½ were not permitted to make Traditional IRA contributions. Now, regardless of age, contributions can be made to IRAs as long as the account owner has earned income. 
  • The “Stretch IRA” is gone. The new law is not all puppy dogs and rainbows as you’ll see here. To pay for this bill, something had to give. 

Previously, a non-spouse IRA beneficiary who inherited an IRA could take RMDs over their lifetime. Now, non-spouse beneficiaries must take 100% of the IRA balance within 10 years. 

Why is this a big deal? 

Imagine inheriting a $1,000,000 Traditional IRA from a parent or aunt. Under the old rules, a 45-year-old would be required to take approximately $27,000 out of the IRA in the first year with this number slowly increasing over time. This meant that the beneficiary could continue to defer anything over and above the RMD to grow and compound tax-deferred for their future, including their own retirement. 

Under the new rules, a non-spouse beneficiary inheriting an IRA after December 31st, 2019 won’t be required to take an RMD annually, however that same $1,000,000 (plus any growth) must be completely withdrawn by the end of the tenth year or suffer a 50% excise tax. This applies to Roth IRAs as well. 

In addition to exempting a spousal beneficiary, the new rules won’t apply to a minor child, individuals who are disabled or chronically ill, or anyone within 10 years of age of the deceased account holder. 

Planning under the new rules will add complexity. Will it make sense to withdraw ~$100,000 per year for ten years while recognizing this additional ordinary income each year during that period? Does it make sense to wait for a low earned income year so these taxable IRA withdrawals can be accelerated? Or should you just “rip off the Band-Aid” and take the entire IRA balance and income tax hit all at the end of year 10? 

While each situation is different, I would imagine most beneficiaries will plan on deferring the taxes while allowing the account to grow as long as possible. It may also be easier from a tax (and mental perspective) to plan for one large income year ten years in the future. Plus, you’d be reserving the option to accelerate distribution of the account if your financial situation changes during that time.  

For those building charitable giving into their estate planning, it becomes even more attractive to leave all or part of a Traditional IRA to a qualified charity in lieu of other assets. 

Doing all this correctly will take planning and coordination between your financial planner and tax professional. Check those 401(k)/IRA beneficiaries!

  • 529 Plan assets can now be used to repay up to $10,000 in student loan debt.  

This is a nice addition to 529 plan rules. Perhaps this allows those in states which offer a tax deduction/credit (California is not one of them and no Federal deduction is available) to make a 529 plan contribution and then immediately withdraw the funds to pay their student loan. Here is a list of the states that offer some tax break for 529 contributions

  • Parents are allowed penalty-free withdrawals for birth or adoption expenses. New parents can withdraw up to $5,000 from an IRA or 401(k) to help pay for expenses related to the birth or adoption of a child during the first year. Taxes are still due on taxable retirement accounts, but no penalties will apply. 
  • Part-time workers can participate in a 401(k) plan. Employees who have worked at least 500 hours per year for three consecutive years must be allowed into a 401(K) plan. Previously, anyone working less than 1000 hours per year could be excluded from a plan. 
  • Retirement plan participants will receive lifetime income disclosures. This rule mandates the Department of Labor to propose its own rule requiring retirement plan participants – those enrolled in a company 401(k), profit-sharing, or pension plan - to receive a retirement income projection based on their current balance. This will likely take two years to fully implement, but this is good news for retirement savers. The projections will act as a progress report for employees toward their goals, provide a different perspective of their current retirement balance, and spur additional savings. 
  • Annuities can now be offered in 401(k) plans. Creating a guaranteed retirement income can be a good option for retirees whose social security and savings might not be enough. The option will exist for a plan to offer participants an annuity income stream in exchange for some or all of their retirement balance. 

Annuities have earned a bad reputation for many justified reasons – some have high expenses, offer high commissions to agents, and are improperly sold – so there is the potential for abuse here. With appropriate vetting, however, this option can help retirees magnify savings and potential happiness during their non-working years. 

  • Business owners get some help here too. Several provisions in the bill are designed to make it easier for small businesses to offer retirement plans to their employees. 

One such benefit will increase the tax credit available to owners who establish new retirement plans to a maximum of $5,000 over five years. Another provides a $500 tax credit for plans that implement auto-enrollment, which has been proven to get workers into a retirement plan and keep them saving. 

There’s also a provision that allows for unrelated small businesses to band together into “multiple employer plans” or MEPs. There isn’t much to report at this point on exactly how these MEPs will be implemented. We’re hopeful MEPs can become a cost-effective way for small businesses to band together, reduce complexity, and lower costs through better economies of scale.

In my experience, offering tax credits to owners already considering the adoption of a retirement plan can be enough to get them moving. With approximately 25% of employees in the US not currently offered a retirement plan, this seems like a step in the right direction. 

There’s some debate, as there always is, about whether any of these changes will help Americans achieve more favorable retirement outcomes. I believe most people only need a small push in the right direction, combined with flexibility in how they can access their savings, to do what’s in their best interest. These steps remove certain barriers to saving, incent business owners to start a plan for their employees, and give savers more options.

While I will mourn the loss of the “Stretch IRA”, the remaining provisions bring a small step forward in improving the much-discussed retirement crisis. 

Happy Planning,

Brian