Right before dispersing for its winter break, Congress passed significant changes to retirement savings law that affect many of us now and will affect all of us in the future. This new law, the SECURE Act, is part of the massive government spending bill that was approved by Congress on December 19 and signed into law by President Trump on December 20, 2019.
What is the SECURE Act?
The SECURE Act stands for the "Setting Every Community Up for Retirement Enhancement" Act with its primary intentions being to enhance the retirement planning opportunities and the grim retirement outlook for many working Americans. This bill enacts the biggest changes to the U.S. retirement system since 2006.
SECURE Act Key Provisions
- Change to RMD age: The age at which individuals must begin taking required minimum distributions (RMDs) from their retirement accounts has been raised from age 70½ to age 72. Note that this provision only takes effect for distributions made after December 31, 2019 for individuals who attain age 70½ after this date. For example, someone who turned 70½ in 2019 still has to begin taking RMDs for tax year 2019 and must continue to take them in 2020 and beyond.
- Contributions to traditional IRAs after age 70½: Individuals are no longer prohibited to contribute to an individual retirement account (IRA) after age 70½. Individuals can continue contributing to an IRA at any age as long as they have earned income. This provision goes into effect for all contributions made for tax years after December 31, 2019.
- New rules for inherited retirement accounts: This provision has the potential to impact estate planning for many. Under current law, assets in inherited retirement accounts (Stretch IRAs) can be distributed throughout a beneficiary's lifetime; however, under the new provisions, these assets must be distributed within ten years. There are exceptions for spouses, children who are minors, disabled individuals, and individuals less than ten years younger than the decedent. Note that this provision does not affect existing inherited accounts; it only affects accounts that are inherited after December 31, 2019.
- Part-time workers can participate in a 401(k) plan: Under current law, employers generally may exclude part-time employees (employees who work less than 1,000 hours per year) from a company retirement plan. With this new provision, employers are required to maintain a 401(k) plan for long-term, part-time employees who have either completed one year of service that involves at least 1,000 hours worked or three consecutive years of service that involve at least 500 hours worked per year. This provision takes effect for plan years beginning after December 31, 2020.
- Penalty-free withdrawals for birth and adoption expenses: New parents can now withdraw up to $5,000 from an IRA or an employer-sponsored retirement plan to cover birth and/or adoption expenses during the first year following the birth or adoption. Note that these new parents still need to pay taxes on withdrawals of pre-tax contributions; this new provision only eliminates penalties for early withdrawals used to cover newborn and adoption expenses. This change takes effect for all distributions made after December 31, 2019.
- Expansion of 529 Plan funds usage. This provision allows tax-free distributions from 529 Plans for qualified student loan payments, known as qualified education loan payments, to be used to pay down the principal and interest of a qualified education loan. Note that there is a $10,000 lifetime limit in terms of the amount of 529 funds an individual can use towards loan repayment. This provision applies to distributions made after December 31, 2018.
- The "kiddie tax" is reinstated to pre-Tax Cuts and Jobs Act (TCJA) rates. This modification reduces the high TCJA taxes levied on children's unearned income like college grants, scholarships, and military survivor benefits that inadvertently caused harm to some students. This provision takes effect for tax years beginning after December 31, 2018, and individuals who paid the higher tax in their 2018 returns may file amended returns to seek refunds.
- Provisions to help small businesses: Certain provisions of this bill are intended to make it easier for small businesses to offer retirement plans to their employees. One of these provisions allows small businesses that may have otherwise been unable to fund a 401(k) plan to band together via Multiple Employer Plans (MEPs) to offer a retirement plan option collectively to their employees. This provision goes into effect for plan years beginning after December 31, 2020.
Source: Townsend, Michael. Charles Schwab: "Significant Retirement Savings Law Changes Are Coming in 2020," 21 December 2019.
What Does This Mean for You?
- New RMD age requirement: If you turned 70½ in 2019, you will need to take your RMDs per the old law, prior to April 1 of 2020 and every year thereafter. If you will turn 70½ in 2020, you will not need to begin taking your RMDs until 2022. The new law still allows the option of deferring your first RMD to April 1 of the following tax year.
- New IRA contribution limits: If you are over age 70½ and still earning income, it may make sense for you to leverage this provision and contribute to an IRA. This will be on a case-by-case basis.
- Inherited IRA changes: If your estate plan involves leaving retirement accounts to your heirs, changes to this plan may be prudent on a case-by-case basis.
- Ending of the Stretch IRA: The new ten-year rule that ends stretch distributions in inherited IRAs makes a Roth conversion an appealing tactic for inheritors. Converting a traditional, inherited IRA to a Roth is beneficial in light of the SECURE Act because the ten-year payout rule lessens the importance of deferral and because the lower income tax rates enacted at the end of 2017 (which are scheduled to last through 2025) offer a temporary opportunity to convert a traditional IRA to a Roth at a lower income tax cost. Although a Roth conversion triggers an upfront tax cost, a Roth is free of mandatory distribution stipulations during the account owner's lifetime, and distributions from the account are tax-free. Additionally, after the Roth owner's death, although the beneficiaries would then again be subject to the ten-year payout rule, the beneficiaries would be able to take distributions tax-free.
Final Points
A majority of the provisions within the SECURE Act go into effect on January 1, 2020; however, there are exceptions that have been noted above. It is clear that lawmakers are focused on improving and fortifying the American retirement system via increased and easier access to retirement savings vehicles, especially workplace retirement plans. To prepare for the changes enacted by the SECURE Act, seek out your financial advisor and ensure you take the necessary measures to enhance your financial life and those of your loved ones.
Questions and/or interested in how this applies to your financial life?
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