By Jaime Ruff and Todd Hall
December 23, 2019
Packaged with the recent spending bill was some of the most significant retirement plan legislation to come along in years. The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in Friday December 20th, and will impact businesses and consumers in a number of ways. Here are five key takeaways
- The End of the “Stretch IRA”… say hello to the new 10-Year Rule
Perhaps the most prominent change under the SECURE Act is that it creates a new 10-Year Rule for non-spouse beneficiaries of inherited IRAs. Most non-spouse beneficiaries who inherit a retirement account after 2019 will need to withdraw the entire account and pay any associated income taxes within 10 years, rather than over their life expectancy. This effectively ends what has colloquially become known as the “Stretch IRA”, since spreading the distributions from an inherited IRA over the life expectancy of the beneficiary potentially can defer those taxes for decades.
The 10-Year rule does not apply in the following situations:
- If the beneficiary is the spouse of the original IRA owner
- If the original IRA owner dies before January 1, 2020, in which case the beneficiaries are grandfathered under the old rules and can “stretch” the IRA over their life expectancy
- If the beneficiary qualifies for “eligible designated beneficiary” status under the SECURE Act, including heirs that are less than 10 years younger than the decedent, chronically ill individuals, disabled individuals, and minor children. Minor children will age out of the exclusion once they hit the age of majority in their state, typically 18 to 21. At that time, the 10-year required minimum distribution period would become applicable to any remaining balance in the inherited defined contribution plan or IRA. As such, minors will still be able to stretch out distributions slightly longer than other individuals.
Example…
Joe was 65 when he died in 2020. He had an IRA worth $500,000 and his designated beneficiary was his daughter Megan, age 40.
Under prior rules, Megan would have only have been required to take out a percentage of the IRA each year based on her life expectancy. The required minimum distribution or “RMD” would start around $15,000 in the first year and the percentage to withdraw would gradually rise until Megan turned 85 when the account would have to be empty. She thus could have “stretched” those distributions over 35 years and deferred the associated income taxes.
Now, if she wants, Megan won’t have to deal with an RMD at all during those first nine years. Instead she must empty the entire IRA balance within 10 years, which could bump her into a higher tax bracket pretty quickly. Notably, she has flexibility as to when within those 10 years to take her distributions, so perhaps she can time her distributions to coincide with years when her income will otherwise be lower.
In light of these changes many existing estate plans should be revisited.
The loss of potential decades of tax deferral further tips the scale in favor of considering charities rather than individuals as retirement account beneficiaries.
Things like Roth IRA conversions and multi-generational trusts are tools that will be useful in managing many wealthier families’ income tax brackets.
Use of a conduit trust as an IRA beneficiary may be a problem now. Under the previous Stretch IRA rules, trust distributions could be spread over the life expectancy of the beneficiary. Now with the IRA emptied within 10 years the funds will effectively be distributed outright to the trust beneficiary, thus negating the elements of the trust that were sought after.
- Later Required Beginning Date for Retirement Distributions
On a positive note, if you were born on or after July 1, 1949 then you are not required to begin taking Required Minimum Distributions (RMDs) from your IRA until age 72, rather than 70½. If you’re already 70½ in 2019, the new rules won’t apply to you as you’ll have an RMD for 2019 that must be withdrawn by April 1, 2020. But if you were born after July 1, 1949 your required beginning date is postponed.
Those with birthdays in the first half of 2020 will benefit slightly more from this provision. For example, someone who turns 70 next spring (and 70½ next fall) won’t have to take distributions until 2022 when they turn 72 —two extra years than if the bill didn’t pass. But if someone is turning 70 next fall (and 70½ in the spring of 2021), they don’t have to take distributions until 2022 when they turn 72. That person gets just an extra year.
- Contributions to Traditional IRAs Allowed After age 70
Another positive aspect of the legislation is in recognition of the fact that many more people are now working after age 70. Under the SECURE Act workers over age 70 can start making IRA contributions up to $7,000 per year (including the $1,000 catch-up contribution for workers over age 50). A nonworking spouse whose spouse earns income also can contribute.
- Qualified Charitable Distributions Still Allowed Beginning at Age 70½
People who are 70½ or older still can make a Qualified Charitable Distribution (“QCD”) from their IRA to one or more charities, up to $100,000 in a given year. The SECURE Act does not change that popular tax break. The legislation does, however, introduce an anti-abuse provision to reduce the allowable QCD amount by any traditional IRA deduction received for that year.
- Initiatives to Increase Employer Adoption of Retirement Plans
The new law increases the tax credit for small businesses to set up new retirement plans, from $500 to $5,000. It also creates a new tax credit of up to $500 per year to defray startup costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. Unaffiliated small employers are now able to band together to offer a 401(k) type of plan and shift some of the administrative burden to a retirement plan administrator. And starting in 2024, 401(k) plans will be required to allow employees who work more than 500 hours for three years to contribute.
