On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act, became law. This marks the first substantial law related to retirement savings since 2006.
The SECURE Act brings numerous changes to the retirement and estate planning landscape, some of which should prompt careful review of your existing plans to determine if they’ll still accomplish your desired outcomes, including tax reduction.
An overview of the most significant changes to the law and how they may impact your retirement and estate plans follows.
Extended IRA Contributions
Prior to the SECURE Act, contributing to traditional individual retirement accounts (IRAs) starting the year you reach age 70 1/2 was prohibited, even if you continued to work. The new law eliminates that restriction, instead allowing anyone with earned income to contribute. This change brings the rules for traditional IRAs in line with those for 401(k) plans and Roth IRAs.
This extended period takes effect for 2020 tax year contributions. While contributions for 2019 can be made as late as April 15, 2020, those contributions are generally permitted only for individuals under the age of 70 1/2 as of the end of 2019.
Delayed Required Minimum Distributions
The SECURE Act eases the rules for required minimum distributions (RMDs) from traditional IRAs and other qualified plans. It generally raises the age at which you must begin to take RMDs—and pay taxes on them—from age 70 1/2 to 72. This new rule, however, applies only to individuals who hadn’t reached the age of 70 1/2 as of the end of 2019.
Qualified Charitable Donations (QCDs)
Some taxpayers have turned to QCDs as a tool for satisfying both their RMD requirements and their charitable inclinations. QCDs arguably became even more attractive under tax law passed in 2017, commonly referred to as the Tax Cuts and Jobs Act (TCJA). More taxpayers are claiming the higher standard deduction and, as a result, losing out on the federal tax benefits previously enjoyed by claiming the charitable contribution deduction as an itemized deduction.
With a QCD, you can distribute up to $100,000 per year directly to a 501(c)(3) charity once you reach age 70 1/2, even if your RMD age is now 72. You won’t receive a charitable deduction, but the distribution is excluded from your taxable income. This potentially allows you to avoid adjusted gross income-based limitations and phase outs such as on certain tax credits.
It’s important to note that the aggregate amount of deductible IRA contributions made under the new rule extending the age for which deductible IRA contributions can be made—that is, for years in which you’ve reached age 70 1/2 and beyond—will reduce your QCD allowance going forward.
This is the case only if those deductible IRA contributions haven’t already been used to reduce your QCD and aren’t below zero. A simplified view of this situation: generally, any deductible IRA contributions allowed because of the new rules will reduce what would otherwise be allowed as a QCD.
Suppose that at ages 71 and 72 you made deductible IRA contributions that, in total, equal $10,000. Then, at age 73, you make a QCD of $50,000. The QCD is limited to $40,000–$50,000 less $10,000. Thus, $10,000 of your distribution is taxable. Note, however, that because $10,000 went to charity, you’ll be eligible to claim that amount as an itemized deduction.
Stretch RMD Elimination
Perhaps more important for some estate plans, the SECURE Act eliminates so-called stretch RMD provisions that allowed beneficiaries of inherited defined contribution accounts to spread the distributions over their life expectancies. Younger beneficiaries could previously use the provision to take smaller distributions and defer taxes while the accounts grew.
Under the SECURE Act, most beneficiaries must withdraw the entire balance of an account within 10 years of the owner’s death, albeit not according to any set schedule; they can wait and withdraw the entire amount at the end of 10 years if they wish.
Effective Timeline and Applicable Beneficiaries
Be aware that the new rules apply only to those inheriting from someone who died after 2019. If you inherited an IRA years ago, you won’t be subject to the new rules with respect to your RMDs. However, when your beneficiaries inherit the IRA from you, they’ll be subject to the new rules.
The law recognizes exceptions for the following types of beneficiaries:
- Surviving spouses
- Children younger than the so-called age of majority; the 10-year rule applies when such beneficiaries reach the age of majority
- Disabled or chronically ill individuals
- Individuals no more than 10 years younger than the account owner
The 10-year requirement also applies to trusts, including see-through or conduit trusts, that use the age of the oldest beneficiary to stretch RMDs and prevent young or spendthrift beneficiaries from quickly depleting the inherited accounts.
Charitable Remainder Trust (CRT)
If you’ve counted on stretch RMDs, you might achieve the same goals by naming a CRT as the beneficiary of your account, with your intended recipients as the trust’s income beneficiaries.
The CRT would provide your benefactors an income stream for a specified number of years, or until their deaths, and then pass the remainder to charity. Your estate could also take a deduction equal to the present value of the charity’s remainder interest.
Roth conversions are another avenue to consider. Moving money from a pre-tax IRA account to an after-tax Roth IRA during your retirement preempts RMDs during your life, and any subsequent growth in the account would be tax-free. Plus, your beneficiaries won’t be subject to tax on any distributions they take.
Keep in mind that you’ll owe tax as a result of the conversion, though you needn’t convert the entire account at once. Making the conversions strategically, over a number of years, may help to manage the tax implications. Roth conversions require consideration of several factors, so it’s important to consult with a trusted advisor before making final decisions.
Penalty-free Withdrawals for Birth or Adoption
The SECURE Act creates a new exemption for qualified births or adoptions from the 10% tax penalty on early withdrawals from defined contribution plans. You can withdraw an aggregate of $5,000 from a plan without penalty within one year of the birth of a child or an adoption of a minor or an individual physically or mentally incapable of self-support.
Couples in which both parents have separate retirement plans can withdraw an aggregate of $10,000 penalty-free. Eligible adoptees don’t include the child of your spouse. Such withdrawals are subject to ordinary income tax.
Expanded Options for Use of 529 Plans
Under the SECURE Act, you can use 529 plans to pay as much as $10,000 of principal and interest on qualified education loans for a plan beneficiary. The law also permits plan distributions, subject to the same limit, to pay off qualified student loan debt for the beneficiary’s siblings.
529 plans are also expanded to include apprenticeship programs. Distributions can be made to such programs for costs related to necessary fees, books, supplies, and equipment.
Kiddie Tax Reversal
The TCJA changed the kiddie tax rules, generally making unearned income generated by children over a certain threshold taxable at the tax rates for trusts and estates, rather than the generally lower rates of their parents. The SECURE Act reverses course, so a child’s unearned income will return to being taxed at the parents’ highest marginal rate.
The law provides the option to calculate the kiddie tax for 2019 under the TCJA or SECURE Act rules. You can also amend your 2018 tax returns to apply the new rule if financially worthwhile.
We’re Here to Help
Most of the SECURE Act’s provisions are already in effect, so it’s important to review your plans and make the necessary adjustments as soon as possible.
To learn more about how the SECURE Act may impact your long-term objectives, or to start making adjustments, contact your Moss Adams professional.