SECURE Act: Planning items for individuals
After stagnating in Congress for much of 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was quickly picked back up and added to legislation passed at year-end, bringing changes that impact individuals saving for retirement, retirement plan participants, and retirement plan sponsors. We’ll cover all of these areas in series, starting here with planning considerations individual investors should keep in mind as we begin 2020.Inherited IRAs are no longer eligible for “stretch” provisions (with some exceptions)
Historically, when beneficiaries have inherited IRAs from someone who has passed away, they’ve been able to spread, or “stretch,” distributions from the account over their life expectancy. In many cases, this would continue deferring tax on the majority of the funds for decades, providing additional benefits to the inheritor.
While these provisions remain in place for inherited IRAs already owned (e.g. the original owner passed away prior to Dec. 31, 2019), for IRAs inherited after Jan. 1, 2020, funds must be withdrawn within 10 years. Exceptions to this rule apply for spousal beneficiaries, disabled or chronically ill beneficiaries, beneficiaries less than 10 years younger than the decedent, and children of the decedent under the age of 18 (once they turn 18, the new 10-year provision applies). For any of these exceptions, the former distribution provisions apply. Additionally, for participants in plans maintained under a collective bargaining agreement or governmental plans (e.g. 457, 403(b)), this new rule doesn’t take effect until Jan. 1, 2022.
The 10-year rule offers planning opportunities for beneficiaries as they consider their cash flow and income tax situation over that time frame. There is no set schedule to follow over that 10-year period, so beneficiaries can distribute it however they wish — the account must be fully distributed by the end of the 10th year. Coordination with tax advisors will be important to time distributions in a way that works for their specific circumstances.
For IRAs inherited after Jan. 1, 2020, funds must be withdrawn within 10 years.
For example, if a beneficiary plans to retire in three years and is still in a high tax bracket, it may make sense to delay any distributions until that time and then take distributions over the remaining seven years as appropriate. Alternatively, if a beneficiary has an abnormally low year from a taxable income perspective, taking additional distributions to max out lower brackets could make sense. Being intentional over the 10-year time frame will be important.
The change in this provision will also necessitate review of and likely revision to any trust documents drafted with the intention of owning inherited IRA assets for trust beneficiaries. This topic will be covered in more detail in a separate article.
Retirement plan provisions tied to age 70 ½
Age 70 ½ historically has been a milestone age as it relates to IRAs, and the SECURE Act changes this in some cases, as follows:
Required minimum distribution (RMD) starting age moved from 70 ½ to 72
IRA owners turning 70 ½ on or after Jan. 1, 2020, can delay their first RMD until they turn age 72. (In fact, they can delay the first RMD until April 1 following the year they turn 72, but that seldom makes sense as two distributions then have to be taken in that second year.)
IRA owners already taking their RMDs can continue as usual. That said, separate from the SECURE Act, the IRS has proposed new distribution tables — the first update since 2002 — that may take effect next year. The new tables would account for the relative increase in life expectancy over the last 18 years and therefore slightly decrease RMD amounts.
IRA holders can contribute past age 70 ½ if they’re still working
Historically, once an individual reached 70 ½, they could no longer make contributions to a traditional IRA. That limitation has been removed, and if an individual has earned income, they can make contributions. However, this needs to be coordinated with qualified charitable distribution intentions, covered immediately below.
Qualified charitable distributions (QCDs) still allowed at age 70 1/2
Under the Tax Cuts and Jobs Act (TCJA) of 2017, significant limitations were placed on itemized deductions, and other deductions were eliminated altogether. As a result, many individuals found themselves better off taking the standard deduction than itemizing, rendering any deductions attributable to charitable contributions moot — unless those contributions were significant. For our clients subject to RMDs, taking a QCD has become a beneficial planning strategy to accomplish their charitable goals while still receiving a tax benefit.
A QCD allows IRA holders age 70 ½ or older to take money from their IRA — up to $100,000 — and distribute it directly to a charity. While no deduction can be taken for this, the distribution isn’t reported as income, effectively lowering reported income for the year.
While the RMD starting age has been pushed back until age 72, individuals wishing to make QCDs from their IRA can still start doing so as early as age 70 ½, preserving this valuable planning opportunity before RMDs kick in.
Individuals should be aware that the aggregate of any deductible contributions made to an IRA after age 70 ½ will reduce QCDs in future years, if applicable. So, for example, if an investor makes a deductible IRA contribution when they’re 71 and 72 ($7,000 each, so $14,000 total), and then makes a QCD of $50,000 when they’re 73, the QCD is limited to $36,000 ($50,000 - $14,000), and the difference is reported as income that year.
A QCD allows IRA holders age 70 ½ or older to take money from their IRA — up to $100,000 — and distribute it directly to a charity.
Education-related provisions
The SECURE Act also impacts several rules related to qualified 529 plan distributions.
Qualified education loan repayments
529 plans can now be used to pay up to $10,000 (lifetime limit) of principal and/or interest of qualified education loans for a 529 plan beneficiary. Interestingly enough, the Act also allows for distributions from the 529 plan, with the same lifetime limit, to repay qualified student loan debt for any siblings of the 529 plan beneficiary.
Apprenticeship programs included as qualified expense
529 plans can now make qualified distributions to apprenticeship programs for costs related to fees, books, supplies, and equipment that are required for program participation. The program must be registered and certified with the U. S. Department of Labor for the expenses to qualify under these provisions.
Additional provisions
The SECURE Act included several other provisions that individuals should know:
Qualified birth or adoption provision
Up to $5,000 may be distributed penalty-free from an IRA or retirement plan for a qualified birth or adoption. The SECURE Act references “any” birth or adoption, indicating this is a per-event limit. For a married couple in which both spouses hold retirement plans, the limit is effectively doubled. The distribution must occur within one year after the event and cannot occur before the event.
The Act also allows an individual to repay the amount distributed under this provision at a later date, up to the amount distributed, above any normal retirement plan contribution limits. The timing rules for this repayment aren’t defined, so we’ll likely need to wait until the Department of Treasury issues additional regulations for clarity here.
Kiddie-tax reversion
Under the 2017 TCJA, the “kiddie-tax” rules were changed such that unearned income generated by certain children was taxed at trust tax rates, which are compressed and reach the highest marginal rate very quickly. The SECURE Act unexpectedly reversed that change and going forward families impacted by the kiddie tax will once again see the child’s unearned income taxed at the parents’ highest marginal rate.
Families and their advisors should note that the SECURE Act gives taxpayers the ability to choose to calculate kiddie tax for 2019 under either the old (TCJA) or new (SECURE Act) rules, and taxpayers can also amend 2018 returns to calculate the tax under the new rule if it proves more advantageous and worth the costs of amending.
The SECURE Act brings new considerations and planning opportunities to individual investors. It’s important to be aware of the changes and consult your tax and financial advisors to understand how they impact your situation. We’ll explore many other provisions of the SECURE Act in forthcoming articles, and we’ll incorporate these considerations into planning discussions with our clients. Feel free to reach out — we welcome your questions.
