As you rang in the new year with a kiss and a glass of champagne, or perhaps (like me) already fast asleep, a new set of laws designed to improve the retirement outlook for millions of Americans took effect. The law entitled, Setting Every Community Up for Retirement Enhancement Act (through a bit of verbal gymnastics known as the “SECURE Act”) had passed the House in July and sat dormant until it was attached to the December spending bill where it was passed and signed into law with most provisions taking effect on January 1, 2020.
The Act makes a number of changes to IRAs and 401(k) plans with the stated objective of encouraging retirement savings. It attempts to accomplish this primarily by expanding access to 401(k)s and to a lesser extent, IRAs. The provisions of the SECURE Act can be divided into three general categories: IRA changes, Employer Retirement Plan changes, and miscellaneous tax extenders.
Key IRA Changes:
- The age at which you will begin required minimum distributions (RMD) from your IRA is moved from 70½ to 72. If you are already taking IRA withdrawals above the required minimum amount, this doesn’t affect you. However, if you are still working or have other income sources, this gives you an extra year or two (depending on when your birthday lands) to let your IRA grow tax deferred before being forced to start taking withdrawals.
- In an odd twist, the age at which you can make a Qualified Charitable Distribution (QCD) from your IRA remains 70½. Previously, the QCD coincided with RMD age (both 70½), making the QCD appear to be a tax concession for charitably minded IRA holders of RMD age. However, the SECURE Act decouples them by increasing RMD age, but not QCD age. Now that QCD age isn’t tied to RMD age, I can’t help but wonder why QCD isn’t allowed for younger IRA holders as low as age 59½.
- One of the more consequential changes is the loss of the “stretch” IRA for most inherited IRAs. Previously, a non-spouse inheritor of an IRA could stretch out distributions over their lifetime. This was a big deal, especially if the beneficiary was a child or grandchild. Under the new rules, the inherited IRA must be fully distributed by the end of the 10th year. In other words, inherited IRAs have zero RMDs in years 1-9, but become 100% in year 10. Of course, depending on the tax bracket of the inheritor and the size of the inherited IRA, smart distribution planning for years 1-9 could result in substantial tax savings. This applies the same to both Roth IRAs and Traditional IRAs, however, Roth IRAs continue to be tax free, meaning that effective strategies for the two types of accounts will be very different.
- Prior to the passage of the SECURE Act, if you were over age 70½ and still working, you were allowed to make Roth IRA contributions (assuming you were not over the income limits), but you were not allowed to make a contribution to a traditional IRA. Why? I don’t think anyone really knows. Regardless, that’s no longer the case, as the over 70 ½ traditional IRA contribution ban has been removed.
- The Act allows you to take a withdrawal from your IRA for expenses related to the birth or adoption of a child without being assessed the usual penalty for withdrawals prior to age 59½. You are limited to $5,000 per parent and are allowed to “repay” your IRA for the funds withdrawn at a later date.
Key Employer Retirement Plan Provisions
- Under the new rules, long term part time employees or those who have taken time off from work (such as for parental leave) are more likely to be eligible for 401(k) plan participation.
- To make it a little more difficult for people to raid their retirement savings, 401(k) loans via credit card are no longer allowed. This one falls under the category, “is this really a thing that was happening?”
- In a change that appears to have insurance lobby fingerprints on it, the SECURE Act makes it easier for plan sponsors to offer annuities in 401(k) plans. Basically, the plan sponsor (typically the employer) is shielded from liability if they include a lifetime annuity option that later is unable to meet its obligations. In other words, an employee invests their 401(k) in an annuity that will pay them a monthly income for life. A few years into retirement, the insurance company behind the annuity goes belly up. Previously, the employee would have potential recourse against the plan sponsor. Under the new rules, as long as certain minimum standards are met, the sponsor is shielded from liability.
- Among other things, the field of behavioral finance has taught us that “default” options are very powerful in influencing human behavior in both desired and undesired ways. The best positive example of this has been the adoption of “auto-enrollment” in 401(k) plans. One of the problems has been that the default enrollment amount has often been too low, commonly 3%. New provisions in the SECURE Act are designed to boost 401(k) auto-enrollment, including a $500 tax credit for employers adopting an auto-enrollment feature, and by allowing employers to auto-escalate contributions to 15% (up from 10%).
Other provisions (that have nothing to do with retirement):
- You can now use up to $10,000 of your 529 plan to pay student loans. This is not an annual amount, but a lifetime cap. Additionally, qualified expenses (tuition, books, room and board, etc.) for attending a Department of Labor certified apprenticeship program are allowable 529 expenses.
- Young investors who are closely watching their tax bill over the past few years might get whiplash over this change. The changes to the Kiddie Tax rules enacted by the 2017 Tax Cut and Jobs Act (TCJA) are effectively repealed. Prior to the the TCJA, a minor with unearned income (typically investment income) over certain levels (around $2,000) would be taxed at their parents’ tax rate, which is presumably higher than the child’s. However, under TCJA, instead of being taxed at their parents’ rate, they were taxed on a separate schedule, which quickly escalated to the maximum tax rate. In an apparent change of heart, we’re back to the child being taxed at their parents’ rate.
- If you have the misfortune of having very high medical expenses, you MIGHT at least have the silver lining of being able to deduct some of those expenses. However, you can only deduct medical expenses if they exceed 7.5% of your Adjusted Gross Income (known as AGI, basically your income minus certain specific non-itemized deductions). The 7.5% hurdle was supposed to go up to 10% in 2019, but this law extends the 7.5% threshold for 2019 and 2020.
In the end, the question is: will the SECURE Act accomplish the goal of encouraging retirement savings? Or as its name literally states, will it set every community up for retirement enhancement? Not to be cynical, but to my mind, it’s a resounding no. But will it help or encourage some who are currently not saving enough or not at all to increase or begin saving for retirement? It’s certainly possible. If you want to learn about how you can help encourage your children and/or grandchildren to start saving for retirement, check out our blog titled, “Using the Roth IRA to Give the Gift of Financial Security.”
This article was intended to be a summary of the main provisions of the SECURE Act. We will be writing in greater detail on some of the provisions, along with potential planning strategies to enhance your financial position given the new rules.