The SECURE Act: How It Could Affect Your Retirement and Estate Plans
This legislative overhaul brought about numerous changes that are likely to impact your finances.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20, 2019, and it took effect on January 1, 2020. Overall, the legislation is intended to strengthen retirement security nationwide, but it also contains multiple changes that impact retirement and estate planning. Let’s dig into a few of the most significant provisions.
No Age Cut-Off for IRA Contributions
In the past, you were prohibited from contributing to a traditional IRA in the year you reached age 70 ½, even if you were still employed. The SECURE Act eliminates this rule so that anyone, regardless of age, can make IRA contributions as long as they have earned income to contribute. With this change, traditional IRA rules now mirror the contribution rules for Roth IRAs and 401(k) plans.
This longer contribution period takes effect for the 2020 tax year. Although 2019 contributions can be made up until April 15, 2020, these contributions must still follow the past rules, meaning only individuals under the age of 70 ½ can contribute for tax year 2019.
Delayed Required Minimum Distributions
Another important change implemented through the SECURE Act was to ease the required minimum distribution (RMD) rules for traditional IRAs and other qualified plans. Previously, you were required to begin taking RMDs – and paying taxes on them – at age 70 ½, but the SECURE Act raised the age to 72. It applies to anyone who was not yet 70 ½ as of December 31, 2019.
Many taxpayers have been using qualified charitable distributions (QCDs) as a way to satisfy the RMD requirement while also contributing to charitable causes that are meaningful to them. A QCD allows you to contribute up to $100,000 per year to a qualified 501(c)(3) organization once you reach age 70 ½, and this remains true even though the RMD age has increased to 72.
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Eliminates ‘Stretch’ RMDs
This new provision is especially important for younger beneficiaries of inherited defined contribution accounts such as IRA or 401(k) plan accounts. In the past, they could “stretch” their distributions by spreading them over their life expectancies, essentially deferring taxes while the accounts continued to grow. The SECURE Act now requires that most beneficiaries withdraw the full balance of an inherited account within ten years of the owner’s death. However, there is no required minimum distributions each year and the beneficiary can choose to take any amounts out as long as the entire balance is distributed by the tenth year. This requires more tax planning each year to take out more during lower income years and avoid being forced to take out the entire amount in the 10th year that could cause you to be at the highest tax bracket.
This new rule only applies to those who inherit a defined contribution account from someone who died after 2019. Anyone who inherited such an account prior to last year will not be required to meet the ten-year rule.
There are also a few exceptions in the SECURE Act for this particular provision. The following individuals may still ‘stretch’ their RMDs:
- Surviving spouses
- Children under 18 (the ten-year rule kicks in when they reach “the age of majority”)
- Chronically ill and disabled individuals
- Those who are no more than ten years younger than the account owner
If you’ve been counting on stretch RMDs in your estate plan – especially if you hope to prevent your beneficiaries from depleting accounts too quickly – you may be able to put protections in place by naming a charitable remainder trust (CRT) as the beneficiary of your account. Then, you would name your children as beneficiaries of the trust’s income. A CRT can provide an income stream for a specified number of years, or until the beneficiaries’ deaths.
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Another tool to consider in your estate planning is the Roth conversion. When you move money from a pre-tax IRA to an after-tax Roth IRA during retirement, you negate RMDs during your lifetime, plus the Roth can continue to grow tax-free and your beneficiaries won’t pay tax on distributions. Of course, you’ll owe taxes on the amount you convert, so you may want to do it strategically over time, rather than in one fell swoop. In general, you should review tax projections over multiple years to identify the year and calculate the specific amount to do a partial Roth conversion without going above your target marginal tax rate. For example, for a married couple with $130,000 taxable income who just retired but haven’t collected social security benefits, they can convert $41,050 IRA to Roth IRA in the year 2020 without going over the 22% marginal tax rate. They may want to do this each year until age 70 when they start collecting social security to reduce the balance of their IRAs without paying income taxes at very high tax rates. It’s best to consult with your financial advisor who works with your tax CPA before starting a Roth conversion.
New Exemption for Births and Adoptions
The SECURE Act implemented a brand-new exemption for qualified births and adoptions, meaning there is no longer a ten percent tax penalty for early withdrawals from defined contribution plans. It is now permissible to withdraw an aggregate of $5,000 within one year of the birth of a child or the adoption of a minor (or an adult who is physically or mentally incapacitated) without penalty. If both parents have their own retirement plans, they may withdraw an aggregate of $10,000 penalty-free. However, it is notable that children your spouse has from prior relationships are not considered eligible adoptees.
More Options for 529 Plans
The SECURE Act also expanded options for using 529 plans. Now, it’s possible to use up to $10,000 to pay principal and interest on a plan beneficiary’s qualified education loans. What’s more, the new law also allows for plan distributions, subject to the same $10,000 limit, to pay student loan bills for the beneficiary’s siblings.
Additionally, 529 plans have now been expanded to cover apprenticeship programs. Distributions can be made to cover the costs of program fees, books, supplies, and equipment required for an apprenticeship program.
Your Next Step
All of the above changes in retirement and estate planning law should prompt you to carefully review your own plans. You may need to make changes in order to accomplish your goals, including minimizing tax liability. If you name your revocable trust as the primary beneficiary of your IRA account, make sure it’s a conduit trust and the trustee has discretionary authority to distribute more than the RMDs of your IRAs. If the trustee can only distribute the RMDs of your IRA, as the new laws do not have required RMDs each year, the beneficiaries do not receive income each year. In the tenth year, they receive the entire balance in one year that may not be your original plan.
If you’d like to discuss how the SECURE Act may impact your financial plans, let’s start a conversation today and ensure you can meet your retirement and estate planning objectives amidst changing laws.
