With the signing of the SECURE Act, Congress has passed its first major piece of retirement legislation in nearly a decade. SECURE stands for Setting Every Community Up for Retirement Enhancement and the bill hopes that some of the changes will encourage individuals to save for retirement. It also contains a revenue-saving provision to help pay for these actions.
Most of these provisions are in effect as of January 1, 2020. Below are some key aspects of the SECURE Act:
- Contributions to Traditional IRAs are now allowed after age 70 ½
- Required Minimum Distributions (RMDs) from retirement accounts do not begin until age 72; this only affects those turning 70 ½ after December 31, 2019
- Qualified Charitable Distributions can still be utilized once someone has turned age 70 ½
- Easier access to annuities and lifetime income options in employer-sponsored retirement plans, as well as better portability of these options between employer-sponsored plans and IRAs
- Requires employers to allow certain long-term part-time employees to participate in their 401(k)
- Up to $10,000 of 529 plan dollars can be used to pay off student loans (including those for siblings)
- Small businesses can create multi-employer retirement plans more easily
- Automatic deferrals can escalate to 15% of employee pay (previously 10%) in automatic enrollment safe harbor plans
- Upon birth or adoption of a child, up to $5,000 may be distributed from an eligible retirement account; the distribution is not subject to the 10% early withdrawal penalty
- Kiddie-tax rates have now reverted back to what they were prior to the Tax Cuts and Jobs Act, meaning income subject to the Kiddie-tax is now once again taxable at the child’s parents’ marginal tax rate
To help pay for these provisions, the SECURE Act has eliminated what some call the Stretch IRA. Historically, non-spouse beneficiaries of an IRA could take RMDs out over their lifetime, stretching the IRA’s tax-deferred status over a potentially long period of time. But as a result of the bill, if the account owner passes away after December 31, 2019, non-spouse beneficiaries will be required to distribute the entire IRA over a 10-year period following the original owner’s death, resulting in more taxes paid in a shorter period of time.
Exceptions can be made for surviving spouses, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the original owner, and any minor children of the original owner. Minor children will be subject to the 10-year payout once they have reached the age of majority. This provision drastically decreases the period of time that IRAs enjoy tax-deferred status. Note that this rule also applies to defined contribution plans. Additionally, it is important to know that existing inherited IRAs will be grandfathered in under the old rule.
Due to the number of changes within the bill, it will be beneficial to revisit previously established strategies to make sure they will still produce the desired outcomes, especially with regards to taxes and estate planning. The following are a few strategies that will likely see increased use, or at least merit some additional thought:
- IRA contributions can be made until death: Contributions could reduce modified adjusted gross income which in turn could reduce capital gains tax, Medicare Part B premiums, and even lower the amount of taxable Social Security benefits. This also allows a longer time to utilize the backdoor Roth IRA strategy.
- Review trusts as beneficiaries: The new rules have created some challenges for trusts that are listed as the beneficiary on retirement accounts. Many trusts are currently set up to comply with the “See-Through Trust” rules which allow the trust to stretch the distributions over the oldest beneficiary’s life expectancy. There are two types of these trusts: conduit and discretionary. Many conduit trusts are drafted in a way that requires the RMD be distributed each year to the beneficiaries. With the new rules, there is only a requirement that an RMD be taken in the tenth year. Therefore, there will be no RMDs for nine years and the entire account will be distributed outright to the beneficiaries in the last year. Discretionary trusts could also have issues because they often require that a significant portion of the distributions remain in the trust. The amounts retained by the trust are subject to trust tax rates which can accelerate much more quickly than individual tax rates. The benefit of this type of trust is that the trustee can determine when to pass the money to the beneficiary so it can give the original account owner more control of how the money is distributed. There is also some uncertainty on whether the IRS will allow See-Through Trusts to actually see through the trust for certain Eligible Designated Beneficiaries. Because of these changes, all trusts that are listed as retirement account beneficiaries need to be reviewed to ensure they comply with the new rules and still provide the desired outcome.
- Charitable Remainder Trusts (CRTs): These trusts allow named beneficiaries to take distributions from the trust for a specified period of time. Once that time period has been satisfied, the remainder of the account goes to a named charity. If the estate that owns the IRA is one of the few that pays estate tax, it can take a charitable deduction for distributing the IRA to the CRT. The distributions are taxable to the beneficiaries, while the remainder that goes to the charity is not taxed. Because distributions can be spread out over a large number of years, this could be an effective way to mimic the durability of old Stretch IRAs.
- Using 529s to pay down student loans: Now that up to $10,000 per person can be taken tax-free from the 529 and applied to loans, contributions to a 529 may make sense even after the beneficiary has graduated from school. The $10,000 is a lifetime limit per person, but a parent with multiple children may take additional $10,000 distributions for each sibling of the beneficiary. If a student graduates with loans, and the parents are in a position to help pay off those loans, they should consider contributing the money to a 529 plan first. Some states offer tax deductions or credits for 529 contributions, which would mean getting a tax benefit, then withdrawing the money and applying it towards the student loans. It is important to check with the plan though, as some states only offer a tax break when the distribution is used for college. It is also worth mentioning that any student loan interest paid for with tax-free 529 plan money will not be eligible for the student loan interest deduction. This rule change also allows a way for grandparents to help grandchildren without affecting financial aid eligibility. Normally, distributions from a grandparent-owned 529 are reported as untaxed income on the student’s FAFSA. But, by waiting to take the distribution from a grandparent-owned 529 until after graduation, there is no FAFSA to fill out, meaning no effect on financial aid.
- Life insurance: IRA distributions can be taken during one’s lifetime while they are in a lower tax bracket, and these distributions can be used to pay the premiums for a life insurance policy. The life insurance will provide a tax-free inheritance to heirs, and it can be customized to simulate a Stretch IRA.
In conjunction with the SECURE Act, another bill was passed that reverts back to the 2018 adjusted gross income (AGI) threshold for the deductibility of qualified medical expenses. For 2019 and 2020, qualified medical expenses must be over 7.5% of AGI to be deductible. America is facing a retirement savings crisis, but it is yet to be determined if the SECURE Act will have the desired effect that Congress and so many others hope it will.Speak to your Hefren-Tillotson advisor if you have any further questions about how this, or any legislative changes, could affect you.