Four ways the SECURE Act impacts your retirement planning now
Retirement and wealth planning have become more dynamic in recent years as Congress amends the rules on a regular basis. In the past couple of years, two significant tax code changes, each with major impacts on families strategic financial planning, were signed into law. The most recent change, the SECURE Act, was passed in 2019, with most of its provisions effective in 2020.
As usual there are a ton of changes, but four areas worth taking a deeper dive into how the SECURE Act may impact you.
1) Inherited Retirement account payout periods shortened to 10 years.
Prior to 2020, individuals inheriting IRAs, Roth IRAs, 401(k)s and other similar retirement accounts were required to take annual account distributions over their life expectancy. This meant that a 30-year old inheriting an IRA may be able to “stretch” payouts over their remaining 53-year life expectancy. Since most retirement accounts distribute ordinary taxable income, this created a fantastic planning opportunity, allowing the beneficiary to spread the tax burden over a very long time period.
Under the new law, beneficiaries are now required to distribute the entire account balance by the 10th year following the decedent’s death. This means that for deaths after 2019, all deferred income taxes on the retirement account(s) will be paid in full within this 10-year period. One nuance is there are no required distributions during years 1-9; the only requirement is the account be depleted by the end of year 10. This opens a planning opportunity for when to distribute the income, for example, in a low-income year post-retirement or changing jobs.
It is important to note there are several important exceptions to this new rule.
A) Spousal beneficiaries are exempt from the 10-year payout rule. Spouses can either leave the account in the decedent’s name and take distributions based on the decedent’s age, or rollover the account to their name and take required minimum distributions over their own lifetime.
B) The disabled and chronically ill are still able to take distributions over their expected lifetimes based on the old rules.
C) Beneficiaries not more than 10 years younger than the decedent may still take distributions over their lifetime.
D) Certain minor children of the original account owner can take distributions based on their life expectancies until they reach the age of majority, then must distribute the remaining account balance in 10 years.
It is important to note beneficiaries not covered by the 10-year payout must use the same IRS Required Minimum Distribution (RMD) tables as existed prior to the law change. You can find the IRS RMD calculation tables and related information here: IRS RMD Information.
One of the big traps in the new law is for IRAs with trust beneficiaries. Some people setup trusts as beneficiaries to try and provide for additional creditor protection, to protect minor children, or to impose spending constraints on their heirs. The language frequently used in these trusts may force the income to be taxed at higher tax rates, rather than being spread over many years and taxed at lower tax rates. Because each trust may have unique language, it’s critical to thoroughly review the language of any trust designated as a beneficiary.
It should also be noted that there is a special delay for Thrift Savings Plans (government plan), 457, 403(b), collective bargaining arrangements and some annuities; their new compressed stretch rules are not effective until 2022.
2) Required Beginning Date increased to age 72.
The next big change under the SECURE Act is delaying from age 70-1/2 to 72 for starting annual required minimum distributions for retirement account owners. Once the account owner reaches 72, distributions begin using the same rules and IRS calculation tables as before. This rule applies to account owners that did not reach age 70-1/2 during 2019.
One strategic planning provision that the new law did not change was using your IRA to donate to charity. This great planning strategy allows up to $100,000 annually be distributed directly to charities from your IRA. This provision is allowed once you have reached age 70-1/2.
3) IRA contributions are now allowed for life.
Under the prior law, once the taxpayer reached age 70-1/2, regular IRA contributions were no longer allowed (remember when age 70 used to be considered old?). Beginning in 2020, you can make IRA contributions in any year that you have earned income. This opens the door for those working later in life to continue making IRA contributions. Of course, there’s still the decision on whether making regular IRA or Roth IRA contributions best fits for your situation.
4) Annuities will become more common in 401(k) and other employer retirement plans.
Annuity payout options have long been allowed in company retirement plans; however, plan fiduciaries have tended to avoid these options due to high fees and liability exposure. The new law includes Safe Harbor provisions that protect plan fiduciaries if they follow certain tests and rules. This will allow many plans to offer lifetime income options as one of the plan payout alternatives. It is worth noting that while lifetime income options will now become more popular, there are no requirements that plan fiduciaries select the lowest cost option.
The SECURE Act includes some of the broadest changes to strategic retirement account planning in more than a decade. The law also includes a number of other small but noteworthy changes impacting 529 plans, medical expense deductions, kiddie tax rules, and retirement planning for businesses. These other changes will affect a much smaller group of families however they are still worth reviewing to see how they may impact your situation.
As always, each person’s circumstances are unique. I urge you to consult your CPA to review how these changes and strategies impact you.