Retirement savings rule changes have been considered for some time without ever reaching the “finish line;” however, Congress surprised many by suddenly passing the "SECURE Act" (Setting Every Community Up for Retirement Enhancement!) in December and the President quickly signed it into law. Although the new law will provide many benefits for those saving for retirement, it will also alter the way many retirement account assets will be transferred to future generations. We will address the more significant changes in today’s newsletter/blog and of course consider the effects of the law changes regarding our client planning recommendations and implementation strategies (of course consult with your CPA and legal advisor for specific advice as well).
10-year Limit for Required Minimum Distributions to Non-Spousal Beneficiaries - The End of the “Stretch IRA”
The most significant component of the law, as it applies to our clients, requires that non-spousal beneficiaries who are more than 10 years younger than the deceased account owners of IRA, Roth IRA, 401k and other retirement plans, withdrawal all plan assets within 10 years of inheritance (account owner’s death). Previously, in most cases, a beneficiary could take required minimum distributions (RMDs) annually over their life expectancy, minimizing distributions and the corresponding amount of taxable income created by these required withdrawals. Even though the new law no longer requires annual distributions, it does require that 100% of the retirement plan assets are withdrawn within 10 years of the date of death of the retirement account owner. Roth IRA withdrawals remain tax-free but also must be withdrawn within 10 years.
If you are a non-spousal beneficiary currently taking RMDs from an inherited IRA (as of 12/31/2019), the new rules DO NOT apply and you can continue with your annual life-expectancy distributions. Exceptions to the new rules when “life-expectancy distributions” are maintained apply to “eligible designated beneficiaries” who are defined as:
-a surviving spouse of the deceased retirement account holder who uses a “Spousal IRA Rollover” to receive beneficiary assets, as under current law
-a minor child of the deceased account holder (however, the new rules apply after the child reaches adulthood - age of majority)
-a beneficiary who is no more than 10 years younger than the account owner
-a chronically-ill individual
Planning Consequences – Naming children and grandchildren as IRA and retirement plan beneficiaries will no longer provide the considerable tax-deferral benefits that were achieved under the previous law (under the old law a 40 year old beneficiary had a 43.6 year life expectancy and only a 2.35% annual RMD). Given that 100% of retirement plan assets must be withdrawn and taxed within 10 years, careful tax planning will be required to minimize the total income tax liability for these beneficiaries – especially since withdrawals do not have to be taken annually. Withdrawals can be planned around potentially “low-income” tax years to minimize income taxes.
For those with more complex estate plans that use trusts to distribute IRA life-expectancy distributions to heirs, adjustments to these plans/trusts will likely be required. We will be in touch assuming your updated estate planning documents have been provided to us as and this applies to you. If you are not sure, we recommend you contact your estate planning attorney for recommended changes to your existing estate plan.
RMD Age Increased from age 70 ½ to 72
The Secure Act increases the age after which you must take required minimum distributions from your IRAs and/or retirement accounts to 72. However, the new rules only apply to those who reach age 70 ½ after 12/31/2019 (if your birthday is 7/1/1949 or later, the new rule applies!). If you are still employed (and do not own more than 5% of the company that employs you), you can still defer RMDs from your company retirement plan until you retire.
Planning Consequences – As with all retired clients who require income from their investments, our goal is to help minimize your long-term income tax liability. The new law will help in deferring taxable income longer if it is beneficial; however, it will have little effect for those where retirement account distributions are advantageous or necessary prior to RMD age.
No More Age Restriction on Traditional IRA Contributions
The old law did not allow Traditional IRA contributions after age 70 ½. The new law allows for post-70 ½ contributions up to $7,000 (or 100% of earned/employment income). Roth IRA contributions are still allowed post-70 ½ based on earned income requirements and existing income limitations.
Planning Consequences - For those who are older than 70 ½, still employed, and may be in higher tax brackets now than in the future, Traditional IRA contributions may be advantageous.
Various Enhancements for Employer Sponsored Retirement Plans
-The new law allows for “multi-employer 401k plans” (MEPs). Previously, each employer had to administer its own company retirement plan. Due to the considerable expense, many small businesses have not offered 401k plans to its employees. Now, multiple, unrelated businesses can take advantage of MEPs and share the expense. Additionally, tax credits are now offered to small businesses to provide these plans. We should begin to see more 401k plans offered to employees of small businesses to enable greater savings for retirement.
-Now employees who work as little as 500 hours/year (for a minimum of 3 years) are eligible to participate in company sponsored retirement plans. Previously, part-time employees were usually ineligible to participate.
-The new law requires the Dept. of Labor to propose new disclosure rules for company plans that will illustrate plan participants’ expected monthly retirement income based their current assets and contributions into their plan. This should help employees understand the future benefits of saving in a more tangible way and encourage greater retirement plan contributions. It will likely take a couple of years before these requirements reach employee benefit statements.
Planning Consequences – If you’re employed by a small business with a retirement plan, it is likely the costs passed onto the employees will be reduced. If your employer does not have a retirement plan, the new law should provide significant encouragement to implement one. As a part-time worker, you may now be eligible to participate in your company retirement plan. We will of course help provide a coordinated investment approach with your current portfolio and new retirement plan assets.
Miscellaneous SECURE Act Provisions
-529 plans can be used to pay up to $10,000 in student loans. This is a lifetime limit and applies for each child (no interest deduction on this portion though). Also, 529 plan assets can now be used for apprenticeships
-$5,000 from an IRA or a company retirement plan can be used for birth or adoption expenses for up to one year without penalty. Previously, withdrawals for these purposes (or most any other) prior to 59 ½ would incur a 10% penalty. Income taxes will still be due on all “pre-tax” withdrawals
-allowance of $100,000 per disaster from retirement accounts without penalty
-7.5% adjusted gross income “hurdle rate” for qualified medical expenses is maintained.
Conclusions and Additional Planning Considerations
The 1,700+ page SECURE Act was part of a massive government spending bill. The most significant changes, however, relating to accelerated RMDs, are estimated to raise $15 billion in government income tax revenue in the first ten years alone. There are many other changes with undetermined consequences – both intended and non-intended (in our opinion).
We believe the most important planning issues created by the new law as it relates to our clients center around retirement distribution strategies – specifically, for those who are concerned with maximizing assets that transfer to their heirs after they pass. Planning should begin well prior to this eventuality, which will focus on coordinating retirement distributions to minimize taxes over multiple generations, not just income tax considerations over your lifetime. In these situations, the use of Roth IRAs and “Roth Conversions” may be effective. The tax-free benefits of life insurance may also play an important role.
Hudson Dynamic Retirement will of course consider all law changes in our planning strategies. An effective and coordinated approach with your tax and legal advisors will continue to be our goal. Please let us know if you have any questions.