What is the SECURE Act and How Will it Impact You?
There seems to be a new pattern emerging, another year and another tax overhaul. On December 20, 2019 President Donald Trump signed into law the Setting Every Community Up for Retirement Enhancement Act, better known as the SECURE Act, as part of the government’s new spending bill which will inevitably affect most retirement savers for better or worse. While the Act is quite extensive, we plan to focus on the key provisions most likely to affect you and your loved ones effective January 1, 2020:
- Changes effecting retirement plan beneficiaries
- RMD pushed to age 72
- Traditional IRA Contributions
- Qualified Charitable Contributions (QCD)
Perhaps the most impactful change resulting from the SECURE Act is the elimination of the “stretch” provision for most non-spouse beneficiaries of inherited IRAs and other retirement accounts. Under the prior law, for those account owners who passed away prior to December 31, 2019, their non-spouse beneficiaries were able to “stretch” Required Minimum Distributions over their life expectancy, or in the case of a qualifying trust, over the oldest applicable trust beneficiary’s life expectancy.
Moving forward, for most non-spouse beneficiaries who inherit a retirement account in 2020 and beyond, the “10 Year Rule” applies. This new rules states that the entire inherited retirement account must be emptied by the end of the 10th year following the year of inheritance. Beneficiaries do have flexibility as to the timing and quantities of the distributions to help with the tax impact as long as the account has been depleted by the end of the 10th year.
While the elimination of the “stretch” provision will affect a significant portion of beneficiaries, there are a few groups deemed “Eligible Designated Beneficiaries” that will not be subject to the new legislation:
- Spousal Beneficiaries
- Disabled Beneficiaries
- Chronically Ill Beneficiaries
- Individuals who are not more than 10 years younger than the decedent
- Certain minor children of the original account owner, but only until they reach the age of majority. Age of majority follows state rules and thus will vary.
For these “Eligible Designated Beneficiaries”, the same rules that applied prior to the SECURE Act will continue.
The SECURE Act has not only changed the rules and requirements of individual beneficiaries but may also lead to significant changes where trusts are named as the beneficiary of a retirement account. In general, there are two different types of trusts that would be set up as a beneficiary of a retirement account, a Conduit “See-Through Trust” or a Discretionary Trust, and both types could have unfavorable outcomes as a result of the Act.
Many Conduit trusts are drafted in a manner that only allows for the RMD to be disbursed from an Inherited IRA, with a subsequent amount passed directly to the trust beneficiaries. With the amendments made by the SECURE Act, for those beneficiaries of trusts who do not fall under this new classification of “Eligible Designated Beneficiaries” and thus subject to the 10-year rule, there is only one year in which there is an RMD, the 10th year. This has the potential to lead to an unfavorable tax situation in which the entire account balance is ultimately distributed to the beneficiaries in the final year.
On the other hand, Discretionary Trusts don’t fare any better than the Conduit Trust. The reason for this is because Discretionary Trusts are typically drafted in such a way as to retain a portion if not all income and distributions within the trust. As such, any income or distributions that are retained in the trust are taxed at the maximum rate of 37% after just $12,950 of income. So, there is the possibility of not only the entire account balance having to be distributed by the 10th year but also the unfavorable trust tax rates if not distributed to the beneficiaries.
Now we intentionally said, possibility , because the IRS has not clearly outlined whether the Conduit or Discretionary Trusts that have an “Eligible Designated Beneficiary” of a spouse, minor child, or beneficiary within 10 years will “See-Through” to these beneficiaries and not be subject to the new SECURE Act rules. The Act does specifically provide guidance that such trusts can be treated as an “Eligible Designated Beneficiary” when the beneficiary of the trust is a disabled or chronically ill person. We will need to await further guidance from the IRS for a final ruling on other groups of “Eligible Designated Beneficiaries”.
Most retirees will not be affected by the change in Required Minimum Distribution (RMD) starting age, however, it is important to mention for those who are about to take their first RMD. The SECURE Act has changed the age an individual must begin taking RMD’s from 70 ½ to 72. So how do you know when you are supposed to begin taking your RMD if you turned 70 ½ in 2019 or will turn 70 ½ in 2020?
For those individuals who turned 70 ½ years old in 2019, you will be required to take your first RMD by April 1, 2020. If you have already begun taking RMD’s in previous years, these changes will have no material effect on your RMD withdrawals.
2020 and beyond
For those individuals who are turning 70 ½ on January 1, 2020 and beyond (i.e. those individuals born after June 30th 1949), will not be required to take their first RMD until April 1 of the year following the year in which they turn 72. This isn’t a huge change but even one or two years of additional growth and contributions can be quite impactful on retirement accounts.
Another major change resulting from the SECURE Act is the elimination of the age limit for traditional IRA contributions. Under current law, Traditional IRA contributions are NOT allowed after 70 ½. However, the new act lifts this age limit and allows contributions past 70 ½ if there is earned income (Roth IRA’s have never had contribution age limits). With the new change, Traditional IRA’s are now aligned with the rules for Roth IRA’s and other retirement accounts.
Married couples filing their taxes jointly, can continue to contribute to their Traditional IRA as well as continue to make spousal IRA contributions for a spouse that is no longer working.
With RMD’s being pushed to age 72 and extension of IRA contributions, it would seem that QCD’s would follow suit, but in fact there were no changes to the rules. Individuals will continue to be able to utilize their IRA or Inherited IRA to make a QCD beginning at age 70 ½ and gift up to $100k per year. This will allow the individual to make the charitable contribution directly on a pre-tax basis. Beginning in the year an individual turns 72, any amounts given to charity via a QCD will reduce the then necessary RMD as well.It is important to note that post 70 ½ contributions will reduce any future QCD’s by an equivalent amount.
In addition to the changes that we have covered thus far, below are a few other notable changes that have been introduced as part of the SECURE Act.
- A penalty-free distribution from a retirement plan prior to age 59 ½ for a qualified birth or adoption up to a lifetime limit of $5,000
- Medical expense deduction AGI hurdle rate of 7.5% extended for 2019 and 2020
- A repeal of the TCJA-introduced Kiddie Tax changes (reverting away from a requirement to use trust tax brackets and back to using the parents’ top marginal tax bracket).
- Reintroduction of the qualified higher education tuition deduction. Allows for up to $4,000 of qualified tuition to be used as an above line deduction
- Mortgage Insurance Premium Deduction: May continue to deduct premiums. AGI phaseouts begin when AGI exceeds $100k MFJ or $50k MFS
- 529 plans are now permitted to use up to a $10k lifetime amount for apprenticeship and repayment of student loans
- Employers may adopt plans that are entirely employer funded, such as stock bonus, pension plans, profit sharing plans, and qualified annuity plans, up to the due date (including extensions) of the employers return
How Weatherly can help:
- Review your beneficiaries
- Discuss your RMD distribution schedule
- Estate planning considerations for IRA beneficiaries
** The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above.