One day ahead of their holiday recess, Congress passed an appropriations bill that avoided a government shutdown. Tucked into that bill is a very significant piece of legislation that had sat dormant since June. The SECURE Act (Setting Every Community Up for Retirement Enhancement) has both a very aspirational name and bipartisan support. The support is well-earned, as several updates are beneficial to savers and investors. One update, however, could be very detrimental in certain circumstances. Let’s examine, starting with the bad news.
One Detrimental Update:
- No More Stretch IRAs for Non-Spouse Beneficiaries (Sec 401)– Today, if someone passes away with pre-tax 401k or traditional IRA dollars, non-spouse beneficiaries such as their children can take distributions based on the child’s age. This is commonly known as stretch IRA treatment. The updated law beginning 1/1/2020 removes this lifetime treatment for non-spouse beneficiaries* and requires them to distribute the entire account within 10 years. Let’s say a 75 yr old passes away and leaves his $1,000,000 IRA to a 40 yr old daughter. With today’s stretch rules, she could take 2.29% or $22,935 as income this year. The new law will require full distributions in ten years, so at 10% per year, her first distribution would become $100,000.
- This represents a substantial potential tax penalty to IRA beneficiaries as the accelerated income can move them into a higher tax bracket. Thus, it reduces the attractiveness of pre-tax retirement dollars for estate planning purposes. On the other hand, Roth dollars become even more attractive, because Roth distributions are tax-free to beneficiaries**. We will examine Roth conversions and other strategies to plan around this new law in a commentary in early 2020 after the IRS has had an opportunity to publish guidance.
Several Beneficial Updates:
- Delay of RMD Age from 70 ½ to 72 (Sec 114)- Required Minimum Distributions are amounts that owners of 401k’s & IRA’s must take as income each year based on their age. Delaying the age of requirement gives savers a longer period of tax deferral before they’re required to take income, but does not affect their ability to take income if they choose. This law applies to those who turn 70 ½ after 12/31/2019.
- No Maximum Age on IRA contributions (Sec 107)- Recognizes the reality that many are working longer and should continue to benefit from retirement savings tools.
- Multiple Employer Plans (Sec 101)- In effect beginning 2021, this allows unrelated employers to combine resources in retirement plans, a feature only allowed for unions and related businesses to date. This has the potential to massively reduce retirement investment costs for small businesses and their employees.
- Small Employer Automatic Enrollment Credit (Sec 105)- Someone that understands retirement statistics is suggesting a great nudge here with an incentive to automatically enroll new employees to save inside their available 401ks.
- Bans 401k Credit Card Loans (Sec 108)- Allowing retirement participants to attach credit cards to their account balances is great for credit card companies! Not so great for savers.
- 529 Plans for Apprenticeships (Sec 302)- 529 accounts are widely known as College Savings Plans, but have lately been reformed to allow distributions for elementary and secondary education. Expansion to apprenticeships removes a disincentive to saving for those worried their children may not attend college. Funds can also now be used to pay off student loans. More flexibility with 529 funds is better for savers.
Clearly the number of beneficial updates inside the SECURE Act outnumber the less favorable update. As with any law with tax ramifications, the IRS must translate these laws into practicable regulations, rules, and procedures. We will monitor this process and make you aware of any beneficial strategies that develop. As with any topic, if you would like to discuss how this may affect your plan, we would love the opportunity to help.
* Minors can delay RMDs until the age of majority, at which point they have 10 years to distribute. Disabled/chronically ill beneficiaries continue to receive stretch treatment equal to spouses.
**While Roth IRAs will be subject to the same 10-year distribution schedule under new law, their tax-free distributions will not affect non-spousal beneficiaries’ tax pictures.
Further Consolidated Appropriations Act, 2020