Retirement planning is about to change in ways not seen since the Pension Protection Act of 2006. The long-awaited Securing Every Community for Retirement Enhancement (SECURE) Act has been passed by Congress and was signed into law by President Trump as part of a $1.4 trillion spending bill.
Here are some of the SECURE Act’s highlights, according to the Investment Company Institute:
- Allows companies—regardless of industry—to join together to form multiple employer 401(k) plans;
- Increases the auto-enrollment safe harbor cap from 10 percent to 15 percent;
- Simplifies the non-elective contribution 401(k) safe harbor by providing notice and amendment flexibility;
- Treats certain taxable non-tuition fellowship and stipend payments as compensation for IRA purposes, thus making it easier for individuals receiving such payments to save through an IRA;
- Repeals the maximum age (now 70½) for making traditional IRA contributions;
- Increases the age at which required minimum distributions (RMDs) must start from 70½ to 72;
- Expands the types of education costs that are coverable by 529 plans; and
- Increases the credit limit for small employer start-up costs and creating new auto-enrollment credit to defray associated start-up costs.
The new law contains dozens of provisions affecting 401(k)s, annuities, IRAs and taxes.
Among other things, the age for required minimum distributions, or RMDs, was pushed from 70½ to age 72 and that “could provide tax benefits to some and tax hurdles for others,” according to Jamie Hopkins, the director of retirement research at Carson Group and author of Rewirement: Rewiring the Way You Think about Retirement!
What’s more, the new law, several provisions of which go into effect on Jan. 1, 2020, overhauls the RMD time frame for inherited IRA accounts, and that, too, could have major tax implications for IRA account owners and their beneficiaries.
New RMD Rules
Under the old law, retirement account owners had to start taking RMDs after age 70½. Under the new law, retirement account owners won’t have to start their RMDs until age 72.
But there’s a wrinkle. If you turned 70½ in 2019 you will still have to take an RMD by April 1, 2020, and another RMD by the end of 2020, according to Hopkins. If on the other hand, you turn age 70½ in 2020 or later, you don’t have to start taking RMDs until age 72. “They need to be aware that the date that matters is when did you hit 70½,” said Hopkins. “If it's 2019 all the way to Dec. 31 you're still under the old rules.”
And for those who turned 70½ in 2019, failing to take your RMD will result in a big penalty. If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required.
Another item to note, though it’s not included in the SECURE Act is this: The IRS will be using the same uniform lifetime table for RMDs, though with an asterisk, said Hopkins. The IRS will be replacing the current lifetime table with a new one in the coming months.
One consequence of increasing the RMD age from 70½ to 72 is that retirement account owner’s RMD is likely to be larger than had someone started at age 70½ because it’s based on a shorter distribution period. Hopkins, however, said the impact of this change is minimal. Retirement account owners can estimate their RMDs at SecureRMD.com.
According to the Wagner Law Group, eliminating the half-year convention reflects the way most individuals think of their age.
Conduit Trust as the IRA Beneficiary
The SECURE Act also eliminated the so-called “stretch” IRA in favor of the “10-year rule” and this could have grave tax consequences for retirement account owners who have named a conduit trust as the beneficiary of their IRA, especially if the trust calls for the trustee to distribute only the RMDs to the beneficiary of the trust.
“The stretch is essentially gone for everyone except for exempted groups, including surviving spouses,” said Hopkins. “The way that the Act is drafted actually says all of the (inherited retirement) account must be distributed by the end of your 10 following the year of death.”
So, what does that mean? It means the owner of an inherited IRA is not required to take RMDs in years one through nine after the retirement account dies. “There is no required minimum distribution under the SECURE Act for inherited accounts until year 10. So, if your trust as that language where you only have access to the RMD, it could lock up those retirement accounts for a decade before the beneficiary has any access to the money.”
And then, he said, the “disaster part” is that the entire account is distributed as a taxable distribution in one year. “There’s nothing you would be able to do about that trust because it set in stone at that point,” said Hopkins. “It's an irrevocable trust.”
According to Hopkins, some people will die next year with those trusts in place and the beneficiary will expect to receive RMDs, but the trust company or trustee won’t be able to distribute any money for 10 years. “That's going to be an absolute disaster,” he said.
If you have a conduit trust as the beneficiary of an IRA, Hopkins recommends changing the language in the trust that addresses access to the IRA. Instead of having it distribute only the RMD, have it distribute 10% of the account value per year and the remainder in year 10.
Hopkins also advised retirement account owners to review their designated beneficiaries and consider leaving money to a charitable remainder trust “where you wouldn't have before.”
If your goal was to provide lifetime income in a tax-advantaged manner to a beneficiary, you're not to be able to do that efficiently anymore because of the stretch IRA being eliminated. But, Hopkins says, you could leave your IRA to a charitable remainder trust. This kind of trust would disperse income to the beneficiaries of the trust for a specified period of time and then donate the remainder of the trust to the designated charity.
One outcome of this strategy? You might be able to transfer more money, because of the provisions in the SECURE Act, to your heirs by leaving it to a charity than leaving it outright to children, said Hopkins.
“Historically, when we say if you want to leave money to charity, you still have to have charitable intent,” he said. “Right now, that's actually not going to be true.”
Another tactic that has even more merit because of the SECURE Act is this: Name a charity as the beneficiary of your IRA and a life insurance policy with a death benefit equal to the value of the IRA and designate your children (or whomever you so choose) as the beneficiary. This way, the charity won’t pay any taxes on the distributions from the IRA and your children won’t pay any taxes when they receive the death benefit. “The argument to use life insurance as the tax-free vehicle to the heirs actually got strengthened through the SECURE Act,” said Hopkins.
Existing Inherited IRA Account Owners
If you own an inherited IRA account or will own because of the retirement account owner dying in 2019, you’ll take RMDS over the course of your lifetime.
Opportunities for Younger Retirement Savers
According to Steve Parrish, co-director of the Retirement Income Center at The American College of Financial Services, this legislation may open more doors for how young people tackle saving for retirement.
For instance, he noted in a release, that multiple-employer plan (MEP) provisions will make it easier for small companies and gig economy set-ups to join small plan offerings and will likely encourage more participation across the labor market.
And, because the new law adds family planning flexibility to existing IRA allowances for home purchases and education, young people will be more comfortable committing savings to retirement.
Education Planning and Taxes
According to Ross Riskin, an assistant professor of taxation at The American College of Financial Services and author of Education Planning and the SECURE Act: Creating a Tax Law Paradox the potential impact of this legislation may include, according to a statement:
More widespread usage of 529 plans, particularly after students have already graduated. The SECURE Act permits $10,000 to be taken (over the beneficiary's lifetime) from a 529 plan as a qualified distribution if the funds are used to repay qualifying student loans.
An uptick in 529 beneficiary changes, especially in larger families, since the SECURE Act extends the $10,000-lifetime student loan benefit to not only the beneficiary but his/her siblings as well. This may be taken advantage of through the generous provisions that already exist for 529 plans allowing for flexible beneficiary changes to other family members.
Increased applications for financial aid and use of student loans, as more people may want to let their 529 accounts grow in order to take advantage of additional periods of tax-free growth, which may be especially beneficial if the children of the taxpayer(s) also qualify for subsidized federal loans where the interest is paid for by the government until they enter repayment.
Income tax compliance will become more complex (especially at the state level), since not all states have followed the federal provision that allows for qualified distributions from 529 plans to be used for K-12 tuition expenses per the Tax Cuts and Jobs Act (TCJA), it is possible that some states will not follow the SECURE Act changes as well. This could result in increased complexity and tax compliance costs for taxpayers who may now think they are able to contribute to a 529 plan in order to receive a state income tax deduction, and then will try to turn around and use the funds to repay a portion of the student loans.
SECURE Act Is a Start
So how good or poor a job does the SECURE Act of setting every community up for retirement enhancement? According to Hopkins, the SECURE Act has a lot of OK and nice modifications. But it falls short of its title of setting every community up for retirement enhancement.
“Our biggest issue out there in the country are Social Security, Medicare and long-term care. This act does really nothing to address any of those issues,” he said. “Those are the things that are really going to move the needle forward.”
In fact, he said the biggest retirement change in the bill was a tax and revenue increase for the government. For instance, the removal of the stretch IRA will generate $15.7 billion in additional tax revenue over the next decade. “And that's the most impactful piece of the bill.”