The SECURE Act Passed…Now What?

Just before the start of the new decade, Congress passed the SECURE Act, which makes important changes to certain rules governing retirement accounts. The formal name for the legislation is the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. There are two questions that retirement account owners need to ask: (1) How will it affect me? and (2) What changes should I make, if any, in response to the new rules?

Contribution eligibility has been expanded

The age limitation for contributing to Traditional IRAs, which is now age 70 ½, has been eliminated. That means that if you work past age 70, you can still make a Traditional IRA contribution and receive a tax deduction, as long as your gross income falls within certain limits.

Recipients of certain academic stipends and non-tuition fellowship income for the pursuit of graduate or post-doctoral study or research may now consider that to be earned income when determining their eligibility to contribute to an IRA.

Many part-time employees are now eligible to participate in their company’s 401(k) plan. The requirement is that they have worked at least 1000 hours for one full year or 500 hours per year for at least three consecutive years and that the employee is at least age 21 at the end of the three-year period.

Annuities Allowed in 401(k) plans

Employers may now offer annuities in 401(k) plans. The intent is to offer an option that provides a guaranteed income stream over a retiree’s lifetime, although participants have always had the option of rolling over 401(k) balances to IRAs for the purpose of buying an annuity.

Given the complexities and fees that characterize many annuities it bears watching to see which types of annuities employer plans will offer. One troubling detail is that the fiduciary responsibility to ensure that the products are appropriate for employees will now fall on insurance companies, which sell annuities, rather than employers. Variable annuities, which usually invest in stock mutual funds, have long been considered inappropriate within retirement plans, which are already tax-deferred. So this new option may be suitable only if a participant wishes to buy either an immediate annuity or a deferred annuity, both of which can guarantee a stream of income for life or for a certain number of years. But at today’s low interest rates, these types of products are currently more expensive than they would be in a higher rate environment.

Required Minimum Distributions now start at 72

For anyone who reaches age 70 ½ after 2019, the age at which minimum distributions from Traditional IRAs and 401(k)s must start has been raised to 72. The amount that must be distributed each year will continue to be based on life expectancy tables published by the IRS.  While this is welcome news for some account owners, not everyone should assume that delaying distributions until legally required is the best long-term tax strategy. For some people, starting distributions even before age 70 ½ may be optimal. An individual’s retirement account withdrawal plan should be designed in consultation with one’s tax adviser and investment professional. (Although the age for required minimum distributions has been increased, IRA owners who have reached age 70 ½ can still make a Qualified Charitable Distribution (QCD) to a qualified charity. See below.)

The “Stretch IRA” has been eliminated

Under prior law, non-spouse beneficiaries of an IRA had the option of “stretching out” distributions over their own life expectancies. With a few, very narrow exceptions, including minor children, the SECURE Act requires non-spouse beneficiaries to withdraw the entire inherited IRA within 10 years. A spouse who inherits an IRA will continue to be able to roll over the IRA money to his or her own IRA and treat it as such.

Traditional IRA and 401(k) owners with high balances who plan to leave their retirement accounts to their children need to re-evaluate their plans. One question to ask: Might my children be in a higher income tax bracket, including the addition of the IRA income, when they inherit the account than I am in currently? (Keep in mind that the current low tax rates are scheduled to expire in 2026.) If so, you may want to withdraw more from your retirement accounts rather than your nonretirement accounts while you are living. This would, of course, increase your own tax liability (unless you are age 70 ½ and make a Qualified Charitable Distribution) but the tax savings for your children might be greater. In a sense, you would be “prepaying” taxes for your children and increasing the value of their inheritance.

• Leaving nonretirement accounts to your heirs takes advantage of a significant benefit our tax laws offer to inheritors of nonretirement accounts—step-up in basis. When appreciated assets in nonretirement accounts are inherited, the tax basis generally can be “stepped up” to the market value at the time of death. That essentially eliminates capital gains taxes on assets, including stocks and real estate, that have increased in value over time. Perhaps in the past, the value of the “stretch IRA” may have exceeded the value of the step-up in basis, but with the passage of the SECURE Act, this may no longer be true.
• IRA owners who have reached age 70 ½ can make a Qualified Charitable Distribution (QCD) of up to $100,000 annually to a qualified charity. The benefit of this, which requires moving the money directly to the charity from the IRA, is that it reduces federal taxable income, like a tax deduction, at a time when most people, especially people who are retired, now take the standard deduction, which is usually higher than the total of their itemized deductions. However, under the SECURE Act, the amount of your QCD is reduced by the total of any Traditional IRA contributions you made and deducted after age 70 ½, which, under the SECURE Act, is now allowed if you have earned income.
• Another alternative is to convert Traditional IRA money to a Roth IRA. This would also increase your own tax liability in order to save potentially higher taxes for your heirs, but it can be done gradually over a period of years to avoid reaching into much higher tax brackets. Like the Traditional IRA, an inherited Roth IRA can be held for 10 years, but during that time the tax-free (not just tax-deferred as with the Traditional IRA) accumulation of earnings is preserved, and then the money can be withdrawn by the beneficiary with no tax liability. This benefit is in addition to the fact that the Roth IRA is not subject to required minimum distributions for the original owner, who can leave the money in the Roth to accumulate tax-free for the rest of his or her life for the benefit of his or her heirs.
• If you have large Traditional IRA or 401(k) balances that you want to leave to your children, you may want to talk to your estate planning attorney about naming a Charitable Remainder Trust as your retirement account beneficiary and naming your children as income beneficiaries of the trust. The trust could pay a regular income stream to your children over their lifetime, with a predetermined charity receiving any assets remaining in the trust after the death of the beneficiaries.
• Although most IRA owners already name their spouse rather than their children as their primary beneficiary, the elimination of the “Stretch IRA” makes that more advantageous. The spouse can treat the inherited IRA as his or her own before leaving it to the children, which extends the life of the IRA. Also, an IRA owner with multiple beneficiaries may want to consider the likely tax brackets of each beneficiary in determining which types of assets, retirement or nonretirement, should be left to each.

At the very least, estate planning documents and beneficiary designations need to be reviewed after the elimination of the stretch IRA, especially if the primary beneficiary of your IRA is your revocable trust. In an example of unintended consequences, some IRA owners may have previously set up a “conduit” trust to leave an IRA to their beneficiaries that requires that only the minimum distribution be paid out each year. Under the new rules, that would be $0 in years 1-9 and 100% in year 10, which could result in a large tax bill in year 10.

Other changes

The SECURE Act contains many other provisions, including:

• A tax credit of up to $5,000, which had been only $500, for employers who set up new plans. If there is an automatic enrollment feature, small businesses could receive another $500 credit.  Also, multiple employer plans are now allowed.
• Tax-free distributions from 529 plans for qualified Apprenticeship Programs and (up to $10,000) to repay student loans.
• Penalty-free distributions of up to $5,000 for “qualified births and adoptions” from IRAs and retirement plans.
• Unearned income of children (“kiddie tax”) will again be taxed at the parents’ tax rate rather than the trust rate, which had been part of the 2017 tax act.

As always, if you have any questions about the SECURE Act or other retirement topics, please give us a call at (413) 256-1225 or info@westbranchcapital.com. We are here to help.