In December 2019, Congress passed the SECURE (Setting Every Community Up For Retirement Enhancement) Act. This bi-partisan legislation contains provisions that can affect everything from the age you can make IRA contributions to small business credits for establishing a retirement plan.
Here are the new changes that investors should be aware of.
1. Required Minimum Distributions (RMDs) are forced withdrawals from retirement plans like IRAs & 401(k)s. Under the new rules, retirement account owners are no longer required to begin taking money out of their plans in the year they turn age 70.5. The new RMD beginning age is 72. Anyone turning age 70.5 in the year 2020 or later can wait. Investors who have already commenced their RMDs must continue under the old rule.
While delaying RMDs may seem beneficial at first, it might not actually be. Imagine you have a relatively large IRA and you wait an extra year or two to begin RMDs. What you're effectively doing is compressing a greater amount of taxable distributions into a fewer number of years. Since IRA withdrawals are taxed at generally higher rates (ordinary income), bunching distributions together can cause negative tax ripple effects; increase the overall tax burden, push you into higher marginal brackets, subject a higher percentage of Social Security to become taxable, and increase Medicare premiums, among others.
Just because you can wait to do something doesn't necessarily mean you should. Consider approaching RMDs like 4th grade book reports. Don't wait until the night before as I used to do.
2. Retirement Plans that pass to kids (more realistically, adult children) can no longer take RMDs over their lifetimes. While spouses still have the option of taking RMDs over either their lifetime or their deceased spouse's lifetime, non-spouse beneficiaries are treated differently.
When a non-spouse beneficiary inherits a retirement plan, including a Roth IRA, they now have 10 years to withdraw the entire plan balance. The new rule affects non-spouse beneficiaries who inherit retirement plans in 2020 and beyond. Any non-spouse beneficiary already stretching out RMDs over their lifetime is grandfathered under the old rules assuming they started prior to 2020.
Knowing that you have 10 years to tear through an inherited retirement plan could be both a blessing or a curse, depending on the scenario. For example, if you are a higher earner and inherit a large retirement plan, you'll pay more taxes on those compressed distributions under the new rules compared to what you would've under the old, more favorable lifetime distribution option.
However, the 10-year window creates an opportunity for non-spouse beneficiaries when they have a lower than normal income year; they could shift a higher percentage of RMDs this particular year.
Interestingly, the IRS doesn't care when a non-spouse beneficiary takes their RMDs equally over the 10 years or all at once. All that matters is that the retirement account is emptied by the end of the 10th year.
There are some exceptions to the new 10-year RMD rule. Non-spouse beneficiaries with disabilities, minors, and people who simply happen to be within 10 years of age of the deceased can choose RMDs based on their lifetimes as an option. Also, charities must empty the entire retirement plan within 5 years, differing from the new 10-year schedule
3. Trusts Can Be Complicated Under The New Rules. Conduit & Discretionary trusts subject to trust "See-Through" rules essentially act as a beneficiary to retirement plan assets. Often, these specialty trusts allow inherited retirement plan assets to be paid out over a beneficiary's lifetime and beyond.
Usually, these trusts are very specific regarding how much trust income is distributed over time. Under the new rules, trust distribution specifics may conflict if the trustee blindly follows what's specified in the trust. This could trigger a mess of tax penalties for the beneficiary(s) named in the trust.
Not only do these two types of trusts have potentially rule violating language, but the whole idea of keeping more of the inherited assets in the trust is subject to its own inherent set of tax challenges. For example, trusts serving as retirement plan beneficiaries benefit a minor trust beneficiary or an adult who's irresponsible or bad with money, but we have to remember that trusts pay some of the highest tax rates. There's a catch 22 here.
A trust generating a measly $12,950 in portfolio income is taxed at a whopping 37%. To put that in context, a $400,000 trust earning a 2% dividend + a normal amount of capital gains could fall into the 37% marginal trust tax bracket.
If one of the potential beneficiaries is a trust in your retirement plan, it's time to have your trust looked at to make sure the language reflects the new RMD rules.
4. Qualified Charitable Distributions (QCDs) allow a retirement plan owner subject to RMDs to send those RMDs directly to a qualified charity. There are several benefits; satisfy the RMD, help charities execute their mission, and lower an investor's taxable income. The latter is especially important as it potentially provides an overall better tax benefit than simply contributing to a charity and itemizing on your tax return.
You would think that because the new RMD age changed from 70.5 to 72, that the age an investor was allowed to use QCDs would also shift. Nope! QCDs are still permitted starting the year the retirement plan owner turns 70.5.
5. Investors Can Contribute To IRAs After Age 70.5. However, the gotcha of having "earned income" still applies. Earned income is any income you realize from a job or self-employment income. For example, a retiree living off portfolio income and Social Security is income not actually "earned". Even though both you and I know you "earned" it, the IRS sees it differently.
There is another catch with IRA contributions as they relate to the QCDs mentioned in #4. If you work past age 70.5 and make a deductible IRA contribution(s), and then a few years later once you're retired execute a QCD, you won't get the full QCD tax benefit until you've taken RMDs equal to the amount of contributions made after age 70.5. Essentially, the IRS says older workers can't double-dip on IRA contribution deductions as well as QCDs.
6. Expect More Annuities In Your WorkPlace Retirement Plan. While annuities were always allowed, retirement plan providers typically shied away from these insurance-based options. There was a somewhat valid fear that the insurance company providing the annuity would go out of business and the employer would be sued by employees for violating its fiduciary duty.
Under the new rules, the law that governs workplace retirement plans (ERISA) like 401(k)s allow a "safe harbor" mechanism that relieves the plan fiduciary (often the employer themselves, who typically know zero about retirement plan design) in the event the insurance company dissolves.
Also, if a retirement plan participant opts into an annuity "lifetime income strategy", aka annuitization, then even in the event that participant loses or changes jobs, they still retain the right to the guaranteed income they were counting on.
I don't make many predictions. But, here's one. If there's a way to extract more fees from investment products without additional liability, then it's going to happen. Annuities are considerably more expensive than mutual funds for a variety of reasons, so expect more insurance companies trying to weasel their way into retirement plans under the spin of greater investment options = advantage to traditional mutual funds.
7. Business Tax Credits. First, any company that establishes a new retirement plan such as a 401(k), 403(b), 457, SIMPLE IRA, SEP IRA, etc, will be eligible for a tax credit. That tax credit can be anywhere from $500 to $5,000, depending on the number of employees eligible for the new plan. Small businesses that currently don't offer a retirement plan should definitely pay attention.
Second, any company that offers a retirement plan auto-enrollment feature can receive a tax credit. The company receives a $500 credit each of the first 3 years following the establishment of a retirement plan auto-enrollment feature. Also pertinent here is employers are now allowed to go as high as 15% of employee compensation as the auto-enrollment contribution threshold.
The auto-enrollment feature is separate and distinct from the establishment credit. So, double-dip away!
8. 529 Plan Distributions Used To Pay Student Loans. Anyone with 529 plan assets can now use up to $10,000 (lifetime max) to pay both principal & interest costs on student loans. In theory, a college grad could cycle money into a 529 plan, potentially receive a state income tax deduction, and then pull that money right back out to pay down student loans.
This would be amazing if every state actually allowed it. This is one of those cases where the federal system says one thing but the state says "we know best, we're doing it our own way".
Unfortunately, the State of Colorado has come out and explicitly stated:
Colorado tax law remains unchanged and CollegeInvest 529 plans can only be used for qualified higher education expenses. Any other use, including student loan repayments, are considered non-qualified withdrawals and subject to penalties.
However, other states might operate with less rigidity than Colorado. This one might be worth checking into.
9. Return of the "Old" Kiddie Tax. Kiddie tax is the tax a parent pays when a minor receives "unearned income", such as that from investments a grandparent thought would be a good idea to leave to a grandchild.
Under the 2017 Tax Cuts and Jobs Act (TCJA), the kiddie tax became taxed at the same rates as trusts. These are highly unfavorable rates as they are some of the highest taxes paid on the smallest amounts of income. Now, just 2 years later, we're back to the old kiddie tax rates where minors with unearned income are now (again) taxed at their parent's marginal income rates.
But, like most things Congress regulates, it's complicated. Going forward, if your child is a minor and has unearned income, you have to decide if you want if the new rules or the old rules applied.
It's tough to say exactly which set of rules will be the better choice going forward. In general, if a minor has substantial unearned income (say, over $9,450, and that's a lot for a kid!) and the parents are in a modest to lower marginal tax bracket, then you'll want to use the old (but new again, sheesh) rules. If the parents are in a higher marginal tax bracket and unearned income is limited to $9,450 or less, you might benefit from the TCJA rates which mirror the trust marginal tax brackets.
Yeah, super confusing!
10. Failing to File Penalties Increased. This applies to both individual taxpayers (in a few somewhat obscure cases) as well as companies offering certain retirement plans offered by employers subject to annual Form 5500 filings.
There is a nice summary HERE.
How about this, just get this stuff done on time so you're not affected! This is one of those things that you have 100% control over.
There are a few other less notable provisions of the SECURE Act. However, these are the top 10 new rules that may affect your finances. If you can't sleep at night and want to know more, you can read the full act HERE.
A better alternative is to give us a call and ask how the SECURE Act might affect your Financial Planning decision-making process. Since most of our clients are affected by the new rules, chances are you will be too. Don't hesitate to drop us a message using the "Contact" button in the upper right corner of this screen.