In late December 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, marking one of the most significant changes to retirement legislation in recent years. This new law follows a growing trend of enacting major financial legislation at the end of the year, much like the Tax Cuts and Jobs Act of 2017. The SECURE Act introduces several provisions that will affect retirement accounts, tax planning, and overall financial strategies for millions of Americans. Whether you’re planning for retirement or already retired, understanding how these changes impact your financial plan is crucial. This guide will walk you through the key components of the SECURE Act and offer practical insights on how to adjust your financial strategy accordingly.
1. The End of the Stretch IRA
One of the most significant changes brought about by the SECURE Act is the elimination of the Stretch IRA for most non-spousal beneficiaries. Previously, individuals who inherited an IRA could take Required Minimum Distributions (RMDs) based on their life expectancy, allowing the IRA balance to stretch over many years. This strategy provided beneficiaries with a way to minimize taxes and allow the account to grow tax-deferred over a longer period.
Example Scenario: Consider Tony, a 46-year-old lawyer who inherits a $1 million IRA from his mother. Under the old rules, Tony could have taken RMDs based on his life expectancy, potentially spreading the distributions over 40 years. This would have allowed him to take smaller distributions annually, minimizing his tax burden and keeping the majority of the funds growing tax-deferred.
However, under the new SECURE Act rules, Tony must withdraw the entire IRA balance within 10 years of inheritance. This means he would need to take an average of $100,000 per year, significantly increasing his taxable income during what are likely his peak earning years.
Implications: This change can be particularly detrimental for beneficiaries in their 40s, 50s, or 60s, as these are often high-earning years with higher marginal tax rates. The 10-year rule applies to both inherited Roth IRAs and Traditional IRAs. While Roth IRA withdrawals remain tax-free, the requirement to withdraw the funds within 10 years can still disrupt long-term financial planning strategies.
Exceptions: Fortunately, there are certain eligible beneficiaries who are exempt from the 10-year rule, including:
- Spouses
- Disabled persons (as defined by IRC Section 72(m)(7))
- Chronically ill persons (as defined by IRC Section 7702B(c)(2), with limited exceptions)
- Individuals who are not more than 10 years younger than the decedent
- Minor children of the original retirement account owner (until they reach the age of majority)
If you inherited an IRA prior to January 1, 2020, you are grandfathered into the previous rules. However, any beneficiaries who inherit from you will need to follow the SECURE Act’s 10-year distribution rule.
2. Delayed Required Minimum Distributions (RMDs)
The SECURE Act introduces a positive change for retirees by extending the age at which they must begin taking Required Minimum Distributions (RMDs) from their retirement accounts. Previously, individuals were required to start taking RMDs at age 70.5. The new law pushes this age to 72, giving retirees an additional 18 months of tax-deferred growth.
Benefits: This change allows retirees more flexibility in managing their retirement accounts. By delaying RMDs, you can potentially reduce your taxable income in the early years of retirement, allowing your investments to continue growing tax-deferred for a longer period. This is particularly beneficial for those who do not need the funds immediately and prefer to keep their money invested.
Retirees still have the option to begin taking distributions earlier if they choose, starting at age 59.5 to avoid penalties. However, the delay in mandatory withdrawals offers more control over when and how much you withdraw from your retirement accounts.
3. Continued IRA Contributions Beyond Age 70.5
Another significant change under the SECURE Act is the removal of the age limit for contributing to traditional IRAs. Previously, individuals could not contribute to a traditional IRA after reaching age 70.5. The new law eliminates this restriction, allowing individuals of any age to contribute to their IRA as long as they have earned income.
Benefits: This change is particularly beneficial for older workers who continue to earn income and want to save for retirement. By allowing contributions at any age, the SECURE Act encourages ongoing retirement savings and provides an opportunity for continued tax-deferred growth. This can be especially valuable for those who may have started saving for retirement later in life or who need to boost their retirement savings.
4. Early Withdrawal Penalty Exceptions for Childbirth and Adoption
Expanding your family can be an exciting yet financially challenging time. Recognizing this, the SECURE Act introduces a new provision that allows penalty-free withdrawals of up to $5,000 from an IRA for qualified childbirth or adoption expenses. This $5,000 limit applies per child, offering some financial relief for new parents.
Considerations: While this provision allows for penalty-free withdrawals, it’s important to note that the distribution is still subject to ordinary income tax. Therefore, it’s advisable to consult with a financial advisor before taking advantage of this option to understand the full tax implications and explore alternative ways to cover these expenses.
5. Expanded Use of 529 Plans
Student loan debt is a significant burden for many individuals, even well into their careers. The SECURE Act addresses this by allowing 529 plan funds to be used to pay down student loans, up to a lifetime limit of $10,000 per beneficiary.
Limitations: While this change provides some relief for those still managing student loan debt, the $10,000 lifetime limit may not make a substantial dent in larger loan balances. Additionally, plan sponsors may take time to fully implement this provision, so it’s important to check with your specific 529 plan provider to ensure compliance with the new rules.
6. Incentives for Small Business Retirement Plans
The SECURE Act includes several provisions aimed at encouraging small businesses to offer retirement plans to their employees. One such provision is the introduction of a new tax credit for small businesses that establish a retirement plan.
Impact: For tax years beginning January 1, 2020, the maximum credit available under IRC Section 45E has been increased, making it more financially feasible for small businesses to set up retirement plans. This incentive is expected to lead to a greater number of small businesses offering 401(k) plans, thus expanding access to retirement savings for more workers.
7. Increased 401(k) Access for Part-Time Workers
Historically, part-time workers were often excluded from participating in their employer’s 401(k) plans due to the requirement of working at least 1,000 hours in a single plan year. The SECURE Act changes this by requiring employers to allow part-time employees who work 500 hours or more annually for three consecutive years to participate in the retirement plan.
Implications: This change is a significant win for part-time workers, many of whom are women, as it increases their access to retirement savings opportunities. Employers will need to adjust their plan administration to accommodate these new participants, but the long-term benefit to employees is substantial.
Conclusion
The SECURE Act brings a variety of changes that impact retirement planning, from eliminating the Stretch IRA to expanding access to retirement plans for small business employees and part-time workers. While some provisions may require adjustments to your financial strategy, others offer new opportunities for growth and security in retirement. Understanding these changes and working with a financial advisor can help you navigate the complexities of the SECURE Act and ensure that your financial plan remains on track.
If you’re interested in learning more about how the SECURE Act affects your financial plan, schedule a consultationwith us today. We can help you evaluate your current strategy and make any necessary adjustments to maximize your retirement security.