Congress and the President delivered an unexpected holiday gift, the Secure Act. After overwhelmingly passing the House earlier this year the Act stalled in the Senate and was not expected to pass. Surprisingly, it was attached to the appropriations bill and passed late last week. The Act is designed to expand taxpayers’ ability to save for retirement and better use tax deferred plans. The majority of the Act’s provisions will positively impact our clients. The major provisions include:
- The ability to defer earned income to traditional IRAs for as long as desired.
- Raising the required minimum distribution age from 70 ½ to 72.
- Eliminating stretch IRAs by requiring inherited retirement accounts to be fully withdrawn within 10 years of inheritance.
- Permitting penalty-free IRA withdrawals up to $5,000 for new parent’s qualified medical and adoption expenses.
- Allowing the use of tax-advantaged 529 accounts for qualified student loan repayments up to $10,000 annually.
- Making it easier for small businesses to set up 401(k)s by increasing the cap under which they can automatically enroll workers in “safe harbor” retirement plans, from 10% of wages to 15%.
- Providing a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment.
- Enabling businesses to sign up part-time employees who work either 1,000 hours throughout the year or have at least three consecutive years with at least 500 hours of service.
- Encouraging 401(k) plan sponsors to include annuities as investment options.
The first three bullet points listed above may have the greatest impact on our clients.
Clients with earned income can contribute to traditional IRAs for as long as they choose. Prior law prevented contributions to traditional IRAs after age 70 ½. Clients with earned income can now make either tax deferred contributions, if they are under the income phase out limitations, or use the traditional IRA to make ‘back door’ Roth IRA contributions. Older clients can now add more dollars to their traditional and Roth IRA accounts.
Clients will be able to defer required minimum distributions (RMDs) until age 72. Clients who have not reached age 70 ½ by the end of 2019 will be able to wait until age 72 to begin RMDs. Those who have already begun RMDs or turned 70 ½ prior to 12/31/19 will continue to take RMDs according to prior law.
By deferring RMDs to age 72, taxpayers could be increasing their taxable RMD. Multi-year cash flow and income tax planning should be reviewed in order to determine if the future payments would push them into a higher income tax brackets or increase Medicare premiums.
In order to fund the Act’s tax deferrals, Congress eliminated the stretch IRA to generate tax revenue. Currently, a non-spouse beneficiary can stretch the RMDs from an inherited IRA over their lifetime allowing them to take smaller distributions and defer the tax longer. The Secure Act would require RMDs to be fully distributed within a 10 year period.
The Act also offers a number of exceptions to the 10 year withdrawal rule. Beneficiaries not subject to the rule can utilize the stretch the IRA. Those beneficiaries include a surviving spouse; a minor child; a disabled individual; and an individual not more than 10 years younger than the deceased plan participant or IRA owner.
The RMDs do not have to be taken annually; instead, the distributions could be deferred until later years. For example, the distributions could be deferred until year nine and then be distributed in a lump sum. This would allow the funds to continue to grow tax deferred. Of course, the lump sum distribution could push the beneficiary into a higher income tax bracket so it will be important to analyze the most tax efficient investment and tax strategy to optimize the IRA distribution.
Clients who are already taking RMDs from a stretch IRA can continue to stretch those payments under their current distribution schedule.
Stretch IRAs have commonly been used as part of a client’s estate plan. Under the new required distribution rules, clients will need to review their estate plans to determine if their plan still meets their objectives. They will need to assess if their plan would be better served by other techniques such as a Roth IRA, charitable remainder trust, or insurance. We would be happy to work with you to understand the Secure Act’s impact on your current planning.