How the New SECURE Act Will Impact Your Retirement
/In the midst of impeachment, among the hustle and bustle of the holidays, our elected officials passed a new law that has far-reaching effects on retirement accounts as we know them.
The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019, which passed the House back in July, intends to improve retirement readiness for millions of Americans who are currently facing a dire retirement future.
Last year, the wealth management giant Vanguard revealed that the median 401(k) balance for those aged 65 and older was just $58,035.1 With average social security income of about $18,000 and a 401(k) of $58,000, a retiree would have to survive on just $20,000 per year, hardly enough to cover food, utilities, and housing.
This article outlines what is in the new Act and offers strategies to consider with this new provision.
Provisions of the New Act
When it comes to understanding the SECURE Act, here are the key takeaways to know:
· Delayed IRA distributions. The Act pushes back the age at which retirement plan participants need to take required minimum distributions (RMDs) from 70½ to 72. This likely postpones taxes for many retirees from age 70 - 72 and also improves an IRA’s ability to last until the end of one’s life.
· The death of the “Stretch IRA” for newly inherited IRAs or 401(k)s. Prior to this act, an inherited IRA could be stretched by distributing funds over the lifetime of the inheritor. This was beneficial because the inheritor could withdraw small amounts of money over many years and likely stay in lower tax brackets by doing so. The new law requires total distribution within 10 years with very few exceptions. Thus, an inheritor in prime earning years might end up paying nearly half of the inheritance to taxes as opposed to 25%. This provision will pay for the SECURE Act, raising an estimated $15.7 billion in additional tax revenue.2
· Traditional IRA contributions allowed beyond age 70. In the past, regardless of employment status, the chance for saving more money in a traditional IRA ended at age 70. Under the new Act, persons with earned income can contribute to IRAs beyond age 70. Ultimately, this offers a tax advantage to employees who continue to work into their 70s, whether it be full employment or a side gig.
· The proliferation of annuities in 401(k) accounts. The Act encourages 401(k) providers to include annuities as an option in workplace plans by reducing their liability if the insurer cannot meet its financial obligations. Also, the 401(k) provider is not required to choose the lowest cost annuity plan.
· Encouragement for employers to offer 401(k)s and to auto-enroll employees in them. The SECURE Act will make it easier for small business owners to set up “safe harbor” retirement plans that are less expensive and easier to administer by providing a tax credit ranging from $500 - $5,000 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment.
· Help for parents having children. Permits penalty-free withdrawals of $5,000 from 401(k) accounts to defray the costs of having or adopting a child.
Biggest Negative – The Stretch IRA Elimination
The most significant drawback of the Act is the new limitations on inherited IRAs. Critics of the Act are frustrated by the fact that inheritors of IRAs will be more heavily taxed by forcing withdrawal within 10 years. Estate planners in particular indicate that thousands have converted IRAs to Roths or handled IRAs in a manner to improve results for their heirs. This meticulous planning now goes out the window.
There are exceptions to the elimination of the stretch IRA, however. The new limitations don’t apply to an heir who is a spouse, disabled, chronically ill, or a minor. In addition, persons who are within 10 years of the age of the deceased or who have already inherited IRAs get to continue with the old rules as well.
Biggest Benefit – Delay of Required Minimum Distributions to Age 72
For all of those who are not 70½ by the end of 2019, there is an enhanced opportunity to manage taxable income up through age 72. In the past, you were forced at age 70½ to take annual distributions that were entirely taxable from your IRAs without any flexibility. It is helpful now that you can consider taking partial distributions in the form of Roth conversions. By doing so, you may be able to reduce the impact of IRA distributions once they are mandated at age 72. The Roth conversion strategy has been deployed in the past most often between the age a person retires and age 70 with the general intention of evening out their taxable income over their retirement years. Having two additional years to work the Roth conversion strategy will prove beneficial for those sophisticated enough to perform this careful tax analysis.
New Planning Opportunities
In light of the new rules, it behooves you to consider making changes that could give you an advantage. This includes:
· IRA beneficiaries should be reviewed. If you were planning to leave your IRA to a grandchild to enable them to stretch the IRA over his or her lifetime, you might consider leaving it with your spouse instead who can still distribute the IRA over his or her own lifetime. If you were planning on leaving your entire IRA to one beneficiary, you might consider adding beneficiaries such that the inheritance can still be split over many years and heirs.
· Weigh the pros and cons of a Roth conversion. Retirees younger than age 72 should work with their CPAs and/or tax software to determine whether taking an annual Roth conversion makes sense in minimizing their taxable income once age 72 arrives and IRA distributions are mandated. This might be even more beneficial now in light of the Tax Cuts and Jobs Act of 2017 that instated reduced tax rates between years 2018 - 2025, which will likely lead to all tax brackets moving back up in 2025 by about 2%.
· IRA heirs should maximize the stretch that still remains. If you do have the good fortune of inheriting an IRA in 2020 or beyond, be thankful that there still is some stretch. The new Act requires the inherited IRA to be distributed within 10 years, but that doesn’t mean it has to be spread evenly over 10 years. A high-earning heir who is planning on retiring in a few years might postpone the IRA distributions until after retirement.
· Small business owners should revisit advantages of setting up 401(k) plans. The tax credits added for opening a 401(k) plan might be significant enough to entice more employers into starting plans. If you have not yet set up 401(k)s, SEP IRAs or Simple IRAs for your employees, now might be the time to do so in order to offset the costs.
· Do nothing. Ultimately, the delay of IRA-required distributions on your own retirement accounts offers additional flexibility. The fact that your beneficiaries might now face steeper taxes when they inherit your IRA might be the least of your worries, especially when you consider that most IRA holders will live well into their 80s and likely reduce their IRA account balances by the time they pass away.
Whether or not the new SECURE Act will make a dent in the frailty of the financial lives of current and future retirees is up for much debate. The major benefit from the required minimum distribution being pushed out from age 70½ to 72 should give some tax benefit to retirees. If IRA inheritors have to pay a higher tax bill, they will still have inherited money that they probably weren’t counting on. Unfortunately, there doesn’t seem to be anything too significant in this bill that will really tip the scales of incentivizing Americans to save more or invest more sensibly. Thus, what could have been a real opportunity to boost retirement success will remain an opportunity for future lawmakers.
Sources:
1. Kurt, Daniel. (Dec. 23, 2019). “What is the SECURE Act and How Can It Affect Your Retirement?” Investopedia.com. Retrieved from https://www.investopedia.com/what-is-secure-act-how-affect-retirement-4692743.
2. Saunders, Laura. (Dec. 21, 2019). “Inheriting IRAs Just Got Complicated, Thanks to New Retirement Overhaul.” The Wall Street Journal.
