The Setting Every Community Up for Retirement Enhancement Act (SECURE Act), signed into law by President Trump on Dec. 20, 2019, pointedly changes many requirements for employer-provided retirement plans, IRAs, and other tax-favored savings accounts.
While some of the provisions of the SECURE Act may provide taxpayers with great tax savings opportunities, not all the changes are helpful, and there may be steps taxpayers can take to minimize its impact.
Below is a summary of the key provisions of the SECURE Act that taxpayers should be aware of now, especially since many of the provisions go into effect in 2020.
Repeal of the Maximum Age for Traditional IRA Contributions
Before 2020, individuals were prohibited from making traditional IRA contributions upon reaching the age of 70 ½. However, starting in 2020, the SECURE Act allows an individual of any age to make contributions to a traditional IRA if the individual has compensation, such as earned income from wages or self-employment.
This SECURE Act provision eliminates the age limitation, which previously prevented taxpayers older than 72 ½ from contributing to their IRAs. This will allow individuals working into their later years to increase, or catch up with, their retirement savings goals.
Required Minimum Distribution Age Raised from 70½ to 72
Pre-2020 retirement plan participants and IRA owners were typically forced to begin taking required minimum distributions (RMDs) from their plan when they reached age 70½. The age 70½ requirement was first established in the early 1960s and, until the SECURE Act, had not been adjusted to account for increases in life expectancy.
Under the SECURE Act, the age at which individuals must begin taking distributions from their retirement plan or IRA is increased from 70½ to 72. Notably, RMDs for individuals who turned 70½ in 2019 are not delayed, and instead, such individuals must continue to take their RMDs under the same rules prior to passage of the SECURE Act.
Increasing the age at which distributions are required allows additional time for the IRA to grow untouched. With many taxpayers remaining in the workforce longer, this provision might prove especially beneficial.
Partial Elimination of Stretch IRAs
If plan participants or IRA owners died before 2020, beneficiaries (both spousal and nonspousal) were generally allowed to draw from the account and pay taxes on their withdrawals over the beneficiary’s life or life expectancy (in the IRA context, this is sometimes referred to as a “stretch IRA”).
For example, if a 25-year old inherited a $1 million IRA from his grandmother, he would take distributions over his life expectancy of 57.2 years (as provided by the IRS table). His required minimum distributions would be about $17,482 ($1,000,000/57.2), which he would need to withdraw yearly over a 57.2-year period. Each year, this would result in a federal tax bill anywhere between $548 (if he were in the lowest tax bracket) to $6,468 (if he were in the highest tax bracket).
The stretch IRA is a beneficial tax strategy, especially for younger beneficiaries, because they have smaller required minimum distributions stretched out through their life expectancy and thus, incur smaller tax bills. Additionally, the stretch allows for tax-deferred growth over longer accumulation periods, which means a larger amount of money may reach the pockets of the beneficiaries.
However, under the SECURE Act, if a plan participant or IRA owner dies in 2020 or after, distributions to most nonspouse beneficiaries are generally required to be distributed within 10 years after the plan participant’s or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed.
To illustrate, using the previously mentioned example of the 25-year old beneficiary of a $1 million IRA, if he were to take equal distributions of $100,000 over the 10-year period, in the first year alone, his income would be bumped up by $82,517 ($100,000 versus $17,482 in the life-expectancy stretch), which could easily land him in a higher tax bracket. He would then have a yearly tax bill between $24,000 (if the distributions were his only income) to $37,000 (if he were in the highest tax bracket). That is an incredible difference in tax bills, not to mention the loss of tax-free compounding that was allowed for longer periods of time under the life-expectancy stretch.
There are exceptions to the 10-year rule for distributions to beneficiaries who are:
the surviving spouse of the plan participant or IRA owner;
a child of the plan participant or IRA owner who has not reached the age of majority;
a chronically ill individual; or
any other individual who is not more than 10 years younger than the plan participant or IRA owner.
Beneficiaries who qualify under these exceptions may generally still take their distributions over their life expectancy (as allowed under the rules in effect for deaths occurring before 2020).
Overall, this change will cause much larger distributions during peak earning years, which will have a significant impact on the tax obligation of nonspouse beneficiaries.
Many retirement and estate plans were created to benefit from the pre-SECURE Act “stretch” tax deferral, so the SECURE Act’s elimination of the “stretch IRA” might change plans to pass on accumulated accounts, or influence how to handle accounts that are passed down.
Conclusion: Many Other Provisions
Aside from the key provisions of the SECURE Act mentioned above, there are many other provisions in the SECURE Act as well – such as an expansion of Section 529 education savings plans, kiddie tax changes for gold star children and others, and sweeping changes for employers with employer-sponsored retirement plans.
However, the individual retirement plan changes under the SECURE Act could have the biggest direct impact upon taxpayers, and the time to act is now.
Taxpayers should review their tax situation along with their wealth-planning documents to understand the implications of the SECURE Act. Many estate plans, trusts, and beneficiary designations will require rethinking and revision. With careful attention and planning, every taxpayer can begin to feel secure about their wealth planning goals under the SECURE Act.
Interested in learning more? Attend the upcoming online CLE webcast, SECURE Act: What Every Trusts & Estates Lawyer Needs to Know, from State Bar of Wisconsin PINNACLE®. The 1.0 CLE session reviews what has changed, who it affects, and what actions your clients may want to take in light of the changes. For more information, visit WisBar.org’s Marketplace.