When we originally wrote about the Setting Every Community up for Retirement Enhancement Act (SECURE Act) back in May, we knew it had a decent probability of finding its’ way to the President’s desk for signature, but we were not sure exactly when, or in what form. As the year went along, the odds of it being passed before the end of 2019 became slimmer. However, like many instances in Washington, we were surprised when Congress included it in the most recent appropriations bill two weeks before the end of the year. As a result, we now have our second major piece of Congressional change to our tax and retirement system in less than two years. This bill will have substantial impact on many clients’ retirement and estate plans, so we thought it was worthy enough to interrupt the holidays with an update to our May post and specifically, a focus on the update to new IRA rules.
The changes to hit most upcoming and current retirees the hardest will be those to Individual Retirement Account (IRA) holders.
The Stretch IRA (for many) is done. Under the current law, (non-spouse) designated beneficiaries who have inherited IRA accounts already (or by the end of 2019), have been able to stretch distributions over their lifetime. Under the SECURE Act, most designated beneficiaries will now fall under a ’10-Year Rule’.
With the 10-Year Rule, the entire balance of an inherited IRA account will need to be depleted by the end of year 10 following the year of inheritance. There will be no “required” distributions in years 1-9 (which is similar to the existing 5-year rule), but by the end of year 10, the inherited IRA account balance must be $0.
There are certain beneficiaries that the 10-Year Rule will not apply to:
- Chronically Ill
- Individuals who are not more than 10 years younger
- Minor children (of the original IRA owner) until they reach age 18*
It is important to highlight that the “Special Rule for Minor Children” will only apply to the IRA owner (or employee for Employer Retirement Accounts such as a 401k). As a result, nieces, nephews, and grandchildren would not apply to such treatment. In addition, for those that do qualify, once the child reaches age 18 the 10-Year Rule would begin.
One of the largest challenges to this rule change will be for those who have named Trusts as beneficiaries, and we strongly suggest you contact your estate planning attorney for a prompt review of your specific beneficiary designations. Why you may ask? For many, IRA trusts have been drafted in a manner that only allows for the required minimum distribution to be withdrawn annually. Under the 10-Year Rule, remember, that the only “Required Distribution” comes at the end of year 10 following inheritance. The risk with this language is a higher than expected tax bill for the beneficiary(ies).
Required Minimum Distribution Age becomes 72. The next headline to impact our readers is the change in the Required Minimum Distribution (RMD) age. While it is not a large change, those who see RMD’s as an unnecessary tax bill will get some reprieve, as the age is pushed back from the year you turn 70.5 to 72.
Similar to the previous law, the RMD will be required to be withdrawn by April 1st of the year following your 72nd birthday. If you turned 70.5 in 2019, you will be required to satisfy your RMD by April 1st of 2020 and also be required to take an RMD in 2020. Therefore, the age setback will impact you only if you turn 70.5 in 2020 or later.
Traditional IRA Contributions allowed beyond age 70.5. The SECURE Act lifts the previous restriction on IRA contributions in the year you turn 70.5 and beyond. This is notable, as Traditional IRA’s were previously the only retirement account that disallowed contributions post age 70.5.
Qualified Charitable Distributions remain eligible at 70.5. While this isn’t a change, it is something relevant for those that are charitably inclined. You can still utilize QCD’s when you have actually obtained the age of 70.5, even though you may not have a Required Minimum Distribution. It is important to remember that you must have actually reached age 70.5, it is not the year you turn 70.5 as the previous RMD law read.
However, it is important to note that there is an anti-abuse rule associated with those that contribute to IRAs post 70.5 and those that are granting QCD’s. What does this mean? Any QCD amount will be reduced by the cumulative total post 70.5 IRA contribution amount, which effectively ensures that individuals aren’t taking advantage of IRA contributions and subsequent QCDs.
Example: John turned 70.5 in 2020 and is currently earning $20,000 in part-time income. As a result, he decided to make a pre-tax contribution to his IRA in the amount of $7,000. He continues to do this for the next three years, totaling $21,000 in IRA contributions over that period until he retires. In 2026, John decides to make a $30,000 QCD to his favorite charity. (His first QCD) Even though he followed all QCD rules, only $9,000 will be qualified as a QCD. ($30,000-$21,000 in total IRA contributions) The remaining $21,000, however, can be claimed as an itemized charitable deduction.
Qualified Birth or Adoption Distribution. There is a new exception to the 10% early distribution penalty under the SECURE Act. Up to $5,000 can now be distributed penalty-free from an IRA (or Qualified plan) for a “Qualified Birth or Adoption Distribution”. The requirement to be eligible for this distribution is a one-year period beginning on either the date of birth, or on the date of which the adoption was finalized. (individual must be under the age of 18).
Beyond the changes to IRA rules, there are a number of changes to small-employers and their access to retirement plans. If you are a small business owner, these changes will be more likely to impact you than others. In addition, the insurance companies received a “win” as lifetime income options through annuities will now be more accessible in employer plans, as the fiduciary responsibilities of plan administrators will change under the Act. Lastly, there are a few tax extenders included in the bill such as the mortgage insurance premium deduction and the deduction for qualified tuition and related expenses.
As you may have noticed by the length of this update, which is limited to details on what we view as the most relevant changes to our readers, this legislation brings sweeping reform to retirement and tax rules.