The SECURE Act, primarily effective for years after 2019, is poised to affect how many people plan for retirement and future beneficiaries of retirement plans and IRAs.
These changes may provide families more opportunity to save on their tax bills for retirement, but they also may present challenges which advisors must prepare to navigate. Here is a look at the top impacts to clients:
Tax deductible contributions to IRAs at any age
The days of traditional IRA contributions being limited to would-be retirees before the age of 70½ are no more. Starting in 2020, the new rules allow an individual of any age to make tax deductible contributions to an IRA if they have earned income from wages or self-employment.
Required minimum distribution age raised from 70½ to 72
Before 2020, in general, retirement plan participants and IRA owners alike had to start taking required minimum distributions (RMDs) from their plan or IRA beginning in the year when they reach age 70½. With the SECURE Act, the new required beginning age is age 72. If account holders work past the age of 72 (and don’t own more that 5% (directly or indirectly) of their employer), they may be able to defer their RMDs. This change to retirement planning allows workers to defer retirement for longer if they choose to do so and will give them at least an additional year and a half to save before they start taking distributions from their retirement accounts.
Partial elimination of stretch IRAs
Prior to the SECURE Act, when an IRA owner passed away, their designated beneficiaries could stretch the tax deferral advantages of the plan over their life expectancy. This allowed designated beneficiaries of IRA owners to stretch out the RMDs for a period well beyond the date of the account owner’s death. The technique was sometimes called a “stretch IRA”. Under the SECURE Act, the stretch IRA is no longer to all designated beneficiaries. Now, distributions to most designated beneficiaries are required within ten years of the IRA owner’s death regardless of their life expectancy.
However, there are some exceptions to the new ten-year requirement. Surviving spouses, minor children of the participant/IRA owner, chronically ill individuals, those with disabilities, and individuals who are not more than ten years younger than the plan participant or IRA owner are exempt from this new rule and can maintain the stretch IRA. Even this limited stretch out availability can be reduced, for example, upon the child of the IRA owner attaining the age of majority. In this situation, the 10-year clock would begin to run.
For those affected by this impactful change, there may be some strategies and design techniques to implement that may accomplish what a stretch IRA formerly accomplished or replace the benefits that have been lost.
New ways to use 529 plans
Some good news that comes with the SECURE Act is what it does for our 529 plans. You can now use distributions made after December 31st, 2018 to pay for things you could not before. These include fees, books, supplies, and equipment required for the designated beneficiary's participation in an apprenticeship program.
Additionally, up to $10,000 per beneficiary (a lifetime limit) can be used to pay the balance of qualified education loans. Now your clients have another way to pay student loans and another way to think about the way they save and invest for college. Clients and advisors should be aware that some states may not follow the federal law changes relating to 529 plans and results may vary by state.
Changes to the Kiddie Tax
At the election of the taxpayer, starting as early as 2018, unearned income of children can be taxed under the Kiddie Tax provisions as they existed before the Tax Cuts and Jobs Act (TCJA) of 2017. Under the SECURE Act, the net unearned income of a child will be taxed at the tax rate of the child’s parents if it is higher than that of the child. After the adoption of the TCJA, the Kiddie Tax taxed the unearned income of minors at the same level as trusts and estates. This was colloquially called “the Kiddie Tax”. For clients that have children with unearned income, changes to the Kiddie Tax is something to pay close attention to when filing taxes for the 2019 taxable year.
Penalty-free retirement plan withdrawals for expenses related to the birth or adoption of a child
For expenses related to child adoption or birth, individuals are entitled to penalty-free distributions from their retirement plans. These kinds of distributions are still includible as taxable income. In addition, prior to the SECURE Act they were also subject to a 10% early withdrawal penalty. Now these penalties are reduced. That is, up to $5,000 per individual in distributions can go to adoption related expenses without any penalty. That means for married couples, each parent is entitled to a $5,000 distribution from their own plan, for a total of $10,000 in unpenalized retirement plan distributions. Again, the regular income tax will still apply to such distributions.
Changing status of compensation for graduate student and post-doctoral compensation
Prior to the SECURE Act, if your clients received stipends or other payments from graduate or postdoctoral work, they were not treated as compensation for IRA contribution purposes. That means if that was their only form of income for the year, they were unable to contribute to their IRA accounts. Starting in 2020, students who receive this kind of compensation can contribute it to their IRAs and save for retirement earlier than they were able to before.
As you can see, the SECURE Act will make an impact on the way consumers plan for retirement, college, and their estates. These changes in the rules close some doors for planners while they open others to provide new savings and investment opportunities. Advisors should pay close attention to the way these new rules impact their clients. Educate them accordingly so that they can optimize their portfolios and adjust to the changing landscape of financial planning.
About the author
Robert Appel is a Vice President of National Design/Advanced Planning at Lincoln Financial Network. In his role, he is responsible for supporting advisors with their clients, financial planning needs including case design, analytic support and legal and legislative interpretation. He also provides coaching and conceptual sales training. His previous experience includes serving as a Senior Tax Consultant and Assistant Manager of Financial Services for financial services firms. He was in private practice of law and continues to be a consultant to other attorneys and law firms. A member of the American Bar Association, he studied Accounting and Finance at Central Connecticut State University, received a JD degree from what is now the Quinnipiac University School of Law, an MBA (Finance) degree from the University of Connecticut, and LL.M. (Taxation) degree from Boston University School of Law.