What’s up with that new SECURE Act?
We’ve had several questions from clients about the SECURE Act (Setting Every Community Up for Retirement Enhancement Act), which was signed into law in late December 2019 as part of a larger federal spending package.
This legislation has some positives and some negatives among its new requirements. It gives incentives for employers to provide retirement benefits, but it restricts a popular estate planning strategy for those with significant retirement plans. Here are some of the changes; keep in mind that these may impact your retirement, tax, and estate planning strategies. All of these were effective January 1, 2020, unless noted.
Benefits for retirement savers
If you were born on or after July 1, 1949, you won’t be forced to take RMDs at age 70.5. You now have until age 72. This is a boon for those who don’t need to take withdrawals, because it postpones payment of income taxes and gives the account a longer time to pursue tax-deferred growth or a longer Roth conversion strategy. As under previous law, you may be able to delay taking withdrawals from your current employer’s plan as long as you are still working.
No traditional IRA age limit.
There is no longer a prohibition on contributing to a traditional IRA after age 70.5 — you can make contributions at any age as long as you have “earned income” and are working. This helps those who want to continue to save and reduce their taxable income. But keep in mind that contributions to a traditional IRA only defer taxes not eliminate them. Withdrawals, including any earnings, are taxed as ordinary income, and if you have a larger account balance at 72, it would increase the amount of withdrawals that must start then.
Tax breaks for special situations.
For the 2019 and 2020 tax years, you can deduct unreimbursed medical expenses that exceed 7.5% of your AGI. In addition, withdrawals may be taken from tax-deferred accounts to cover medical expenses that exceed this threshold without owing the 10% penalty that normally applies before age 59½.
*The threshold returns to 10% in 2021. So if you can plan large healthcare expenses paid in 2020, it could be beneficial for you. Penalty-free early withdrawals of up to $5,000 are also allowed to pay for expenses related to the birth or adoption of a child. Regular income taxes apply in both situations.
More part-timers gain access to retirement plans.
For plan years beginning January 1, 2021, part-timers age 21 and older who work at least 500 hours annually for three consecutive years must be allowed to contribute to qualified retirement plans, with some exceptions. (The previous law required 1,000 hours and one year of service.) However, employers will not be required to make matching or nonelective contributions on their behalf.
Elimination of “stretch” IRAs
Under previous law, non-spouse beneficiaries who inherited IRAs could “stretch” the RMDs — and the tax obligations associated with them — over their lifetimes. The new law generally requires a beneficiary who is more than 10 years younger than the original account owner to liquidate the inherited account within 10 years. Exceptions include a spouse, a disabled or chronically ill individual, and a minor child. The 10-year “clock” will begin when a child reaches the age of majority (18 in most states).
This shorter distribution period could result in bigger tax bills for children and grandchildren who inherit accounts. The 10-year liquidation rule also applies to IRA trust beneficiaries, which may conflict with the reasons a trust was originally created.
In addition to revisiting beneficiary designations, you might consider how IRA dollars fit into your overall estate plan. For example, it might make sense to convert traditional IRA funds to a Roth IRA, which can be inherited tax-free (if the five-year holding period has been met). Roth IRA conversions are taxable events, but if converted amounts are spread over the next several tax years, you may benefit from lower income tax rates, which are set to expire in 2026.
Benefits for small businesses
In 2019, only about half of people who worked for small businesses with fewer than 50 employees had access to retirement benefits. The SECURE Act includes provisions intended to make it easier and more affordable for small businesses to provide qualified retirement plans.
Effective January 1, 2021, employers will be permitted to join multiple employer plans (MEPs) regardless of industry, geographic location, or affiliation. “Open MEPs,” as they have become known, enable small employers to band together to provide a retirement plan with access to lower prices and other benefits typically reserved for large organizations. (Previously, groups of small businesses had to be related somehow in order to join a MEP.) The legislation also eliminates the “one bad apple rule,” so the failure of one employer in a MEP to meet plan requirements will no longer cause others to be disqualified.
The tax credit that small businesses can take for starting a new retirement plan has increased. The new rule allows a credit equal to the greater of (1) $500 or (2) $250 times the number of non-highly compensated eligible employees, or $5,000, whichever is less. The previous credit amount allowed was 50% of startup costs up to $1,000 ($500 maximum credit). There is also a new tax credit of up to $500 for employers that launch a SIMPLE IRA or 401(k) plan with automatic enrollment. Both credits are available for three years.