Is The Secure Act Really Helping You?

In late December 2019, Congress passed a major piece of legislation: Setting Every Community Up for Retirement Enhancement (“SECURE”) Act. There seems to be a growing trend to pass legislation just before year-end. The last significant tax overhaul happened in late 2017, forcing millions of Americans to take the higher standard deduction and providing a generous business deduction to select entrepreneurs.

The SECURE Act will impact each family’s financial plan differently, but here are seven significant components of the new law. 

Elimination of the Stretch IRA

We are most upset by this provision. If you inherited a non-spousal IRA prior to 12/31/19, you (the beneficiary) were able to take Required Minimum Distributions (“RMDs”) based upon your life expectancy.

Now, under the new rules, if you inherit and IRA on or after January 1, 2020, the IRA balance must be completely exhausted in 10 years.

For example, suppose Tony is a 46-year old lawyer. Tony’s mother passes away and designates Tony as the sole beneficiary. Under the former rules, Tony withdraws the IRA balance over his life expectancy. If his life expectancy was estimated to be 86, that equaled 40 years of required distributions.

Tony no longer has the luxury of taking smaller distributions under the SECURE Act. Assuming a one million dollar IRA balance, Tony has to distribute $100,000 annually over the next 10 years. He'll pay ordinary income tax on each distribution.

Why is this negative?

In most scenarios, IRAs are inherited by individuals in their 40s, 50s, or 60s. These are often the highest-earning years when your marginal income tax bracket is unusually high. Tax planning is paramount!

This 10-year-rule applies to both inherited Roth accounts and inherited Traditional accounts. Although you will not pay income tax on inherited Roth IRA withdrawals, you are still required to make the withdrawal. These required distributions could be deposited into a permanent life insurance policy.

Nonetheless, not all is lost. The following eligible beneficiaries are exempt from the 10-year rule:

• Spouses;
• Disabled (as defined by IRC Section 72(m)(7)) persons;
• Chronically ill (as defined by IRC Section 7702B(c)(2), with limited exception) persons;
• Individuals who are not more than 10 years younger than the decedent;
• Minor children of the original retirement account owner, but only until they reach the age of majority.

If you are already taking RMDs from an inherited IRA, you will be grandfathered into the former rules, but your beneficiaries must follow SECURE Act rules.

Now, let’s turn to six advantages of the SECURE Act:

1. Required Minimum Distributions (RMDs) Begin at Age 72 instead of 70.5

Required minimum distributions (“RMDs”) are distributions that retirees are mandated to withdraw by a certain age.

Instead of having to take RMDs from your traditional or rollover IRA account at age 70.5, you can now defer distributions until age 72. That's an additional one and a half years of tax-free growth! You may choose to withdraw from an IRA sooner (age 59 1/2 to avoid penalties), but you are not required to withdraw until age 72.

2. Individuals of any Age Can Make Contributions to their IRA

Prior to the SECURE Act, you could not make IRA contributions past age 70 1/2. You can now contribute to an IRA at any age, as long as you have earned income. 

3. Exception to the 10% Early Withdrawal Penalty for Childbirth and Adoption Expenses

Have your sights set on expanding the family? What if you don't have enough in a brokerage, savings, or checking account to pay for out-of-pocket childbirth or adoption costs? Thanks to recent legislation, you can take up to $5,000 penalty-free from an IRA. This $5,000 max applies to each child. 

Please note that this exception only shields you from the 10% early withdrawal penalty; you will still be required to pay ordinary income on the amount distributed from your IRA. Therefore, it's important for to discuss this strategy with a financial advisor first. Additionally, we offer personal financial planning and investment management services.

4. Money from 529 Plans Can Now Be Used for Student Loans

Do you still have a heavy student loan burden? Federal law now allows you to distribute up to $10,000 per beneficiary from a 529 account to pay down student loan debt. This $10,000 is a lifetime limit and is not adjusted for inflation. 

Each 529 plan sponsor decides how to comply with the SECURE Act provision, so it may take a while before your 529 plan sponsor treats student loan debt reduction as a qualified distribution.

All of the aforementioned provisions pertain to a particular life stage. However, items 5 and 6 below apply to a particular profession: small business owners.

5. Get a Tax Credit for Establishing A Retirement Plan

This new incentive credit could create more 401(k) plans in small businesses across the U.S. by lowering the cost of administration. For tax years beginning January 1, 2020, the maximum credit available under IRC Section 45E (available up to 3 years) will be 

increased to the greater of:

$500; or

The lesser of:

$250 × the number of non-highly compensated employees eligible to participate in the plan

or $5,000.

6. Part-Time Workers Are Provided Greater 401(k) Plan Access

Historically, employers generally excluded employees from participating in the 401(k) plan if they did not work at least 1,000 hours in a single plan year -- equivalent to 20 hours per week.

Under the SECURE Act, employers are required to make a part-time employee eligible for the retirement plan if he or she worked 500 hours or more annually for the last three consecutive years. That brings the weekly average down to 10 hours.

There are other provisions under the SECURE Act that affect small businesses as well, such as Multiple Employer Plans and in-plan annuity offerings. However, those provisions are unlikely to take effect until 2021.

I sincerely hope you find this article helpful. Please schedule a free, initial consultation or call (909) 330-1400 if you are interested in working with us and uncovering how the SECURE Act impacts your family’s financial plan.