Each new calendar year brings about changes in our savings and retirement planning efforts, and 2020 is no exception. With the December 2019 signing of the Setting Every Community Up for Retirement Enhancement (SECURE) Act, Congress set out “to make significant progress in fixing our nation’s retirement crisis and helping workers of all ages save for their futures.”
While the bill addressed many items, a few are particularly noteworthy in their impact upon our clients, including continued traditional IRA contributions, delayed start for required minimum distributions and increased flexibility for 529 plans.
Adjusting the required beginning date for Required Minimum Distributions (RMD)
Previously, required minimum distributions from qualified retirement accounts (including IRAs, 401(k)s, etc.) began at age 70 ½. The SECURE Act now pushes this start date back to age 72, allowing an additional 18 months of tax-deferred growth. It is important to note that this only applies to those who were not yet 70 ½ before December 31, 2019.
No age limit on IRA contributions
Along with the changes to RMDs, Congress removed the age cap on contributions that can be made to IRA accounts. Those over the age of 70 ½ with earned income can now continue to make IRA contributions up to 100 percent of earnings or the annual limit ($6,000 plus an over-age-50 catch-up of $1,000), whichever is less.
It is important to remember that, even before these changes, self-employed business owners or those working for a company with an employer-provided retirement plan (401(k), 403(b), SEP and SIMPLE IRAs) could continue to contribute to those plans even after age 70 ½. For less than 5 percent owners of those businesses, RMDs can also be deferred in a 401(k) or 403(b) while still actively employed, even on a part-time basis. (SEP and SIMPLE IRAs do not have an exception and RMD must be taken even when actively contributing.)
Additional 529 plan flexibility
Section 529 plans were originally created as tax-advantaged savings vehicles for qualified post-secondary education expenses. Benefits were expanded in the 2017 Tax Cuts and Jobs Act (starting January 1st, 2018) to include up to $10,000 per year toward K-12 tuition. Starting in 2020, up to $10,000 can be withdrawn penalty-free to pay down student debt over the student’s lifetime. Additionally, 529 plan assets can now be used to pay for registered apprenticeship programs, including books, fees, equipment and supplies.
While we welcome these changes and their potential positive impact on long-term retirement planning, the SECURE Act has also removed what has, in the past, been an important planning tool.
Elimination of the Stretch IRA
For many people, the 401(k) has been the savings vehicle of choice throughout their working years, and the accounts are often consolidated through rollovers into an IRA. This tax-deferred savings is often a major part of their retirement income plan and can also be a significant asset to pass down to heirs. Under the previous rules, a non-spouse beneficiary who inherited an IRA could “stretch” the required distributions over their own lifetime, rather than the life of the deceased or be required to take a lump sum. This option provided the beneficiary with the flexibility to use the money as long-term supplemental income or to delay taxable distributions as long as possible. The SECURE Act has now restricted this strategy to only those who meet one of the following definitions of “eligible beneficiary”:
- Surviving spouse of the deceased
- Minor child of the deceased
- A beneficiary who is no more than 10 years younger than the deceased
- A chronically ill individual
Beneficiaries falling outside these limited exceptions must distribute the account within 10 years, which may have major tax implications for sizeable inherited pre-tax balances. Large annual distributions may not only incur significant federal and state tax liabilities, but may cause an individual or family to be “phased out” of certain tax deductions like education credits, student loan interest deductions, or the ability to contribute to Roth IRAs.
For those who have been diligently saving and have built large pre-tax retirement balances, there are opportunities for your estate and long-term tax planning.
Review your beneficiary designations
If you previously named one or two non “eligible” persons to your pre-tax retirement account, consider including additional beneficiaries who may have been considered for other inherited items. By spreading the balance among more people, the tax burden on each may be lower.
Qualified charitable distribution
For those who are charitably inclined, consider making a Qualified Charitable Distribution (QCD). By donating to a qualified charity directly from an IRA, the distribution is not recognized as income and does not need to be deducted on an income tax return. QCDs are not limited to the RMD calculation for a given year, but are available up to a $100,000 annual maximum.
Roth Conversion and 401(k) Roth assets
Consider converting a portion of your pre-tax retirement account to after-tax dollars via a Roth conversion. This strategy allows taxes to be paid now on assets that are converted, then allow for future tax deferred growth and tax-free distributions, if held for the prescribed period of time (5 years and beyond age 59 ½.) This strategy may not be for everyone and will depend on a person’s current tax bracket, timeline and goals. However, it may provide a meaningful way to pass down tax-advantaged assets.
Similarly, for those who are still working, consider adding after-tax dollars (Roth) to your annual 401(k) contributions. Making even a portion of your annual contribution on an after-tax basis may make an impact on the tax burden you pass to your heirs.
Change often brings opportunity. If you would like to start a conversation about your retirement planning needs, please reach out to us to get started.