What the SECURE Act Is and What it Means for Your Retirement Plan
by Scott McCaghren - January 08, 2020
The new legislation, passed on December 20, 2019, is known as the SECURE Act - Setting Every Community Up for Retirement Enhancement Act. This new law contains several features that will impact many retirees over the coming years. Below, we will review some of the significant changes that will be applicable to many pre/post retirees.
Required Minimum Distribution:
The most significant change surrounding the SECURE ACT is in relation to RMDs. The previous requirement was that an individual must begin distribution from Traditional IRAs and 401ks beginning April 15th of the year following age 70 ½. The caveat here is that if one were to wait until the year following, then two RMDs must be completed that year. There can potentially be tax implications for an individual taking two RMDs in a single year, which is why we typically advised that RMDs begin the actual year one turns 70 ½.
The SECURE Act has pushed that age back to 72, for the main reason that individuals are working longer and this will allow for more time to make retirement contributions. Now individuals are required to begin those required minimum distributions by April 15th of the year following age 72. We will continue to advise most to begin those distributions in the actual year one turns 72. This change also allows retirement accounts, for those already retired, more time to potentially grow given various investment instruments.
This change will affect only those turning 70 ½ AFTER January 1st, 2020. Individuals who have already begun the distributions based on the previous laws must continue the RMDs based on the current life expectancy tables. Those that will turn 70 ½ in 2020 can now delay these distributions until age 72. It is very important to understand that if you have already started RMDs, those distributions must continue.
The second most significant impact is in relation to individuals inheriting an IRA from someone other than a spouse. The previous requirement allowed individuals a choice between the 5-year rule or a “stretch” IRA. The 5-year rule calls for the beneficiary to deplete the Inherited IRA, and pay taxes, over a five-year period. It could be done in any manner so long as the account was depleted by the end of the 5th year. The “stretch” IRA allowed individuals to take distributions based on their own life expectancy, which would result in smaller distributions which allowed for more growth potential and fewer tax implications.
The SECURE Act eliminated the “stretch” option while also extending the 5-year rule to a 10-year rule. This means that an Inherited IRA must be depleted by the 10th year following the death of the original IRA owner. This change only affects Inherited IRAs in which the original owner died after January 1st, 2020. For those who inherited an IRA prior to 2020, the previous rules still apply. One significant exception to this change would be those less than 10 years younger than the original IRA owner who was other than a surviving spouse or minor child.
A 10% penalty will typically apply to distributions made from qualified plans for individuals younger than 59 ½. The SECURE Act allows for an exception to this penalty for distributions up to $5,000 for “qualified birth or adoption distributions”. The previous penalty exceptions, such as first-time home buyers, remain intact.
Some families utilize 529 accounts for their college savings plans. These savings plans contain some tax advantages if used for qualified educational expenses. The SECURE Act has extended the allowable expense to student loan debt. These 529 funds can now be used to pay off up to $10,000 of student loan debt over the student’s lifetime.
While these changes seem somewhat convoluted, keep in mind these apply only to events occurring after January 1st, 2020. Changes such as these often require updates to comprehensive retirement plans. Because these changes will affect individuals in vastly different ways, we highly encourage a discussion with your financial and tax professionals to determine how exactly this will affect your situation.