Understanding the SECURE Act
With Congress passing one of the most sweeping pieces of retirement legislation in recent history, it’s more important now than ever to review your retirement plan, tax plan, and retirement account beneficiaries. The SECURE Act has many planning implications, and we’re prepared to help you navigate them.
What is the SECURE Act?
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 passed in December 2019 as part of the government budget package. The new law changes many of the rules regarding retirement plans, including the types of investments they can use, mandatory withdrawal ages, treatment of beneficiaries, and some 529 account rules. The law also makes several administrative tweaks for employers and plan sponsors.
When does it take effect?
Most provisions of the SECURE Act take effect in 2020. Notable exceptions include the expansion of 529 account usage for apprenticeship programs and student loan repayments which take effect in 2019.
What do I need to know?
Retirement Accounts – While you’re alive
One of the most significant adjustments the SECURE Act makes is shifting the age for required minimum distributions (RMDs) from 70 ½ to 72. This is the first change in over thirty years and can allow for up to two more years of tax-deferred growth before you must start taking withdrawals.
The SECURE Act applies to those born after June 30, 1949, – i.e. those who had not yet turned 70 ½ in 2019. Your first required minimum distribution (RMD) will not be until the year you turn 72. This creates up to two more years without mandatory withdrawals—allowing for more tax planning opportunities after age 70.
Retirement Accounts – After you pass away
Second only to the increased minimum distribution age, the new law has dramatic implications for those who pass away with IRA assets. These implications are largely dependent on who you list as beneficiaries.
Under the prior law, most non-spouse beneficiaries (often children) who inherited retirement accounts had the opportunity to take withdrawals over their actuarial life expectancy. With a few exceptions, under the new law, this will change significantly.
- Surviving Spouse
Those who inherit a retirement account from their deceased spouse continue to have two primary options: roll that account into their IRA, or keep it separate and take distributions based on the deceased spouse’s life expectancy. Later in the in Planning Considerations section, we’ll discuss why some taxpayers may want to reconsider leaving all of it to their spouse.
- Minor Children
Minor children (under age 18 in Michigan) have special rules under the inherited account. They can take distributions based on their life expectancy until age 18 when they start a 10-year clock to fully empty the account. Note that this does not apply to grandchildren—only minor children of the account owner.
- Disabled and Chronically Ill Individuals
Special provisions apply in this case that allow for more favorable treatment of the distributions—comparable to the prior rules that allow a longer duration of withdrawals. Similar provisions also apply for beneficiaries who are not more than 10 years younger than the deceased account owner.
- Everyone Else—Including Trusts, Estates, and Adult Children
If retirement accounts are left to anyone else under the new law, including a trust, they now have 10 years to empty the account in its entirety. There’s no set amount to take annually, and there’s technically only one required withdrawal: the account balance at the end of year 10.
For example, if you were to pass away and leave your entire retirement account to your 40-year-old child, they would have 43.6 years to take withdrawals from that account, based on a life expectancy of 83.6 years determined by the actuarial tables the IRS uses. Under the new rule, your child would have less than 25% of that time—just 10 years—to empty it! You can imagine the tax impact this could have. See the Case Study for an example.
How does this impact estate planning?
At a very minimum, you should review your estate plan and beneficiaries because of this new law, as indicated in our checklist. If you have assets in your 401(k), IRA, Roth IRA, or other retirement account that lists a trust as beneficiary, you’ll likely need to update your documents as soon as possible. Consult a qualified estate planning attorney.
Many trusts that are linked to IRA accounts have special language that require them to function as conduits, flowing required minimum distributions (RMDs) from the IRA through the trust and to the ultimate beneficiary. Under the prior law, the distribution was based on the life expectancy of the oldest trust beneficiary. Now, with a 10-year rule for these accounts, there is no set distribution to flow through the trust until the end of year 10 and that’s likely not the most advantageous strategy from a tax perspective.
You’ll also want to consider how to better structure your beneficiaries for multi-generational tax savings. We’ll discuss this more in the Planning Considerations section below.
What else does the SECURE Act change?
In addition to the required distribution adjustments, the new law has a few other changes that can impact your planning:
- The new law allows traditional IRA contributions after age 70 if you have earned income.
- 529 accounts are now eligible for apprenticeship programs and qualified education loan repayments. Student loan payments from the 529 account have a $10,000 lifetime limit.
- Retirement account withdrawals up to $5,000 related to a qualified birth or adoption can be distributed without an early withdrawal penalty.
- Employer-sponsored retirement accounts can now offer annuity products that are portable and can be transferred to another provider.
- Small business owners can receive greater tax credits for starting an employer-sponsored retirement plan.
See more at SECURE Act Checklist and Case Study
If your financial plan revolved around taking withdrawals at age 70 ½ and you haven’t attained that age yet, you now have a couple “bonus years” without mandatory withdrawals. Those bonus years should not go to waste and will require some additional planning.
Perhaps you can use them to make Roth IRA conversions or to proactively harvest capital gains to fill up a specific tax bracket. Either way, you need to make sure these bonus years are not lost.
If you’re in a position where your surviving spouse might not need all your retirement account assets, you may want to consider updating your primary beneficiaries.
For example, if you leave a portion of your IRA to your spouse and another portion to your adult children, your adult children will start the 10-year clock upon your passing. If, for instance, your surviving spouse lives another five years and leaves their IRA to your adult children, the kids will get another 10 years when receiving that IRA account. From a practical perspective, this spreads the distributions over 15 years, compared with leaving the funds entirely to your spouse and only having 10 years once the surviving spouse dies.
Be careful, since you don’t want to leave your surviving spouse without enough money. Another option is for your spouse to disclaim all or part of the retirement account funds if they don’t need them, passing them on to the contingent beneficiaries.
Multi-generational Tax Planning
One important consideration for pre-tax retirement accounts is the multi-generational tax implication. For example, if your heirs are in their peak earning years when you pass away, they could potentially be in a much higher tax bracket than yourself as a retiree. Adding additional income from the retirement account distributions can result in a very high tax rate on their inheritance.
In this case, we may want to consider partial Roth IRA conversions while you’re alive to pay the tax at your rate and leave the funds tax free for your heirs.
A Different Lump and Clump
We’ve spent plenty of time in recent years discussing a lump and clump (or bunching) of charitable gifts, but this new law creates a new type of lump and clump for those who inherit retirement accounts. For example, if you’re 60, and you inherit a $300,000 IRA and plan to retire at 64, it may make sense to take no withdrawals for the first four years, then spread the $300,000 over the next six years until the 10-year window is up.
Likewise, if you see some fluctuations in your income, perhaps as a small business owner or with capital gains and dividends, you may want to lump distributions into lower income years to pay less in tax over the 10-year period.
If you do significant charitable giving, it likely makes sense to consider qualified charitable distributions (QCDs) from your IRA account. Decreasing the amount of funds there for your heirs to take over 10 years, while preserving other after-tax savings, likely helps both you and your beneficiaries save in taxes.
Spread the Wealth
Finally, the 10-year rule may cause you to reconsider beneficiaries even further. Instead of simply listing children, for example, you may want to list grandchildren and spread the tax and withdrawal burden among a broader set of beneficiaries. Be careful of the kiddie tax, however, that can impact children with unearned income!
See more at SECURE Act Checklist and Case Study