In 2019, the U.S. House of Representatives proposed a bill called the Setting Every Community Up for Retirement Enhancement Act – the SECURE Act – to overhaul the retirement system. The bipartisan bill easily passed in the House and the Senate passed the bill Dec. 19 as part of a spending package. President Donald Trump signed the act into law the next day.
This sweeping set of changes to retirement accounts and retirement planning is the most significant in more than a decade. The reform offered both positive and negative changes to the existing system.
One of the positive elements includes the ability of working plan participants to continue contributing to traditional IRAs past age 70½. Similarly, under the new rules, the minimum age to take required minimum distributions has increased from 70½ to 72.
Even part-time workers have access to company-sponsored 401(k) plans, so long as they have worked at least 500 hours in the last three consecutive years.
The SECURE Act also allows a couple of important exceptions to penalties for early withdrawals. Going forward, within one year after the birth or adoption of a child, a parent who is a plan participant may withdraw up to $5,000 to help cover qualifying expenses. There is a similar exception for a withdrawal of up to $10,000 from a 529 plan to apply toward student loans.
While most of the changes appear to be positive, there are some negative affects which appear primarily to be at the cost of the beneficiaries.
Until Jan. 1, 2020, the law allowed for those inheriting IRAs or 401(k) accounts to “stretch” the account across their own life expectancy. This allowed smaller distributions for longer periods of time. That also helped to minimize tax consequences to beneficiaries.
Under the SECURE Act, however, designated beneficiaries now are required to take distributions over approximately a 10-year period. The changes are expected to generate more than $15 billion in tax revenue over the next 10 years.
There are five exceptions to the 10-year rule.
First, spouses inheriting accounts still may stretch the distributions for their expected lifespan. Spouses will not be limited to the 10-year withdrawal. Similarly, beneficiaries who are no more than 10 years younger than the plan participant may continue to stretch out distributions.
Beneficiaries who are minor children must follow both the actual 10-year distribution rule and a special exception. If a beneficiary is a minor child, the 10-year rule does not apply until they reach majority, which depends both on state law and whether the child is enrolled in school.
Because of the range of ages, those who inherit retirement accounts as a minor may be able to stretch the distributions out until as late as 36 years old.
The last two exceptions are for those who are disabled or chronically ill. Individuals claiming to be within these exceptions must have disabilities or illnesses that meet the government’s definitions. Those who meet the criteria to establish disability or chronic illness will qualify for a stretch across their expected lifespan.
With the passing of the SECURE Act, asset and tax protection for beneficiaries must be intentional when using retirement proceeds. Planning strategies going forward carefully must consider the status of the beneficiary – their health, their age and tax bracket.
New planning strategies may need to be used. For example, for those considering charitable gifts upon death, using Charitable Remainder Trusts for retirement accounts can provide an excellent way to extend distributions and give to charity. On the other hand, transferring traditional IRAs into Roth IRAs may provide the best option to minimize taxes for beneficiaries.
Take advantage of the new laws, but be aware of potentially major pitfalls to beneficiaries. With careful planning, even the seemingly grim changes can result in favorable outcomes for you and for your beneficiaries.