The SECURE Act, explained

During our decades of working in the industry, we’ve encountered many changes, especially when it comes to retirement planning. Being able to share key points and determine areas of opportunity during change is an important aspect when working with clients, especially when it comes to retirement planning. The most recent changes that could affect the way we plan for retirement were introduced at the end of 2019 through the SECURE Act.

This act sets a record of being the largest overhaul of the retirement system in more than a decade, with, we believe, a slew of small changes that could be extremely impactful if not planned for accordingly. With that comes uncertainty and confusion, so we’ve created a list of topics and discussion points around the biggest planning opportunities for advisors and their clients.

IRA contribution age limits

Fortunately, people are living longer, although working longer as well. In response, the new SECURE Act removes the age restriction on traditional IRA contributions. (Roth IRA contributions do not have age restrictions.) This also offers consistency relative to its similar retirement accounts that are offered (i.e., 401(k) and Roth IRA contributions).

Potential impact to clients

Participants who are still working but stopped contributing at 70 ½ may now start contributing to their traditional IRA and may continue to do so if they have earned income. Additionally, eligible individuals who are older than 70 ½, and have earned income, may bypass RMDs altogether by contributing to a Roth IRA. (See RMD explanation below.)

Required Minimum Distributions (RMD)

Provisions in the new SECURE Act have increased the age at which Required Minimum Distributions must occur in qualified accounts from 70½ to 72. The new provision effects those who turn 70½ in 2020; those who turned 70½ before 2020 will still be subject to the old RMD rules. Put another way, anyone born before July 1, 1949, must take their RMD by April 1, 2020, while individuals born on or after the cutoff date must take their first distribution by April 1 following their 72nd birthday.

Potential impact to clients

Increasing the age Required Minimum Distributions start is generally considered a good thing, as it grants more flexibility around distributions. For clients who may not need distributions to support their lifestyle, additional time before RMDs kick in may allow for continued tax deferred asset growth and serve as an opportunity to revisit cash flow and tax planning. Reviewing a client’s anticipated tax situation may reveal that taking early distributions may produce better tax outcomes by spreading out the anticipated tax burden. A final note of consideration: the act did not adjust the mortality tables or age factors used to calculate RMD amounts.

Charitable giving

The SECURE Act includes provisions which keep the age requirement at 70½ for Qualified Charitable Deductions (QCD). A QCD gives IRA owners the ability to make donations of up to $100,000 per year directly out of their IRA to a qualified charity without realizing income from the distribution.

Potential impact to clients

Qualified Charitable Distributions can be a great way for charitably inclined individuals to fulfill philanthropic intentions. A QCD can be strategically used to reduce the tax impact of mandatory distributions, as it has been deemed to satisfy the Required Minimum Distribution requirements. So, if a client is in a situation where a RMD would be detrimental to their overall tax situation, they could consider doing QCD and avoid all or a portion of the tax ramifications from the distribution. QCDs can also be a more impactful solution if clients are taking the standard deduction, as charitable deductions would not carry the same benefit for individuals using the standard deduction.

Under the new SECURE Act, if a client is contemplating utilizing a QCD, there are a few considerations to keep in mind. The age requirement is 70½, which means a client must be at least 70 ½ at the time of distribution, not turning 70½ during the calendar year. QCDs made before RMDs will not be counted toward future required distributions as they are completely voluntary. Changes to contribution rules by the SECURE Act have indirectly affected QCDs. Any contribution after 70½ will reduce the allowable QCD. If a 71-year-old client contributes $5,000 to a traditional IRA and then later makes a $15,000 QCD, $5,000 of the contribution would be counted as taxable income and thus would be subject to ordinary income taxes.

Lifetime stretch provision (all inherited non-spousal IRAs, including trusts & 401(k)s)

Prior to the SECURE Act, one of the biggest tax-efficient wealth transfer vehicles was inheritance of retirement assets and basing withdrawals off of the life expectancy rule. In some cases, this allowed beneficiaries to stretch distributions over decades, while simultaneously spreading out the amount of tax paid. Under the SECURE Act, most beneficiaries must completely deplete inherited retirement accounts within 10 years of inheritance. After the 10th year, any remaining money must be withdrawn, regardless of steep tax consequences. This only impacts inherited IRAs beginning on Jan. 1, 2020, meaning if you inherited an IRA in 2019 or earlier, withdrawals would be based on your life expectancy. Although, there are exceptions for certain individuals to continue using the life expectancy rule. Eligible beneficiaries are:

• Surviving spouse – Life expectancy rule
• Disabled or chronically ill individuals – Life expectancy rule
• The deceased's child who is under the age of majority (Once age of majority is reached, then the 10-year rule takes effect.)
• Individuals who are not more than 10 years younger than the deceased

Further, if you inherit certain IRA Trusts, which place specific guidelines on withdrawal amounts and frequency, regardless of the beneficiary, the trust guidelines could now be void and replaced by the 10-year rule. This would place high importance for proper planning to create a trust that would negate the 10-year rule for certain eligible beneficiaries.

Potential impact to clients

This provision may lead to larger taxable income and higher tax bills over a short time frame. For instance, if an individual inherited $1 million dollars and made equally dispersed withdrawals to abide by the 10-year rule, this would add an additional +$100,000 to the beneficiary's income for the year. Not to mention, in most cases the beneficiary would be at their peak earning age (40 to 50 years old), placing them in one of the highest tax brackets of their life. If not accounted for properly, this could greatly impact the planning you have previously done, specifically pertaining to estate planning. 

529 plans

Under new provisions of the SECURE Act, 529 plans now have an additional benefit. The act allows for tax-free distribution from 529 assets if used toward repaying student loans or cost of qualified apprenticeship programs.¹ The benefit is limited to a lifetime amount of $10,000 per beneficiary or sibling of the beneficiary.In terms of 529 plan structure, each plan allows for one beneficiary. If a family sets up one 529 plan and has two children, even though there is only one named beneficiary, each child may withdraw up to $10,000 tax-free to be used for student loan repayment.

Potential impact to clients

529 plans have been a great option for college savings, and the new provision only make them a more versatile tool. Since plans can be opened at any time, individuals may be able to make contributions into a plan to take advantage of tax-free growth.

Adoption or qualified birth

The SECURE Act now allows a new parent to withdraw up to $5,000 out of qualified accounts without penalty, to pay for adoption² or qualified birth expenses. The $5,000 limit is per child, per parent and must be taken within a year of the birth or adoption of a new child. While the 10% early withdrawal penalty will not be assessed, pre-tax distributions are considered taxable and will be subject to parent’s ordinary income tax rate.

Potential impact to clients

While this may not be the most tax-efficient way to pay for new child related expenses, it is another option for families who may need some additional resources. If a parent is planning on taking advantage of this penalty-free distribution, they must do so after the birth or adoption of a new child, so funds cannot be preemptively taken out.

The bottom line

We believe the SECURE Act does not radically alter the current retirement planning landscape. While your unique tax situation will dictate if the SECURE Act makes any significant changes to your retirement planning goals, we feel now is a good time for advisors to revisit their client retirement and estate plans and initiate appropriate conversations where needed.