Financial security during retirement is paramount in the minds of many. The burden for retirement funding has shifted to the individual, with employer-sponsored 401(k) plans the norm and traditional pension plans less prevalent. On December 20, 2019, significant modifications were made to retirement asset accumulation and wealth transfer opportunities when the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into federal law. Although there are many nuances to the SECURE Act, this summary will focus on key considerations impacting an individual’s ability to accumulate retirement assets, utilize those assets, and transfer assets through his or her estate plan.
1. Stretching the Payout of Inherited IRA/Retirement Plan Assets Limited
Historically, many beneficiaries of IRAs, Roth IRAs, and defined contribution plan assets have had the option to extend, or stretch, the payout of the inherited asset over their lifetime, effectively deferring income tax liabilities and maximizing tax-deferred or tax-free growth. The SECURE Act eliminated the stretch option for most beneficiaries inheriting from decedents who die after December 31, 2019. The general rule has changed and now requires that assets be distributed within ten years of the year following the decedent’s death unless an exception applies. Under the new general rule, Required Minimum Distributions (RMD) are not mandatory, and it is not necessary that amounts be withdrawn on any given schedule, only that all assets must be completely withdrawn before the expiration of the ten-year period. In order to extend beyond this ten-year requirement, the named beneficiary must be considered an “eligible designated beneficiary.” Eligible designated beneficiaries include: (a) a surviving spouse, who is still allowed to rollover an IRA or other asset into their own name and take RMDs based on his or her life expectancy; (b) a disabled or chronically ill individual; (c) a minor child, who can defer full distribution until ten years after he or she reaches the age of majority; and (d) a beneficiary that is less than ten years younger than the decedent, who is allowed to take distributions over his or her life expectancy.
The loss of the previously available stretch options for distributions, including the related acceleration of income tax liabilities, may lead to additional conversions of traditional IRAs into Roth IRAs, particularly for those with federal or state taxable estates.
In addition, due to the accelerated payout requirements, individuals that have named conduit or other trusts as the beneficiaries of IRA assets should review their plans to ensure their goals will be met under the new rules. Depending on trust terms, mandatory distributions to trust beneficiaries could be accelerated and intended asset and creditor protection provisions may be ineffective as compared to results under the old rules. In addition, some who previously did not use a trust as the beneficiary of their IRA assets may wish to consider revising their plan to incorporate a trust beneficiary.
2. Required Minimum Distribution (RMD) Age Extended to 72
The Required Beginning Date (RBD) for RMDs has been extended to age 72 from age 70½ for anyone turning age 70½ after December 31, 2019. If an individual turned age 70½ prior to January 1, 2020, he or she must continue to take RMDs and cannot delay them until age 72. Regardless of whether an individual’s RBD is age 72 or 70½, he or she must take his or her first year’s RMD by April 1 of the year following the year he or she reaches the RBD. This rule applies to both traditional IRA and 401(k) accounts, with an exception for a 401(k) account from current employment if an employee continues his or her employment beyond the normal RBD and does not own more than 5% of the employer. Any lengthening of the RBD allows individuals to prolong tax-deferred growth and potentially continue to contribute to their retirement savings.
3. Post-70½ IRA Contributions Allowed
Individuals can now continue to contribute to IRA accounts after age 70½ as long as the individual or his or her spouse have qualifying employment income. This is a change from the prior law where traditional IRA contributions were not allowed after age 70½.
4. Qualified Charitable Distributions (QCD) Continue if Over Age 70½
Individuals over age 70½ can transfer up to $100,000 per year from their IRA account directly to qualified charities, with the amounts transferred counting towards the RMD and avoiding ordinary income taxation. This age did not change with the SECURE Act, but if an individual makes deductible contributions to an IRA after age 70½, the amount of the QCD avoiding current taxation will be decreased by the amount of any post-70½ deductible contributions.
5. Definitions of Income for IRA Contribution Eligibility Expanded
In an effort to allow more individuals to proactively save for retirement, the SECURE Act also allows IRA contributions based on taxable non-tuition fellowship and stipend payments as well as any non-taxable difficulty-of-care payments received by foster care providers, in addition to traditional employment income.
6. Long-term Part-time Employees Eligibility
New rules have expanded access to 401(k) plans by requiring employers to allow part-time employees who have worked at least 500 hours in each of the previous three calendar years and attained the age of 21 to be allowed to participate in the company’s 401(k) plan. This will assist individuals who might otherwise not be saving for retirement to have access to a savings vehicle, potentially including a company match. This change begins to be effective after December 31, 2020.
7. Automatic Enrollment Deduction Maximum Percentage Increased
Some employers’ defined contribution plans provide for automatic enrollment in the plan with the employee having the option to opt out and/or change his or her desired contribution rate. In order to encourage additional savings, the SECURE Act increases the maximum automatic enrollment percentage from 10% to 15%.
8. Disclosure of Projected Lifetime Income Stream and the Use of Annuities
Under the new rules, custodians for employment-based plans will be required to provide annual projections of the monthly payments that would be available to the participant, utilizing either a single life or joint and survivor spousal annuity, if the participant’s entire account was utilized to purchase an annuity. It is not required that annuities be offered in a plan, but if they are, the SECURE Act helps protect employers if the annuity provider fails to fulfill the annuity contract. Under the new provisions, an employer is protected from liability if, at the time the annuity provider is selected, the employer has received written representations that the insurer has satisfied state law requirements and is properly licensed. Required ongoing review is limited. This effectively puts the risk back on the employee. An educated consumer will be aware of this as well as the embedded costs in annuities, the potentially decreased purchasing power of long-term annuity payouts due to inflation, and the lack of flexibility once an annuity asset is either purchased or annuitized.
9. Birth or Adoption Withdrawals Allowed
Individuals are now allowed to withdraw up to $5,000, without penalty, from their retirement accounts within one year of the birth or finalization of the adoption of a child. This penalty-free withdrawal is not available in the case of an individual adopting his or her spouse’s child. When opting to take advantage of this, an individual should be mindful of both the income tax consequences of the withdrawal and the negative impact the loss of compounding on the assets withdrawn may have. If withdrawals are taken, it is highly recommended that procedures be followed to re-contribute the funds withdrawn.
10. Section 529 provisions
Two provisions of the SECURE Act related to Section 529 plans are also noteworthy. The first allows for the tax-free distribution of up to $10,000 from an individual’s 529 plan to each of the account’s designated beneficiaries, or his or her sibling(s), to pay principal or interest on qualified education loans. Under this provision, the $10,000 limit is per recipient, regardless of the number of 529 plans utilized, and is only available if the recipient has qualified education loans. Note that if 529 plan assets are utilized to pay interest, the interest will not be deductible regardless of income level. Another provision allows for Section 529 plan assets to be utilized to pay qualified expenses related to registered apprenticeships, a category not previously included.
Whether the SECURE Act will help you and your family be more financially secure will depend on your individual circumstances. As with any change in the tax law, this is an opportune time to review your planning and make sure that your current plan reflects your wishes and will meet your financial planning and wealth transfer goals. If you have questions or would like to discuss your situation, please reach out to your Fiduciary Trust Company Investment Officer.
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The opinions expressed in this article are as of the date issued and subject to change at any time. Nothing contained herein is intended to constitute investment, legal, tax or accounting advice, and clients should discuss any proposed arrangement or transaction with their investment, legal or tax advisers.