This new legislation, which is part of a broad appropriations bill for fiscal year 2020, makes several changes to tax laws that could have a significant effect on retirement planning. More broadly, SECURE is aimed at providing retirement plan access for small business employees by making it easier for small business employers to offer plans and by providing enhanced, initial and annual, tax credits to certain employers starting new plans.
Participants in a qualified plan (e.g., a 401(k)) and owners of traditional IRAs are generally required to begin taking distributions at age 70½, though they may defer the distribution for the year in which they reach age 70½ until April 1 of the following year. There is an exception for an employee participating in a qualified plan like a 401(k) who is not a 5% owner of the company. In that case, the employee may defer withdrawals until retirement from the company.
The SECURE Act increases the required minimum distribution age from 70½ to 72. This change would be effective for required minimum distributions for individuals who attain age 70½ after December 31, 2019. For those turning age 70½ in 2019 or earlier, this new provision would not apply and they must continue to take their annual required minimum distributions under the pre-SECURE rules.
Upon the death of an IRA owner or qualified plan participant, it is common planning to leave the retirement assets to one’s spouse. If there is no spouse, it is common planning to leave the retirement assets to one’s child(ren) or grandchild(ren). If structured properly, the retirement assets can then be distributed over the child’s or grandchild’s lifetime, often referred to as a “stretch” provision. This ability to stretch the retirement asset distributions allows undistributed amounts inside the retirement accounts to continue to grow on a tax-deferred basis until distributed. Moreover, the younger the beneficiary, the longer the life expectancy. The longer the life expectancy, the smaller the annual required distributions and the greater potential for deferring income taxes and growing the retirement account.
The SECURE Act changes this rule and severely limits the ability to stretch distributions from retirement assets in IRAs and qualified plans like 401(k)s. The new legislation generally requires non-spouse beneficiaries to take complete distribution of the benefits by the end of the tenth calendar year following the account owner’s death. This rule would apply regardless of whether the account owner died before or after his or her required beginning date.
There are exceptions to this new 10-year rule for a designated beneficiary who is (i) the spouse, (ii) a minor child, (iii) a disabled or chronically ill person, or (iv) a person not more than 10 years younger than the account owner. However, in the case of a minor child, the benefits would have to be distributed within 10 years from when the child attains majority. The age of majority is 18 in most, but not all, states. Hopefully there will be regulatory guidance from the IRS to clarify the age of majority.
This change would generally become effective for account owners dying after December 31, 2019.
IRA Planning– Following are some suggestions to address the new 10-year rule that will end stretch distributions. These suggestions apply for IRA owners and are not as suitable for participants in qualified plans such as 401(k)s.
With certain exceptions, there is a 10% penalty on distributions from qualified plans and IRAs before age 59½. The SECURE Act adds an additional exception under which 401(k) participants and IRA owners could withdraw up to $5,000 for expenses for each qualified birth or adoption, without penalty. (Interestingly, adopting the child of one’s spouse does not qualify for this provision.) The withdrawn amounts would still be taxable as income; this new provision only removes the penalty. In addition, amounts withdrawn could later be recontributed and treated as a rollover.
The new provision is effective for distributions made after December 31, 2019. However, in order to qualify for this exception, the distribution must be made during the 1-year period beginning on the date on which the child is born or the adoption is finalized.