The Six Things You Need to Know About the SECURE Act
In July of 2019, the House passed a new bill entitled the “Setting Every Community Up for Retirement Enhancement Act” or SECURE Act.1 The Senate approved the bill on December 19, 2019, and it was signed into law on December 20 by President Trump.
This sweeping bill offers several adjustments to our current laws surrounding saving and preparing for retirement. Among many SECURE Act provisions, the law allows savers to delay required distributions, make penalty-free withdrawals for certain expenses, and offers new tax incentives for small-business retirement plans. Below we’re outlining the most prominent changes of this new act and how they may affect your own retirement.
Change #1: Required Minimum Distribution or RMDs change from age 70½ to age 72
The new age threshold applies to individuals who reach age 70½ in 2020 or later. Those who turned 70½ in 2019 will not be able to take advantage of the new law and will still need to take required distributions on the previous timeline.
Also of note, the age threshold for making qualified charitable distributions (QCD) from an IRA remains at 70½. This means there’s a one to two year period during which an individual does not have to take distributions from their IRA but can still make QCDs on a pre-tax basis.
Change #2: Make Penalty-Free Withdrawals For Qualified Birth or Adoption of a Child
Section 113 of the SECURE Act introduces a new exception for those who seek early distributions. You may now withdraw from your retirement accounts penalty-free for "Qualified Births or Adoptions." New parents, whether through birth or adoption, are allowed to withdraw up to $5,000 from their individual retirement accounts. In order to make a penalty-free withdrawal, new parents must do so within one year of the birth or adoption.1
Notably, the exception applies on an individual basis. Meaning, if both of a child’s parents have available retirement assets, each can make a Qualified Birth or Adoption Distribution of up to $5,000 for each child born or adopted. That means a couple can withdraw $10,000 per child.
The requirements around the timing of these repayments and their tax consequences are still a bit unclear. Further clarification is likely to come from future regulations by the U.S. Treasury Department.
Change #3: Required Withdraw Timeline From Inherited Retirement Accounts
Under the new act, beneficiaries who have inherited a retirement account will be required to withdraw the amount in its entirety within 10 years of receiving the account. Previously, inheritors were given the opportunity to “stretch” the withdrawal amount over their life expectancy (often known as a stretch IRA). With this change, there is the possibility your tax obligation could go up since you are required to withdraw more from the account over a shorter period of time. Beneficiaries must have the entire account disbursed to them by the end of the tenth year following the year of inheritance. There are certain groups of people who are exempt from this rule and can still abide by the old lifetime stretch rules:
- Spouses of the deceased
- Beneficiaries who are disabled or chronically ill
- Certain minors—those children of the original retirement account owner—but only until they reach the age of majority.
- Individuals who are not more than ten years younger than the decedent1
The term “stretch IRA” refers to an estate planning strategy that involves either a Roth or a traditional individual retirement account (IRA); it is not a special type of IRA. By “stretching” the IRA, individuals can preserve their retirement account’s tax-deferred status and allow its continued use by future beneficiaries.
Change #4: Eliminating the Age Limitations on Contributing to IRAs
Contributions to traditional IRAs by those aged 70½ or older are now permitted as long as employment income is still coming in. Previously, individuals were no longer eligible to contribute to their traditional IRA once they reached age 70½. Beginning in 2020, individuals of any age will be allowed to contribute to a Traditional IRA. The SECURE Act has eliminated the previous age cap, allowing people to continue contributing to their IRA for as long as they continue working.1
Keep in mind, post-age 70½ contributions to traditional IRAs may affect an individual’s ability to make QCDs. Starting at age 70½, individuals can annually make up to $100,000 of QCDs, which allows IRA funds to be used for certain charitable contributions on a pre-tax basis. However, the act does add language that prevents an individual from distributing as QCDs any deductible contributions made to traditional IRAs for the year that the individual reaches age 70½ and for years thereafter.
Change #5: 401(k) Eligibility For Part-Time Workers & New Incentives for Small-Business
Before the SECURE Act, employees were required to work 1,000+ hours for an employer in order to be eligible to participate in a 401(k). Congress has recognized how important it is for all workers to participate in employer-provided retirement plans, so the SECURE Act includes additional provisions to help employers encourage their employees to increase contributions and to let (some) part-time employees participate when they were previously ineligible to do so.
In order to be eligible, part-time employees will have to have worked 500+ hours per year for an employer (which averages out to 9.6 hours a week) for the past three consecutive years. In addition, the employee must be 21 years of age or older by the end of those three years.1
These changes for part-time workers apply to plan years beginning in 2021, but the SECURE Act does not require an employer to start ‘counting’ 500-hour years for the purposes of this new rule until 2021. That means that the earliest an employee would be eligible to participate in a 401(k) plan as a result of this change will be in 2024.
Equally important is an improvement in the federal tax credit for small business owners starting their first-ever retirement plans. Under the old law, employers could receive a tax credit up to 50% of expenses incurred to start the plan not to exceed $1,500. Under the SECURE Act, that tax credit can be used for up to three years after the plan’s launch. The SECURE Act significantly increases the tax credit from a maximum of $500 a year to $250 for each non-highly compensated employee who is eligible to participate in the plan, up to $5,000 a year. The credit is available for SIMPLEs, SEPs and 401(k) plans.
Change #6: 529 Funds Can Now be Used to Pay Down Student Loan Debt, Up to $10,000
In some cases, families have money remaining in their college savings plans after their student graduates. 529 plans may now be used to pay for certain student loan expenses up to a $10,000 lifetime maximum as well as certain apprenticeship program expenses. The act makes these changes retroactive to distributions made after December 31, 2018.
In addition to using 529 funds to pay the account beneficiary’s student loan debt, up to $10,000 can be used to pay down the student loan debt of each of the beneficiary’s siblings. Keep in mind, if withdrawals are used for purposes other than qualified education expenses, the earnings will be subject to a 10% federal tax penalty in addition to federal and, if applicable, state income tax.
A potential benefit of this new provision is that grandparents who want to help pay for college can do so to a certain degree without affecting the student’s financial aid eligibility. So, instead of paying tuition directly from a 529 funded by a grandparent, which can affect financial aid eligibility, the grandparent can wait and use the funds to help repay the student’s loans.
While there are additional changes being proposed in this new act that may affect you, above are a few of the most impactful ways in which the SECURE Act could be making a difference in how you save for retirement. Changes in the tax code, family relationships, and your own financial circumstances are common—requiring that you update your planning strategies every few years. If you have questions or would like to talk further about the items above, contact us today.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a fiduciary financial planner, accountant, and/or legal counsel for advice for your specific situation.