January 17, 2020
Major Legislation – SECURE ACT
Who will be affected by the SECURE ACT? (Short answer: almost everyone!)
Before we get to the analysis, here are the relevant action items:
· Have your estate plan reviewed in 2020 to make sure your trust will accommodate the new 10-year inherited IRA distribution period
· If you are already retired, talk to a planning and tax professional about a Roth conversion – even more appealing given the new tax and distribution rules
· For workers over age 70 ½, consider making IRA and spousal IRA (if married) contributions
This past summer, the House of Representatives passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. However, for many months following, the bill seemed to languish in the Senate. That being said, it was only a matter of time before it was ratified as its passage through Congress was almost unanimous: 417 to 3 (12 non-votes). There may have been…but I do not recall in my lifetime…any other legislation with as much bipartisan support.
Fast forward to December 19, the bill was tacked on to a government spending bill that Congress was “forced” to pass. With the new bill now ratified, combined with the Tax Cuts and Jobs Act of 2017 and the Taxpayer Certainty and Disaster Relief Act of 2019, we are looking at some of the most significant tax and investment changes in over 20 years. While the SECURE Act is not as expansive as the TCJA, I believe it presents more planning considerations for investors today.
Chiefly among the new rules is the elimination of stretch IRA provisions for inherited IRAs. Instead of the previous, lifetime distribution allowance, IRA beneficiaries will be forced to liquidate inherited accounts over a 10-year window. Additionally, retirees will now be able to make IRA contributions regardless of their age. However, contributions will still require earned income. Finally, of note, required minimum distributions have been pushed back from age 70 ½ to age 72.
Beyond these large retirement plan changes, there are several smaller but still important updates. A new exception reason (birth or adoption) has been added to the approval penalty-free withdrawal reasons for IRA accounts. The TCJA addition of trust rates in place of prior kiddie tax rates has been repealed. Unearned income for minors will once again be subject to parents’ marginal rates. Likewise, the higher floor for medical expense deductions introduced in the TCJA has been reduced to 7.5%. Approved uses of 529 funds has been expanded and the mortgage interest deduction for mortgage insurance premiums has been extended. Income received from fellowships and stipend payments can also be treated as income for IRA purposes as it was not previously considered “earned.” Also, some foster care payments that are not taxed can be considered when making non-deductible IRA contributions.
Stretch IRA Provisions
As stated, the biggest change to IRA treatment is more of a hurdle than an opportunity. In prior years, IRA accounts inherited by non-spousal beneficiaries could be distributed over the recipient’s lifetime in
the form of a required minimum distribution (regardless of the age of the beneficiary). Under the SECURE Act, inherited IRA accounts (Roth and Traditional) must be disbursed over a 10-year window, starting with accounts inherited in 2020. Any IRA accounts that have already been inherited will continue to be subject to the old rules. Spouses will also not be subject to the 10-year rule. Nor will disabled persons, anyone labeled “chronically ill” or minors. Notable, minors are only granted temporary reprieve as they are subject to the 10-year rule once they reach the age of majority.
For retirees, these changes highlight two important planning considerations. One, Roth conversions now look even more appealing. The TCJA has allowed for more income to be taxed at lower rates until at least 2025. Owners of large IRA accounts should consider the tax brackets of their future heirs. Large IRA distributions could push a high-income beneficiary into the top income bracket of 37% (or even higher if taxes go up or return to prior rates!) while an IRA owner could still achieve a top marginal rate of 24% with income up to $160,725 (single) or $321,450 (married). It could make sense for retirees with large IRA accounts to consider converting IRA money to Roth annually up to the marginal 24% bracket as their beneficiaries could end up being taxed closer to 50% (assuming a reversion to prior tax tables)! Of course, there are other factors such as social security tax rates and Medicare premiums to consider as well – always consult with a qualified financial planner and tax professional before making changes to your retirement income strategy.
Secondly, and more importantly, anyone with a trust needs to schedule an estate plan review. Currently, most trusts are written to accommodate the stretch provisions previously available to IRA accounts. There are a number of ways that a trust could be drafted and likewise, there are a number of ways that a trust could run afoul of the new rules.
New RMD Rules
In addition to changing the way IRA distributes assets after you pass, there is also a small change to how your account will distribute assets while you are living! Required Minimum Distributions previously started when an account owner achieved age 71 ½. Under the new rules, RMDs will not need to be taken until 72. While relatively minor, any RMD relief is welcome. If nothing else, at least the timing of the 1st RMD will be easier to understand. Certainly, my 6-year old keeps track of when she is 6 ½ but I imagine she will have outgrown the practice by age 70. Everyone knows when they are 72 but 70 ½? That’s silly. As before, the first RMD can still be delayed until April of the following year. Of course, if delayed, two RMDs will be required the first year: The prior year’s RMD as well as the current year’s RMD. As lower tax rates allow for a larger Roth conversion, delayed RMDs allow for a longer Roth conversion. Meaning, there are now 1-2 additional years where an RMD is not required, and more funds can be used to convert to Roth. Finally, please keep in mind if you are approaching RMD age, you will need to have turned 70 ½ in 2020 to forgo your RMD until age 72. Person’s turning 70 ½ in late 2019 will still be subject to the old rules.
Qualified Charitable Distributions
One minor change of special note is that despite RMDs being pushed out to 72, qualified charitable distributions or QCDs can still be executed at 70 ½. If you are not familiar with a QCD, it is a distribution from a qualified account, like an IRA, that is given to a charity and therefore not subject to tax. The QCD strategy is slightly cleaner than just performing a distribution and subsequent gift to charity, as there is no room for “tax drift” due to varying income sources and above/below the line deductions.
For persons still working past age 70 ½, there is a final opportunity. The age restrictions have finally been lifted for IRA accounts. I say “finally” because IRA accounts are the only type of retirement plan to limit participation by age. That being said, the earned income requirement remains. For couples where one spouse is young enough to still be working, or where one or both spouses chooses to work beyond age 70 ½, this is a tremendous saving opportunity as non-working spouses can have a spousal IRA contribution made on their behalf.
Finally, several small changes also made it to the final bill. One interesting change is the addition of a new exception for penalty free distributions from IRA accounts. Up to $10,000 can now be taken, penalty free, for the birth or adoption of a child. In order to qualify, the distribution must be taken 12 months following the date of birth or adoption, and therefore cannot be used to prepare for a child, but rather, only to cover costs already incurred. Also, these rules are account level, meaning that each parent or caregiver can make a distribution. A couple could each take $10,000 or $20,000 total. Whereas 529 accounts can only reimburse owners for qualified expenses, a birth or adoption distribution is event based. There is no requirement for qualified expenses and the money can be used for any purpose. The funds can also be “repaid” into the account, although, the rules about timing of repayment are as yet unclear. Finally, 529 accounts can now be used to repay student loans up to $10,000 over an owner’s lifetime. Although, any student loan interest paid will be rendered non-deductible.
If you have any questions about these changes or how they impact you and your family, please call us at 248-385-3737 or drop an email to [email protected].
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