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 summer, the House passed the SECURE Act, which gained overwhelming bipartisan support. The bill was later included in a government spending bill and ratified on December 19. Combined with the Tax Cuts and Jobs Act of 2017 and the Taxpayer Certainty and Disaster Relief Act of 2019, these changes represent some of the most significant tax and investment reforms in over 20 years.

One of the main updates in the SECURE Act is the elimination of the “stretch IRA” for inherited IRAs. Instead, beneficiaries must liquidate the inherited accounts over 10 years, rather than being able to stretch distributions over their lifetime. Additionally, retirees can now make IRA contributions regardless of age, as long as they have earned income. Required minimum distributions (RMDs) have been delayed from age 70 ½ to 72.

Other changes include a new penalty-free withdrawal exception for birth or adoption, the repeal of the kiddie tax rates (with unearned income for minors now taxed at parents’ rates), and a reduced threshold for medical expense deductions to 7.5%.

The SECURE Act also expands the uses of 529 plan funds, extends the mortgage interest deduction for mortgage insurance premiums, and allows fellowship and stipend payments to count as income for IRA purposes.

Stretch IRA Provisions

The SECURE Act introduces a significant change to IRA treatment, particularly for non-spousal beneficiaries. Previously, inherited IRA accounts could be distributed over the beneficiary’s lifetime. Under the SECURE Act, however, inherited IRAs (Roth and Traditional) must now be disbursed within 10 years, starting with accounts inherited in 2020.

Existing inherited accounts remain subject to the old rules. Spouses, minors, disabled individuals, and those classified as “chronically ill” are exempt, though minors must adhere to the 10-year rule once they reach adulthood.

These changes raise two key planning considerations for retirees. First, Roth conversions become even more attractive. The Tax Cuts and Jobs Act (TCJA) has lowered tax rates, making it a good time for IRA owners to convert funds to Roth IRAs, potentially avoiding higher tax rates for their heirs.

Large IRA distributions could push beneficiaries into the top tax bracket of 37%, while retirees may still convert at the lower 24% rate (up to $160,725 for single filers or $321,450 for married couples). Converting IRA funds annually up to the 24% bracket could save heirs from paying significantly higher taxes, especially if tax rates revert.

However, it’s important to consider other factors like Social Security taxes and Medicare premiums, so consulting a financial planner and tax professional is crucial.

Secondly, anyone with a trust should review their estate plan. Most trusts were designed to accommodate the old stretch IRA provisions. The new 10-year rule could lead to unintended tax consequences or misalignment with trust terms. A thorough review ensures the trust complies with the new rules and protects your estate plan.

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.

IRA Contributions

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.

Additional Items

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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