How the December 2019 SECURE Act Legislation is Influencing Financial Planning
It isn’t often that new tax or retirement legislation has such a great or immediate impact on the financial planning process, but the reforms passed by Senate and approved by the President on December 20, 2019 under the SECURE Act are doing just that.
Whether you are nearing retirement or just beginning to gain your financial footing early on in life, these significant modifications in law are something you’ll want to discuss with your financial advisor. While some of the changes might not affect you at all, one or more could considerably impact the current strategies directing your financial plan, estate plan, and/or tax plan.
1) The Elimination of the Stretch Provision on Inherited IRAs: In the past, beneficiaries of non-Roth retirement accounts could choose to leave the inherited assets of the IRA in an inherited IRA account and spread the distributions out over the course of their lifetime. Not only did this allow them to keep the money invested, but granted them the opportunity to stretch out their tax liability on the distributed funds, as well. For many accountholders, this was an essential tax consideration in their estate plan.
However, the SECURE Act has eliminated this “stretch” and implemented a maximum deferral period of ten years over which the beneficiary must deplete all funds.
There are a few exceptions to this rule, though, for spouses inheriting the IRA, individuals with disabilities, minor children, and individuals who inherited a retirement account prior to the passing of this legislation.
Is there another option? If so, when and how should it be exercised?
If withdrawing one-tenth of the account balance each year for the ten-year window will force the beneficiary into a higher tax bracket than the accountholder is in, then it may be prudent for the accountholder to perform Roth conversions for some or all of the invested funds in the IRA. Of course, taxes will be due on the funds at the time of the conversion, but they will be taxed at a lower rate, preserve more of the accrued wealth in the account, and pass on to the beneficiary income tax free. Roth IRAs have always been a tax-smart savings tool, but now may be even more attractive.
2) Later Required Minimum Distributions (RMDs) Age: Through 2019, retirees were required to begin taking Required Minimum Distributions (RMDs) from their non-Roth IRAs at age 70 ½. Those who did not would be heavily penalized.
However, IRA account holders can now postpone their first RMD until age 72. With individuals working later in life and enjoying longer life spans, many will find this extended window will be a welcomed update to the rule.
Unfortunately, though, if you began taking your RMDs in 2019, you do not have the option to delay and must continue on the old schedule.
The age at which an individual can make a Qualified Charitable Distribution from their IRA remains age 70 ½. Now, though, a unique period of one to two years is open for individuals to take IRA distributions that qualify as charitable contributions, but not as RMDs.
Also See Northstar Related Article: Creating Your Retirement Paycheck
3) Allowance for Later IRA Contributions: Individuals over age 70 ½ can now continue contributing to their IRA. In the past, individuals were prohibited were doing so beyond this age. Essentially, any person with earned wages can now make contributions to their IRA regardless of age.
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4) Penalty-Free Withdrawals for Birth and Adoption Expenses: The SECURE Act allows for penalty-free distributions up to $5,000 by new parents for a qualified birth or adoption. This allowance was designed to help alleviate some of the financial burden of adding a new member to the household. However, we warn strongly against withdrawing invested funds unless absolutely necessary, as nothing can beat your money’s time in the market to earn on compound interest.
5) Repeal of Kiddie Tax Changes: Although this provision was not laid out in the SECURE Act itself, but in adjacent legislation passed within the same spending bill, changes to the 2017 Tax Cuts and Jobs Act (TCJA) have been repealed. This repeal to the 2017 change means that unearned income for a child under 18, or under 24 if a full-time student, will now be taxed using the parent’s top marginal tax bracket again, not the trust tax brackets.
6) 529 Provisions: Two additional provisions were added to the list of 529 allowable expenses for tax-saving purposes to include: (1) The use of funds for qualified Apprenticeships and (2) the use of up to $10,000 to pay toward student loan repayments.
Also See Northstar Related Article: Paying for College: 3 Smart Alternatives to Borrowing
7) The Creation of a Fiduciary Safe Harbor for Selecting an Annuity for ERISA fiduciaries: The new law gives individuals the option to invest money within their current defined-benefit plan into annuities. However, the trustees of the retirement plans are not bound to the same fiduciary duty in helping their participants choose an annuity. Trustees are only legally required to collect information from the insurance company, not necessarily evaluate it. In other words, there is no guarantee that the trustee will choose an annuity option that works best for you.
It may not be prudent to invest in an annuity in this situation since an IRA grows tax-free anyway. Choosing an annuity within your tax-free IRA for its tax-free growth option is redundant. Not to mention that purchasing an annuity now while interest rates are low means that you are buying that guaranteed income at an escalated rate you may be locked into going forward.
Some additional retirement-centered changes include:
- A notable increase in the tax credit for small businesses opening a retirement plan
- A brand-new tax credit for small businesses that adopt auto-enrollment in their plan
- An increase in the auto-enrollment default 401 (k) plan contribution
- Improved access to employer plans for long-term part-time employees
Where is this all coming from? Ultimately, these changes in rules and retirement plans were enacted to help fix America’s growing retirement crisis. These provisions were ostensibly enacted to help Americans become retirement ready by increasing access to employer-sponsored retirement plans, postponing forced withdrawals, and granting new permissions for retirement and 529 distributions.
Of course, the provisions noted above will influence some more than others. As Certified Financial Planner ® (CFP) professionals, it is our duty to see that your financial plan evolves with such changes.
We are always monitoring your portfolio and reviewing your plans to ensure this is so. However, if you have questions or concerns about how these changes may or may not affect your current financial planning and investment strategies, we’d be happy to go over it with you. Feel free to schedule a review or send us an email to solidify these arrangements.