As the sun set on 2019, Congress passed a $1.4 trillion budget deal that contained major changes to an array of the rules governing investing for retirement. It’s the most significant development for retirement savers in more than a decade.
Buried within the enormous budget pact was a reform package known as the SECURE Act. The legislation, which enjoyed broad bipartisan support, seeks to provide provisions to boost Americans’ ability to fund their own retirement savings as company-sponsored vehicles like pensions are increasingly less common.
Here are the key provisions:
- Increased age limits for required minimum distributionsA required minimum distribution is the amount of money that must be withdrawn each year from tax-deferred retirement accounts once the beneficiary reaches retirement age (72, according to IRS rules). (RMDs) and IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. savings
- Limits on beneficiaries’ tax-free inheritance of IRAs and 401(k)s
- Incentives for employers to provide annuities—and the promise of “guaranteed income”—in 401(k) plansA 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn. Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn.
- Improved options for part-time workers
- No-penalty IRA withdrawals for a birth or adoption
Those are the quick-hit takeaways. Here’s a longer look at what it means and how you may be impacted.
Invest Longer, Take Distributions Later
Under the SECURE Act, the required age for taking minimum withdrawals from your qualified retirement accounts has been pushed back from 70½ to 72, effective January 1, 2020. This allows additional time to grow your tax-deferred retirement money (and using a whole-number age makes it easier to figure out when you need to start). The change, however, is no help for those under age 72 already taking RMDs: The clock has not reset, and you must stick with the old schedule.
Additionally, those who reached age 70½ in 2019 (which means you turned 70 on or before June 30, 2019) must take their first RMDA required minimum distribution is the amount of money that must be withdrawn each year from tax-deferred retirement accounts once the beneficiary reaches retirement age (72, according to IRS rules). by April 1, 2020.
Inherited IRAs Must Be Wound Down
Under the previous law, many beneficiaries were eligible to “stretch” distributions from retirement savings accounts they inherited out over the course of their own lives.
Beginning in 2020, as a result of the SECURE Act, some beneficiaries inheriting defined contribution accounts and IRAs will receive those assets under what’s been dubbed the “10-Year Rule.” Rather than meting out distributions throughout their life, beneficiaries must draw those assets down to zero within a decade. (The law may impact both those who inherit directly and heirs who inherit through certain types of trust—if your estate plan includes a trust provision, you should review it with your estate attorney.)
There are important exceptions to the 10-Year Rule. Surviving spouses, disabled and chronically ill beneficiaries, minor children and recipients within 10 years of age of the deceased are exempt, for example. However, once minor children reach age 21, the 10-year clock starts ticking.
If you are subject to the 10-Year Rule, how and when you take those distributions within the 10-year window is up to you—there are no specific requirements, only that accounts are completely cashed out by the end of the tenth year.
So while you do lose the ability to put off paying taxes on withdrawals from inherited accounts in perpetuity, you have some flexibility to enhance your tax efficiency. For example, say you’re 62 years old, still working and earning $150,000 a year, and you inherit a $400,000 IRA from a relative. You plan to retire at age 67, at which point your income will go way down. It probably makes sense for you to avoid taking any distributions from that IRA while you’re still working, and then distribute the funds to yourself over years six through 10 after your relative’s death when you’re not earning a paycheck (especially if you can wait until age 70 to file for Social Security).
‘Guaranteed Lifetime Income’ Comes With RisksThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline.
Lawmakers on both sides of the aisle have been playing up one aspect of the new law: Incentives for 401(k) plans to ramp up the number of annuitiesA financial instrument that pays the holder a guaranteed stream of payments. The annuity is funded by either a lump sum (one-time) or a series of deposits. Once funded, the sum is invested by the insurance company who sold the annuity (the accumulations phase). After a certain trigger (for example, the holder’s retirement or reaching a certain age) payments begin to be issued to the holder (annuitization phase). Annuity payments may be fixed or variable in both amount and in length (some pay out for a designated span of years, others until the holder’s death). available as investment options. Advocates claim that annuities will help recreate the “guaranteed lifetime income” workers once received from pension plans by converting retirement savings balances into annuities. Plus, the SECURE Act protects employers from being sued if the insurer they select to make the guaranteed payments doesn’t pony up.
While annuities can be a useful tool for some retirees, we don’t consider them well-suited for all. We’d urge anyone considering them to do their research before taking the plunge. We’ve written before about how to tell if variable annuities are for you, and we also took a look at the pros and cons of using annuities in a 401(k) when we discussed the SECURE Act last spring. Click here for that analysis.
We’re certainly aware that some American retirees are at riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. of outliving their money—and their ranks are growing. But, depending on your situation, annuities may not be the answer.
Using annuities in 401(k)s could help people manage retirement income more effectively. But it could also lead to average investors getting stuck with high-cost annuities that aren’t a good fit for their goals, or worse, placing their whole retirement at risk if the insurance company sponsoring the annuityA financial instrument that pays the holder a guaranteed stream of payments. The annuity is funded by either a lump sum (one-time) or a series of deposits. Once funded, the sum is invested by the insurance company who sold the annuity (the accumulations phase). After a certain trigger (for example, the holder’s retirement or reaching a certain age) payments begin to be issued to the holder (annuitization phase). Annuity payments may be fixed or variable in both amount and in length (some pay out for a designated span of years, others until the holder’s death). proves unable to meet their long-term obligations.
We’re certainly aware that some American retirees are at risk of outliving their money—and their ranks are growing. But, depending on your situation, annuities may not be the answer.
Increased Opportunities to Save for Part-Timers
Under previous law, you were unable to contribute to a tax-deductible IRA after age 70½. Now, if you continue to receive a paycheck in your 70s, you and your spouse can keep making those contributions. (It’s not covered by the SECURE Act, but it’s worth knowing that employee-sponsored 401(k) plans also have no upper age limit on contributions while you are still working.)
Many seniors working into their 70s are part-timers. But they aren’t the only part-time workers who are now eligible to save. Going forward, employees who have worked at least 500 hours per year (just under 10 hours a week) for at least three consecutive years are guaranteed 401(k) eligibility.
Charitable Distributions Remain
One of the lingering questions after the SECURE Act passed the House over the summer: With the age for RMDs bumped up to 72, will eligibility to make qualified charitable distributions (QCDs) also be pushed back? Nope.
As a refresher, QCDs are a direct transfer of money from an IRA to an eligible charitable organization. Unlike regular IRA withdrawals, QCDs are excluded from taxable income. And unlike other charitable contributions, you don’t have to itemize them when filing your tax returns. Assuming you’re in a position to make them, QCDs’ tax treatment allows you to enjoy the higher standard deduction while using the QCD to carry out your charitable giving.
Many retirees opt to make charitable distributions from their IRAs to help reduce taxes. Even though the SECURE Act bumps the RMD age threshold to 72, qualified charitable distributions (QCDs) are unaffected. After hitting 70½, you can still make charitable distributions from your IRA of up to $100,000 per year. However, if you’re still working and adding money to your IRA accounts after 70½, those additions will reduce your annual QCD limit dollar for dollar.
Penalty-Free Withdrawals for Birth or Adoption
Congratulations! You’re welcoming a new family member. (Step one: Read our Financial Checklist for New Parents.) With new babies come new budgeting issues, and many couples find themselves stretched too thin. While ordinarily we’d strongly recommend against taking withdrawals from your retirement accounts, under certain circumstances, you may find it beneficial to do so.
The SECURE Act allows you to take out up to $5,000 from a 401(k), IRA or other retirement account without incurring the usual 10% early-withdrawal penalty. Your spouse or partner can also take $5,000 out penalty-free. Then you can put the money back in at a later date, with the payment treated as a tax-free rolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax., not included in taxable income.
Again, we’re not advocating taking money out of a tax-deferred retirement account. But circumstances do tend to get in the way of perfect plans; at least now there’s no penalty (other than missing potential market gains) for those who need to do so. And maybe it’ll get young people to start funding their 401(k)s and IRAs earlier than they would otherwise—another benefit.
Defrayed Plan Administration Costs for Small Businesses
If you own a small business, offering a retirement plan to your employees comes with administrative expenses. Unfortunately, having fewer employees gives you less leverage to negotiate on fees. And those costs could be a disincentive to providing a 401(k), just as the failure to provide potential employees with this important benefit becomes a disincentive for them to want to work for you.
Prior to the SECURE Act, small business owners could only band together to share those administrative and management costs of 401(k) plans if they shared common relationships like being in the same industry or trade association. Now, completely unrelated businesses can pool together in a multi-employer plan. And they do so without assuming unnecessary risk; the SECURE Act protects members in these joint agreements from any liabilityLiabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.). resulting from one negligent company—a bad apple won’t spoil the entire bunch.
As a bonus, the bill also increases the business tax credit for plan start-up costs from $500 to $5,000. Furthermore, small business owners get an additional $500 tax credit for three years if they adopt a plan with auto-enrollment for new hires. More people saving for retirement? Sounds good to us.
Non-Retirement-Related Changes—Student Loans and the ‘Kiddie Tax’
There were also a couple of notable tax-law changes outside the retirement savings sphere.
Regular readers know that we’re big fans of 529 plans, tax-advantaged vehicles designed to help save for tuition and expenses related to higher education. The SECURE Act adds two new provisions to the qualified education expenses for which 529 funds can be deployed tax-free.
First, any expenses related to apprenticeship programs that are appropriately certified by the Department of Labor are now permitted to use 529-plan funds.
Also, the SECURE Act introduced 529 plan distributions for “qualified education loan repayments” of up to $10,000 toward the principal or interest of student debt. That $10,000 lifetime limit is per student, not per household. An additional $10,000 can be applied to each of a beneficiary’s siblings as well.
Aside from 529 plans, the SECURE Act also repeals the so-called “Kiddie Tax”—which taxed a child’s unearned income at the same rate faced by their parents—imposed as part of the 2017 Tax Cuts and Jobs Act. Starting in 2018, the Kiddie Tax was based on the significantly higher rate imposed on estates and trusts; these are the same rates that apply to the taxable portion of college scholarships, fellowships and grants, as well as military survivor benefits of Gold Star families—the result was low- and middle-income kids getting dinged with much higher taxes than their parents, causing families to scramble to meet unexpectedly high tax bills.
The SECURE Act undoes all that, reverting to the pre-2018 rules; the change is effective for tax years beginning after December 31, 2019. However, taxpayers can also apply the reduction retroactively to the 2018 and 2019 tax years to receive a refund on the excess tax.
We hope this has been a helpful overview of what elements of the SECURE Act may prove impactful for you. The 125-page legislation contains plenty of room for interpretive nuance and everyone’s situation is different—don’t hesitate to contact an experienced professional to make sure you’re taking full advantage of the opportunities for you and your bottom line.
About Adviser Investments
Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the seventh consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2019. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015, 2016, 2018 and 2019.
For more information, call 800-492-6868.