When Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act — which took effect on Jan. 1, 2020 — it created a mixed bag of benefits and new requirements for Americans saving for retirement. The law was also a way for the government to get access to retirement savings sooner so that money could be taxed. Anyone hoping to actually be more secure needs to give those benefits and requirements a closer look.
The SECURE Act’s main changes affected defined contribution plans, such as 401(k)s, defined benefit pension plans, individual retirement accounts (IRAs) and 529 college savings accounts. Prior to passage of the SECURE Act, you had to start withdrawing funds from a traditional IRA by April 1 of the year after you turned age 70½. These annual withdrawals are called required minimum distributions (RMDs).
Good News about RMDs and IRA Contributions
Some good news: The SECURE Act allows another year and a half before the RMD requirement kicks in, from 70½ then to age 72 now. So, when you turn 72, you have to start withdrawing money from your IRA or 401(k), and you have to pay income tax on the amount of those withdrawals. (Note: Thanks to the recent CARES Act, everyone gets to skip their RMDs this year. For more on that, please see Retirees Get Another Break with Expansion of RMD Waiver.)
Some more good news: The SECURE Act also removed the age limit for IRA contributions. You can now continue contributing to your IRA at any age as long as you are still working.
Also, eligibility for participating in a 401(k) plan was broadened to include certain part-time employees. An employee who works a minimum of 500 hours during a 12-month period for three consecutive years can now contribute to a 401(k) plan (as long as he or she is 21 years of age or older).
Perks for Small Businesses and New Parents
As a complement to that change, the SECURE Act offers small-business owners a tax credit for starting a workplace retirement plan. The tax credit starts at $250 per eligible employee, with a maximum credit of $5,000 per year, available for three years. Plus, small-business owners can join together with other unrelated employers to create an open multiple employer plan (MEP). An open MEP can help small businesses reduce the cost of offering a retirement plan for their workers.
New parents get a perk, too, in the form of a penalty-free $5,000 withdrawal from an IRA or 401(k) after the birth or adoption of a child. Prior to the SECURE Act, withdrawing funds from an IRA or 401(k) prior to age 59½ would make that withdrawal subject to income tax and a 10% penalty. Now, parents won’t have to pay a penalty, and they can repay the funds as a rollover contribution. The full amount of the distribution will be taxed as ordinary income to the parents.
Sorry: The Stretch IRA Is Now History for Many Beneficiaries
Now for the tricky part. The SECURE Act made a huge change that affects inherited IRAs. Previous to Jan. 1, 2020, the beneficiary of an inherited individual retirement account (IRA) was able to defer taxation over their lifetime by taking required minimum distributions based upon the age of the beneficiary. The younger the beneficiary, the longer the tax deferral. Of course, the beneficiary still had to pay income tax on those withdrawals, but could essentially spread distribution for decades where the beneficiary was a child of the owner.
Beginning with retirement account owners who passed away after Jan. 1, 2020, however, most beneficiaries must withdraw assets from the inherited IRA or 401(k) within 10 years of the death of the owner. There are some exceptions, such as a surviving spouse, minor children, and disabled and chronically ill beneficiaries who are up to 10 years younger than the deceased retirement account owner (“Eligible Designated Beneficiaries” or “EDBs”) who retain the ability to defer taxation over a longer period of time.
The 10-year requirement effectively accelerates the speed at which an inherited retirement account has to be liquidated. The account beneficiary will have to determine the best strategy for withdrawal, based upon their own income and tax bracket, but the account must be completely distributed within 10 years of the death of the owner. Accordingly, the beneficiary will be required to take out larger amounts of money at once — and be taxed on that larger distribution. As a consequence, the federal Treasury gets its piece of those withdrawals faster than in the past.
Tricky Times for Trusts
The ramifications of this change are significant for tax- and estate-planning purposes. The new requirement is problematic for families with an accumulation trust, because the tax rate for the trust is a lot higher than the individual tax rate. Likewise, you will want your attorney to review the language in a conduit trust to avoid any unintended adverse consequences resulting from the changes mandated by the SECURE act. Conduit trusts cause the distributions to be taxed at the beneficiary’s individual rate, but may be drafted in a way that, in light of the SECURE Act, cause all of the taxable account to be distributed in a single tax year at a higher marginal rate. In addition, where there are multiple beneficiaries of a conduit trust, and a mixture of EDBs and non-EBDs, all beneficiaries of the trust will be ineligible to defer taxes beyond the 10-year period provided under the act.
A thorough review of your trust agreements with experienced legal counsel and financial advisers would be prudent to identify any potential tax trap for beneficiaries that have resulted as a consequence of the changes implemented by the SECURE Act.
Some of the changes made by the SECURE Act are especially urgent to understand now as the coronavirus pandemic continues to pose a serious health threat. Mortality is a difficult thing to face, and perhaps even more difficult to discuss with loved ones, but doing so is all the more important during this unique time in our history.
We all live busy lives, and on the long list of to-do’s, estate planning is often pushed to the end. However, changes in the law and the coronavirus pandemic provide a good reason to revise your planning to take care of your family in the future.
Foster Friedman concentrates on planning and controversy matters involving estates and trusts. He has extensive experience advising clients on the transfer of wealth from one generation to another, including the orderly and tax-efficient succession of family-owned businesses, through the preparation and implementation of wills, trusts, family limited partnerships and LLCs.
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