On December 20, 2019, Congress passed legislation making significant changes to the rules that apply to many of our favorite retirement plans. Nicknamed “the SECURE Act,” this new federal law will touch many of our clients as they seek to accumulate, distribute and inherit retirement accounts. Although there are many components of the Act, this article will focus on those that impact your ability to accumulate and use assets during a lifetime and, ultimately, transfer assets at death.
The Good News: 72 is the new 70 ½
The Secure ACT raises the age at which RMDs (required minimum distributions) must begin. The previous rule was that RMDs had to start the year you turned 70 ½. If you were born before June 30th, you began distributions by the end of the year you turned 70, but if you were born in the second half of the year, you began the year you turned 71.
The new rule allows you to wait until you turn 72 to begin, regardless of when you turn 72 during the year. (Note that if you are still working and not a business owner, you do not have to take an RMD from your current employer’s plan, no matter your age.)
Unfortunately, this rule does not go into effect until 2020, so anyone who turned 70 ½ in 2019, will still have to take RMDs in 2019 and 2020. In contrast, if you turn 70 ½ in 2020, you’ll get to wait until you turn 72 before taking your first RMD, either in 2021 or 2022.
More Good News: IRA contributions allowed after 70 ½; Exception to 10% penalty
It may come as a surprise to some, but under the previous rules, after you turned 70 ½, you were no longer eligible to make an annual contribution to an IRA. Not to be confused with a SEP IRA, Roth IRA, 401 (k), or 403(b) contribution, which were allowed; this inconsistency made no sense, and we are glad to see it corrected.
In addition, the SECURE Act added a new exception to the 10% early distribution penalty for a distribution for a birth or adoption if made during the one year period before or after the event. There is a $5,000 limit applied to each new birth or adoption, and tax is still due on the distribution.
The Bad News: Inherited IRAs must be distributed in 10 years
Without a doubt, the most complex aspect of this legislation is how it changes the rules for inheriting an IRA, Roth IRA, or 401(k). Generally, these changes apply to deaths after December 31, 2019; however, certain government plans such as 403(b), 457(b), and TSP plans are not affected until December 31, 2021.
One very important point to keep in mind is that a spouse is not subject to these rules because they can rollover a deceased spouse’s account into their own retirement account. Therefore, the changes ONLY apply to inheritors who are children, parents, siblings, and other friends and relatives.
Under the old rules, a child, for example, could roll over the deceased IRA into an inherited IRA and be required to begin distributions the year after the death, and withdraw an amount each year based on their life expectancy per the IRS single life table. For example, a 50 year-old has a 34.1 year life expectancy (per the IRS) and would be expected annually to withdraw a minimum amount such that the account would be depleted in 34 years, or sooner. The first year the amount would be 1/34th, the second year 1/33rd of the account value, continuing for 34 years. In this example, this 50 year-old could extend the life of the IRA to age 84, and in doing so, continue the tax deferral for many years. It might also allow them to postpone some of the tax impact into their retirement when their tax rate might be lower.
The new SECURE Act adds some new flexibility for beneficiaries, but sharply limits the life of the inherited IRA to 10 years. The good news is that beneficiaries are not required to make any specific distributions in any one year, but must have distributed the entire account by the 10th anniversary of the death of the original IRA owner.
There are a few exceptions to the 10-year distribution requirement for a spouse, a disabled or chronically ill individual, a minor, and a beneficiary who is less than ten years younger than the decedent. All of these eligible beneficiaries are allowed to take distributions over their life expectancy, following the old rules. A minor must convert at age of majority to the ten-year limit.
While most of these rule changes are negative in that they force inheritors to pay tax sooner and in doing so accumulate less, the fact that no annual RMD is required gives heirs the flexibility to engage in tax planning. In other words, you can delay or accelerate the distribution depending on your tax circumstances. It is a modest consolation for the loss of what is commonly called the “STRETCH” IRA.
Grandfathered Inherited IRAs
If you already inherited an IRA from a decedent who died before 12/31/19, you are grandfathered and are allowed to use the old rules. There is no change to your schedule of RMDs.
A Disconnect: Qualified Charitable Distributions (QCDs)
There is a “disconnect” between the SECURE Act and the rules that apply to QCDs. Per earlier QCD legislation, those over the age of 70 ½ could transfer up to $100,000/yr from their IRA to a qualified charity and have it count towards their RMD and not be taxable. The starting age of 70 ½ did not change with the SECURE Act, even though no RMD may be required any longer. But be careful, if you are making IRA contributions and QCDs at the same time, some of the QCD may be disqualified.
More to Come
Stay tuned for more chapters in this saga of changing retirement rules. There are numerous aspects of the SECURE Act that we will explore in future posts.