Approximately 10,000 people turn 65 every day. People are working longer. In March 2017, defined contribution plans, such as 401(k) plans, were available to only 47% of workers at small business (those with fewer than 50 employees). And the unemployment rate continues to trend downward. All of this to say, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was enacted in December 2019 which expands savings opportunities for workers as well as provides incentives for employers, especially smaller ones, to provide retirement plan benefits.
Let's take a 14,000' look at the major changes that were brought about by the SECURE Act that may affect your retirement, tax, and estate planning strategies. Keep in mind that these provision take effect January 1, 2020, unless otherwise noted.
Later Required Minimum Distributions (RMDs)
For those born after July 1, 1949, you can wait until age 72 to take required minimum distributions. This allows folks a bit more time to postpone income tax and to continue to accumulate tax-deferred retirement savings. Under the previous rules, you had to take your RMD based on age 70 1/2. If you're still working, you may be able to delay taking retirement withdrawals from your current employer's plan. I discussed this strategy in this Simple Dollar article.
While RMDs can be a bit tricky, a few points to keep in mind:
If you turned age 70 1/2 prior to January 1, 2020, you're still required to take your RMDs in 2020 under the old rules. Bummer.
Your employer's plan documents may dictate that must you begin taking distributions upon reaching the age of 72 (or 70 1/2) even if you're still working. You'll need to check the plan documents. Also, if you're a 5% or more owner, you cannot delay taking RMDs out of an employer retirement plan.
Penalties are steep if you do not follow the rules. Be sure to discuss with your tax or financial advisor your individual requirements and double check your plan documents.
Traditional IRA age limits have been removed
Under the prior rules, you could not make traditional IRA contributions if you were age 70 1/2 or older. Under the new rules, you may continue to contribute to a traditional IRA as long as you, or your spouse, have earned income, regardless of age. This puts the traditional IRA in parity with the Roth IRA and employer plans, like the 401(k) - see my note above about 401(k) plan documents. For those individuals that may not have access to a plan at work or need to continue to accumulate for retirement, this a nice tax advantaged option that provides additional flexibility.
Remember, however, that traditional IRA balances are tax-deferred. Therefore, as the balance grows, you may be subject to increased RMDs in the future. Additionally, the age limit has been lifted but the the RMD requirements have not. This means that someone age 75, for example, with earned income could be contributing to the traditional IRA while at the same time taking RMDs.
Part-time workers gain access to employer retirement plans
Beginning with plan years starting on or after January 1, 2021, more part-time workers, those age 21 and older and who work greater than 500 hours annually (about 10 hours per week) for three consecutive years, will generally be eligible to contribute to employer sponsored retirement plans. The old rules were 1,000 hours (basically half-time workers) and one year of service. While employers will not be required to make any matching or nonelective contributions on the employee's behalf, this provision should allow greater access to retirement plans for more people. While the same person may be eligible to make a traditional and/or Roth IRA contribution, there's additional steps involved; having the ability to enroll with potentially other employer provided benefits may make for a more seamless enrollment process.
An attempt to incentivize small employers
While Fortune 500 organizations may have teams of people and ample resources dedicated to retirement plans and employee benefits, the SECURE Act seems to acknowledge that small businesses don't have the access to the same resources. Therefore, the Act provides for tax credits for those business starting certain retirement plans as an incentive. Additionally, the rules around Multiple Employer Plans (MEPs) have been relaxed effective January 1, 2021. This provides additional opportunity for smaller businesses to coalesce to provide a retirement plan with access to lower costs and richer benefits that are typically reserved for larger organizations - basically buy in bulk.
Stretch IRAs have been eliminated
A quick discussion on what a stretch IRA is (well, was). Previously, if a non-spouse beneficiary inherited an employer plan, such as a 401(k), or IRA, that beneficiary could stretch required minimum distributions (RMDs) over their own lifetime. This allowed for the beneficiary to recognize less taxable income annually and provide more flexibility as to when those plan assets were to be distributed and taxed. This ability to stretch out the inherited IRA distributions and keep taxable income down had the benefits of potentially paying lower income tax, additional tax deferred growth within the account, and reducing the possibility that the beneficiary would be disqualified from certain income-based benefits. The new rules generally require certain non-spouse beneficiaries - such as one who is more than 10 years younger than the original account owner (think grandchild) - to begin liquidating the account and therefore picking up into income and paying tax on those distributions within 10 years. And these new rules also apply to trusts.
There are some very key exceptions that must be noted. These new rules do not apply to surviving spouses, disabled or chronically ill individuals, and minor children. IRAs inherited from an original owner prior to January 1, 2020 are also not affected.
The key takeaway with the elimination of the stretch IRA is that it's a great time to rethink your estate plans and double check your beneficiary designations. If you had trust documents drawn up to take advantage of wealth transfer using the stretch provision, those documents should be reviewed as soon as possible. While Roth IRA conversions have been a hot topic lately, this SECURE Act provision adds yet another reason to give serious consideration as to how pre-tax and Roth accounts fit into your overall financial plan. Don't forget that the currently low tax rates are set to expire on December 31, 2025.
While the SECURE Act set out to provide additional flexibility in the retirement planning of many Americans, it did so by adding new layers of complexity. There are additional provisions within the Act that were not discussed as part of this post that may have an effect on you. Do you have questions about how the SECURE Act could impact you and your family? Schedule some time to chat about how this fits into your financial plan.
The above is for general information only. Consult with competent investment, tax, or legal counsel to best understand your unique circumstances before implementing any strategy. Read our firm's disclaimer here: https://www.windingtrailfinancial.com/disclaimer.
Vandenbroucke, Guillaume. "How Many People with Be Retiring in the Years to Come?" Federal Reserve Bank of St. Louis. May 30, 2019. https://www.stlouisfed.org/on-the-economy/2019/may/how-many-people-will-be-retiring-in-the-years-to-come.
Yoe, Jonathan. "Why are older people working longer?" U.S. Bureau of Labor Statistics. July 2019. https://www.bls.gov/opub/mlr/2019/beyond-bls/why-are-older-people-working-longer.htm
"The benefits of working for a small business." U.S. Bureau of Labor Statistics. May 4, 2018. https://www.bls.gov/opub/ted/2018/the-benefits-of-working-for-a-small-business.htm#bls-print
"Retirement Topics — Required Minimum Distributions (RMDs). Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmds