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The SECURE Act
The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) made numerous changes to the retirement landscape. Many of these changes, although important, will have little to no effect on most working individuals. However, there are three cornerstone provisions of the Act that will impact nearly every retirement saver. This Act was signed by President Trump on December 20, 2019 and most provisions in the Act are effective beginning January 1, 2020.
The term “stretch IRA” was used by the financial and tax community to describe the ability of certain individuals to inherit an individual retirement account (IRA) or defined contribution plan and stretch the required minimum distributions (RMDs) of the account over their life expectancy. In other words, the recipient of the retirement account could extend the required distributions across their life expectancy instead continuing the life expectancy of the deceased original account owner. In the case of young beneficiaries, the stretch provisions enabled distributions over decades which had two direct benefits; spreading out the tax impact across more years and allowing the account to continue to compound tax deferred for the extended distribution years.
This “stretch IRA” thing sounds cool, huh? Well say goodbye because the SECURE Act eliminated the ability for most beneficiaries to stretch inherited retirement accounts over their life expectancy. Instead, the SECURE Act requires IRAs and other retirement plans to be completely distributed by the end of the tenth year following the year of death. Notably, there are no required distributions in year one through nine, but the account must be emptied by the end of the tenth year.
Beneficiaries now must look closer than ever at their tax projections over the next ten years to determine the most tax efficient way to empty the account by the end of year ten. In the case of most traditional IRAs or retirement plans every dollar that is distributed from the account will be taxable income at ordinary tax rates to the recipient. Depending on the size of the account, the beneficiary should think strategically with their tax or financial advisor as to how to spread the distributions across the ten-year window to maximize the after-tax value to the beneficiary at the end of the day.
RMD Age Now 72
The second wide reaching change of the SECURE Act is that the required beginning date for distributions from a retirement account was pushed back from 70½ to 72. This change extended when RMDs must begin by a year or two depending on whether your birthday is in the first six months or the year or the latter six months of the year.
Lee was born on 1/1/1950 and has a $100,000 IRA on 12/31/2019. Under the old law Lee must take a distribution of $3,773.58 for 2020. Since Lee does not turn 72 until 2022 there is now no required distribution under the SECURE Act for 2020. This allows the $3,773.58 to stay inside the IRA and compound tax free. If we continue to compare the previous age 70½ rules versus the new age 72 distribution requirement with a 6% return both inside and outside of the IRA, the dollar benefit of the delayed RMDs only amounts to a cumulative $2,180 after 10 years on a $100,000 IRA.
This delay in required minimum distributions does not add up to much in terms of dollar impact as shown above however, it should reduce confusion around half birthday calculations.
Age Limit for IRA Contributions Removed
The third impactful change to IRA owners is the new ability to contribute to a traditional IRA at any age. Prior to the enactment of the SECURE Act, traditional IRA contributions were allowed as long as the individual had sufficient earned income and was under the age of 70½. The SECURE Act removes the age limitation allowing any individual at any age to contribute the lesser of their earned income or (in 2020) $6,000 plus an additional $1,000 for those over the age of 50. As individuals continue to work longer, the ability to fund traditional IRAs after age 70½ was a logical change for Congress.
One important anti-abuse rule related to post 70½ deductible traditional IRA contributions is the new requirement to adjust Qualified Charitable Distributions (QCDs). A QCD is a gift to a charity directly from an IRA. The benefits of QCDs are outstanding for charitably inclined individuals over the age of 70½ as the QCD counts toward the individuals RMD but is excluded from income. This provides greater tax benefits than picking up the RMD income and deducting the charitable contribution on Schedule A as an itemized deduction.
The new anti-abuse rule requires individuals making a QCD to reduce the amount excluded from income by cumulative post 70½ deductible traditional IRA contributions that have not previously reduced a QCD. This rule simply exists to prevent people from flowing money through an IRA to a charity just to increase the tax benefits of the charitable gift.
Joe has a $500,000 IRA and turns 70½ in 2020 but is still working. Joe decides to make $7,000 deductible IRA contributions four years in a row totaling $28,000. In 2027, Joe decides to make a $30,000 QCD. The amount Joe is able to exclude from income under the QCD is $2,000 because Joe must reduce the QCD by the post 70½ deductible IRA contributions ($30,000 – $28,000). The $28,000 is picked up as retirement distribution income and a subsequent charitable contribution deductible on Schedule A. Joe will likely not receive the full tax benefit fo the $28,000 charitable contribution due to the way itemized deductions are calculated.
The SECURE Act made numerous changes to retirement plans, some of which were taxpayer friendly and some of which were revenue generators for the US Treasury. The three most foundational changes involved the elimination of the stretch, the delay of required minimum distributions to age 72, and the ability to now make post 70½ traditional IRA contributions. Please consider reaching out to your tax or financial advisor to see if any updated planning is needed for you and your family with regard to any of these rule changes.