Expertise Beyond the Numbers

SECURE ACT ANALYSIS: Impact of Recent Law Changes on Individuals and Families

On December 20, 2019 the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law as part of a Consolidated Appropriations Act. This largely bi-partisan legislation makes a few modest, but potentially important changes to the US retirement plan system. This article, the second in our series, we will review a number of provisions which may be impactful to individuals and families.

Changes to IRA provisions

Much of the impact of the SECURE Act is related to IRAs. A few of the most notable changes are as follows:

  • Delayed Required Minimum Distribution (RMD) rules
    • Many taxpayers have been forced to begin withdrawing retirement assets from their IRAs starting in the year in which they attain age 70 ½ (subject to special first year distribution rules)
      • These required distributions are generally includable in taxable income and thus increase tax and limit other long-term planning strategies
    • The SECURE Act delays RMD’s until taxpayers reach age 72
  • Limitations on “Stretch” IRAs
    • Many taxpayers’ retirement plans anticipate passing their IRAs to younger generations in order to decrease the overall tax burden on the assets
      • Prior laws allowed inherited retirement plan assets to be withdrawn (and thus included in taxable income) over the inheritor’s actuarial lifetime
      • This meant that a young inheritor may have been able to take out very little of the assets each year and allow the majority of assets to continue to grow in a tax deferred environment… this is the so-called “stretch” IRA strategy
    • The SECURE Act decreased this “stretch” period to not longer than 10 years after the death of the plan contributor for non-spouse beneficiaries
    • This may have significant effects on estate planning for taxpayers for a number of reasons
      • IRA assets will not be allowed to grow in a tax free environment for as long, thus decreasing the overall value of inheritance
      • Younger taxpayers may be forced into higher tax brackets due to the larger amount of taxable income they are forced to report over the (shorter) 10 year period
    • These new provisions will result in significantly higher tax burdens for some taxpayers. Forbes reports that changing the “stretch” IRA rules will generate an additional $15 billion of tax revenues for the federal government over the next 10 years
  • For many years, contributions to Traditional IRAs was prohibited for taxpayers over age 70 ½. The SECURE Act removes this provision
    • With many American workers well into their 70’s, and lifespans often expanding into the 90’s, this option allows workers to save more over a longer period of time
  • Non-Tuition fellowships and stipends may be treated as compensation for IRA purposes
    • IRA contributions are only allowed to the extent taxpayers have sufficient compensation (i.e. earned income)
    • For some graduate and post-doctoral students their fellowship grants or stipends paid by educational institutions were taxable, but were not considered compensation for purposes of making IRA contributions
    • The SECURE Act expands the definition of compensation for purposes of IRA contributions to include these taxable amounts so that students may begin saving for retirement earlier in their careers

IRAs, estate planning, and income tax strategies are all highly complex and taxpayers should discuss these new rules, along with their overall goals with their financial planner and/or tax advisor.

Creation of New Penalty-Free Withdrawal Allowance from Retirement Plans for Birth or Adoption of a Child

In a new development not previously seen in the Internal Revenue Code, taxpayers who have a child or adopt a child will be allowed to take a distribution of up to $5,000 from retirement account(s) without incurring the 10% penalty which would normally apply to distributions for taxpayers under 59 ½ years of age.

While the avoidance of penalties is for new parents is commendable, many retirement planning experts would likely say that once funds are put into retirement plans they should not be removed until retirement. Such distributions would also likely increase tax burden in a given year. Taxpayers should consult with their financial planner and/or tax advisor before taking distributions from retirement plans.

Expansion of Approved Uses of Section 529 Education Savings Plan Assets

Section 529 plans have been a useful tool for education savings for decades.

In 2017 The Tax Cuts and Jobs Act (TCJA) expanded the use of Section 529 plan assets to cover some K-12 educational costs (up to $10,000 per year).

The SECURE Act further expands the uses for Section 529 plan assets to cover expenses such as registered apprenticeship programs, and qualified student loan repayments.

Increased Auto-Enrollment Safe-Harbor Limits

For many American families, a workplace defined contribution retirement plan, such as 401(k) or 403(b) plan, is the only retirement savings they have. That said, research indicates that many employees do not save enough for retirement. One tool that can have a major impact on long-term retirement savings is including automatic escalation provisions within employer sponsored retirement plans. These provisions are designed to increase employees’ retirement contributions by small amounts each year (often 1% – 3%) in order to help employees reach long-term retirement goals. According to the Society of Human Resource Management (SHRM), many employees favor automatic escalations provisions. Further, such provisions can help even out disparities in retirement savings rates between disparate socio-economic groups.

The SECURE Act increases the upper limit for automatic escalation of employee contributions to 15% of earnings as opposed to the previous 10% limit.

Employees should review their contribution rates periodically to determine the appropriate retirement savings rate. Often, workplace retirement plans offer access to free professional advice to employees who participate in employer sponsored plans.

Inclusion of Long-Term Part-Time workers in 401(k) Plans

For many years employer sponsored defined benefit retirement plans (ex: 401(k) plans) were only required to be offered to employees who worked more than 1,000 hours per year. The SECURE Act expands that participation threshold for employees who work more than 500 hours per year for three (3) consecutive years. The house Ways and Means committee references research which indicates that women are more likely than men to have part-time employment and, thus, may be at a long-term disadvantage with respect to retirement savings.

If you work part-time and are not eligible for an employer sponsored retirement plan, you may want to discuss these new provisions with your employer.

CONCLUSION: Like most tax laws, the SECURE Act will surely create winners and losers. Broadly, it appears that the Act favors “Savers” and penalizes “Accumulators”. Folks who use retirement accounts to secure their long-term goals may have more options while families that use retirement accounts as an integral part of estate planning may find they are more limited. Contact us with questions or to establish the best plan of action for these requirements.