6 Key Retirement Changes of the SECURE Act
by Erik Brenner on Jan 21, 2020
©️ 2020 Carol Schmidlin. All rights reserved. This article may not be reproduced without express written consent from Carol Schmidlin.
The Setting Every Community Up for Retirement (SECURE) Enhancement Act was signed into law by President Trump on December 20, 2019. This is the most extensive retirement act since the Pension Protection Act of 2006.
Although the law is effective January 1, 2020, the Thrift Savings Plan (TSP) website states that they are evaluating how the SECURE Act may affect the TSP.
Here are the six notable key retirement changes that are effective January 1, 2020:
1. Eliminates the age limit for making traditional IRA contributions.
Under the old law, IRA contributions could no longer be made starting the year an individual turned age 70 ½.
- Back-Door Roth IRA benefit – This is a way for people with income that is too high to qualify for a Roth IRA contribution – to contribute to an IRA and then convert IRA to a Roth IRA. Prior to this law change, the year an IRA owner turned age 70 ½, they were not eligible to contribute to an IRA. Beginning January 1, 2020 people over age 70 ½ with income too high to qualify for a Roth IRA contribution can now contribute to an IRA, and then convert to a Roth IRA.
- Expands the ability to do a spousal IRA contribution (for a non-working spouse) for spouses who are over age 70 ½, doubling the contribution for a couple.
- While the age limit for making traditional IRA contributions is eliminated, earned income is still required to make an IRA, Roth IRA or spousal IRA contribution.
- IRAs are prorated to determine the taxable amount of the conversion. Example: John is 71 and wants to take advantage of the Back-Door Roth IRA. He contributes $7,000 to an IRA and then converts it to a new Roth IRA. Meanwhile, John has $500,000 in a pre-tax IRA. The pro-rata rules apply, so John’s IRA balance is $507,000 ($500,000 + $7,000 = $507,000), making 1.4% of the $7,000 conversion tax-free and 98.6% taxable.
2. Increases the RMD age from age 70 ½ to age 72 for all retirement accounts subject to Required Minimum Distributions (RMDs).
This applies to individuals that have not attained age 70 ½ by December 31, 2019.
- Allows more time to do Roth conversions before RMDs begin. This can be very compelling for those who want to shift some of their taxable assets to tax-advantaged assets.
- For Americans living longer, this may help their savings last throughout their retirement years. “A theoretical $500,000 portfolio, earning 5 percent annually, would have $33,500 more at age 89 if the RMDs started at age 72,” CNBC reported.
- This provision does not change the age at which an individual can make a Qualified Charitable Distribution (QCD) from their IRA, which remains at age 70 ½. This creates a 1-2 year window where IRA distributions may qualify as charitable distribution, but not as RMDs, therefore reducing your income by the amount of your donation up to $100,000 per year.
- Participants no longer employed by the federal government will continue to be required to take RMDs from a Roth TSP. RMDs are not required from Roth individual retirement accounts (IRAs), which may be an incentive for some older plan participants to roll over Roth 401(k) funds into a Roth IRA.
- Once RMDs begin, those RMDs cannot be converted to a Roth IRA.
3. Allows penalty-free withdrawals for birth or adoption, but the distribution is still taxable.
Under the old law, there was no exception from the 10% early withdrawal if under age 59 ½.
- This applies to all contributory retirement plans (not defined benefit plans like your FERS or CSRS annuity).
- This exception applies to any distribution from the retirement account within one year from the date of birth or adoption.
- Repayments to the plan are allowed and can be repaid (re-contributed back to the retirement account). The repayment will be treated as an eligible rollover.
- The limit is $5,000 lifetime distribution, not per year.
- Applies only to children age 18, or physically or mentally disabled and incapable of self-support
- My personal note is that retirement accounts should be used for your retirement and should only be touched as a last resort for any use, except for your retirement.
4. Eliminates the “Stretch IRA” by mandating inherited IRAs, for non-spouse beneficiaries, be withdrawn and taxes paid within 10 years.
Exceptions are made for (1) surviving spouse, (2) minor children (not grandchildren) up to age of majority or age 26 if student, (3) disabled individuals, subject to IRS tax code, and (4) chronically ill, based on the tax rules for Long-Term Care Services, and (5) beneficiaries not more than 10 years younger than the IRA owner, for example a sibling close in age will be able to stretch the IRA.
- This provision is not retroactive, so will not affect those who have inherited an IRA in 2019 or prior years. It applies to those who inherit on January 1, 2020 and after.
- There are many people that name a trust the beneficiary of their retirement accounts. As long as the trust qualifies as a “see through trust,” the inherited IRA could be stretched over the oldest beneficiary’s lifetime, possibly for decades. The SECURE Act no longer allows that since the only minimum distribution is the end of tenth year – 100% of the account would come out and be taxed at that point. All inherited funds would be release to the beneficiaries, abolishing what the account owner wanted.
Critical Action Item:
- If you have named a trust as your retirement account (IRA, TSP, 401k, etc.) as your beneficiary, you should review immediately and probably revise the trust or get rid of it altogether.
5. Encourages employer-based plans to offer annuities in their plan by providing liability protection for offering annuities.
The provision provides a safe harbor for employer liability protection. The employer is still required to do due diligence as a fiduciary when selecting the insurance company and the annuity option. The employer is not required to select the lowest cost contract.
- TSP currently provides an immediate annuity through MetLife. This annuity provides lifetime income for an individual or joint life with a spouse. The disadvantages of this, especially if you choose to transfer your entire TSP balance to the annuity, are: (1) You are locking in today’s low interest rate for life. When interest rates rise, your annuity payment will not be any larger. (2) You are making an irrevocable decision. If you choose the annuity with the largest monthly payout (single life annuity) and you pass away the next day, MetLife keeps the entire balance. (3) If you have an emergency and need a lump sum amount, you are out of luck. Again, this is an irrevocable decision, so no other payment to you is possible.
- There are many annuities that offer lifetime benefits and still allow you the flexibility to take additional withdrawals if needed, as well as pass any remaining balance to your loved ones. Will TSP look at other types of annuities?
6. Allows Taxable non-tuition fellowship and stipend payments to be treated as compensation to qualify for an IRA or Roth IRA contribution.
There is a lot of information to understand and planning opportunities to consider.
Here are 5 Solutions and Opportunities to Consider:
- Re-Evaluate Beneficiaries
- Spousal rollovers can be more valuable for tax deferral
- If you listed a trust as a beneficiary, review immediately
- Tax Bracket Management
- Maximize low tax brackets
- Qualified Charitable Distributions if you are charity inclined
- Examine Roth Conversions
- Current lower rates under the Tax Cuts and Jobs Act are scheduled to sunset after 2025
- Is paying the tax worth it if the Roth can only last for 10 years after death?
- Life Insurance as an estate and tax planning vehicle
- Can replace all of the benefits of a stretch IRA and IRA trusts
- Less tax for beneficiaries
- Avoid Trust Tax Rates by All Means
- Highest trust tax rate at present is 37% for income over $12,950
For details, see the white paper 5 Planning Opportunities Brought About by the SECURE Act.