The SECURE Act: What You Need to Know Before Retirement
January 10, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial
Twice in a decade! It’s unusual to have to overhaul our tax or retirement practices more than once every ten years because of legislation. But we had the Tax Cuts and Jobs Act of 2017. And now we have the SECURE Act, or the ‘Setting Every Community Up for Retirement Enhancement’ Act of 2019.
The Act saw the light of day in late December. It has some employer tax credits and looser rules for small employers to set up retirement plans. But the rules that most affect you are three: two that benefit you and one that benefits the government.
Let’s look at the two beneficial ones first.
IRA Maximum Age Repeal
Fewer Americans are retiring at 62 or 65 than in the past. They’re also living a lot longer – and working a lot longer.
If that’s your case, maybe it’s because you’re still putting money away to cover your later years. Or because you are still full of energy and you love what you do.
Whatever your reason, up to now, it was frustrating that you had to stop contributing to a traditional IRA after age 70½. (The traditional IRA is where you put in pretax dollars and take a deduction from your income tax for the amount contributed.) You could still contribute to Roth IRAs, but not to traditional IRAs.
The SECURE Act removes the age limitation on traditional IRA contributions. And that’s a good thing.
The only condition is that you have to contribute to your IRA from earned income. The IRS website defines earned income as:
- Wages, salaries, tips, and other taxable employee pay.
- Union strike benefits.
- Long-term disability benefits received prior to minimum retirement age.
- Net earnings from self-employment.
Here’s what is not earned income: Social Security, retirement income, alimony, interest and dividends.
RMD Age Change
For any tax-advantaged retirement accounts (those where you contributed pretax dollars), the IRS would like to collect the taxes you deferred. That’s the purpose of annual Required Minimum Distribution (or RMDs), which until now you had to start taking by April 1 of the year after you reached age 70½.
The SECURE Act provides an extension from age 70½ to age 72. This grace period means you can save longer before having to start taking withdrawals. The government hopes those 18 months will extend how long your IRA savings last.
Do you know how to calculate RMDs? They are based on standard life expectancy. To calculate the minimum amount to withdraw each year, you first look at your IRA’s balance at the end of last year. Then you refer to an IRS table that assigns a life expectancy factor to each age. (The IRS has three different tables, so be sure to use the right one.)
Find your age and factor. If you divide your balance by that factor, you will know how much you must take out and pay tax on. You can withdraw more than the minimum, but you will be penalized heavily if you don’t take the minimum. (The amount not withdrawn is taxed at 50%.)
Can you be withdrawing RMDs from an IRA you’re still contributing to? Yes. Now that the age limit for contributing to IRAs is gone, you could find yourself in a money-in-money-out situation with your IRA account.
Qualified Charitable Distributions (QCDs) from IRAs will not be affected by the SECURE Act; accordingly, QCDs may still be taken from IRAs as early as age 70 1/2.
So now you know the ‘two for you” changes. What’s the “one for the government” one?
The IRA “Stretch” Provision
This rule change affects how inherited retirement accounts are treated. In the past, as part of a retirement strategy, IRA owners would look to the age of their beneficiaries to extend the tax-deferred aspect of the plan. You may have done this, too.
If so, you could stretch the number of years over which your heirs could take the required withdrawals, or RMDs, after your death. (That’s why it’s called a “stretch” provision.) Meanwhile, the assets in the IRA had more time for tax-favored growth.
The age of the beneficiary mattered because it determined the size of the annual withdrawal. Longer life expectancies meant smaller annual withdrawals – and lower associated tax payments.
So, if you designated your grandchild as your beneficiary and she inherited at age 25, she’d have more than 60 years of life expectancy left. The RMDs she’d have to start taking some time after your death would be much smaller than if she were 60 with 25 years of life expectancy left.
But the SECURE Act has changed all that.
Starting with a benefactor who dies after December 31, 2019, most designated beneficiaries have just ten years to empty the IRA account. Only spouses and a few other categories are exempt from this change. Not only will withdrawals be much larger, but they could push the beneficiary into much higher tax brackets.
The stretch provision has worked for many as an estate-planning vehicle. You might want to consult with your planner or advisor if:
- You have an IRA that you were planning to leave for younger beneficiaries as part of your retirement strategy; you may find a better way to provide for your heirs.
- You are the future beneficiary of an IRA, and you were counting on certain distributions in your long-term planning; you will want to recalculate that benefit over the SECURE Act’s shorter distribution window.
If you think we can help, let us know.
So, Who Has to Worry About the New SECURE Act?
The SECURE Act will not affect you if you inherited an IRA from someone who died before December 31, 2019. You also don’t have to worry if you are a future beneficiary and you are:
- The IRA owner’s spouse.
- A minor child, which exempts you until you become a legal adult at age 18.
- Younger than the IRA owner by ten years or less.
The SECURE Act will affect the IRA aspect of your planning if you are:
- Still contributing to traditional IRAs and think you’ll have to stop at age 70½.
- Getting near age 70½ and planning to have to start taking RMDs.
- Leaving your IRAs to a designated beneficiary who is not your spouse or other classification mentioned above.
Have questions? Reach out to Complete View Financial for an initial consultation. 210-201-6216.