On December 20, 2019 a new Act was signed in law that advisors should understand.
The Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act) includes provisions aimed at helping people save for retirement. It includes increasing access to tax-advantaged accounts, as well as opportunities to help prevent older Americans from outliving their assets in retirement.
This is the second legislative tax or retirement reform in the past 2 years, and it will likely have significant impact on how financial advisors help clients plan for their retirement for years.
First, we’ll tackle the top 8 facts advisors should know about the SECURE Act. After each, we’ll share a practical, actionable step advisors can take.
1. Required Minimum Distribution Age Has Increased to 72
The SECURE Act pushes back the onset of RMDs from age 70 ½ to age 72. This should make it a bit easier for advisors to explain when RMDs begin, as well as the calculation of the first RMD.
Individuals age 70 ½ before 12/31/2019 will still need to continue to take required minimum distributions (RMD). There is no waiver for the IRA owner from taking RMD distributions.
For those individuals who reach age 72 after 12/31/2019, the first RMD can be delayed until April 1 of the following year. However, if RMD is delayed (and not taken in the first year), another (second) RMD is required for distribution by the end of the same year.
Anyone taking RMDs under the old rule cannot suspend (or skip a year) under the new rule.
Practical Step Advisors Can Take: Revisit any RMD plans for clients about to be age 70 ½. This change is a slight advantage for your clients born in the first half of the year. Pushing back to age 72 earns them 2 extra years of no RMDs. Those clients born in the second half of the year will see their first RMD year shifted back by 1 year.
Although most of your clients will not be affected by the change in RMD starting age, those that are may change their retirement-saving projections knowing that they have extra time to benefit from the tax-free investment growth of a retirement plan.
2. After Death “Stretch” IRAs Now Have 10-Year Limit
As you likely know, a “stretch” IRA isn’t a type of IRA; it’s a strategy to stretch the after-death distributions of an inherited IRA over the non-spousal beneficiary’s lifetime. This defers paying taxes on the entire amount and helps pass an IRA to multiple generations.
The SECURE Act mandates that most non-spouses inheriting IRAs take distributions that end up emptying the account in 10 years. The change introduces a tax burden for the beneficiary who is still earning an income. Exceptions: a surviving spouse, a minor child of the decedent (until they reach the age of majority), a disabled person, a chronically ill individual, beneficiaries less than 10 years younger than the decedent (sibling or friend, for instance).
In general, the SECURE Act’s “stretch” rule changes take effect in 2020. There are some exceptions, however.1
- January 1, 2022, is the effective date for plans maintained pursuant to a collective bargaining agreement (unless it terminates sooner).
- January 1, 2022, is when governmental plans — 403(b) and 457 plans sponsored by state and local governments and Thrift Savings Plans — are impacted
- Completely exempt — deaths that occurred in 2019 or prior are still under the former rules; life expectancy (stretch) distribution for any beneficiary may continue, or 5 year distribution. Also, non-qualified annuities are unaffected by the new legislation.
Practical Step Advisors Can Take: Review beneficiary designations on all tax-qualified accounts. Many beneficiaries (children, grandchildren, and certain trusts) should be aware that instead of stretching out the death benefits (and deferring income tax payments), the timeframe for taking after-death distributions from an account is now 10 years.
Advisors should also review any situations where trusts are named as retirement account beneficiaries. These are typically drafted to comply with “See-Through Trust” rules, which lets the trust stretch distributions over the oldest trust beneficiary. Two types of trusts — Conduit Trusts and Discretionary Trusts — could be unfavorably impacted by the SECURE Act.
Advisors should encourage any client with a trust to have it reviewed by their attorney. In an effort to preserve maximum income tax deferral and avoid surprising consequences of the SECURE Act, most estate plans drafted prior to the act’s passage should be examined closely.
3. Annuity Options Are Now Possible Within Employer Retirement Plans
Changes by the SECURE Act make annuity options more attractive within 401(k) and similar defined contribution plan investments. A significant change provides for a Fiduciary Safe Harbor for ERISA fiduciaries selecting a “lifetime income provider” (an annuity company).
The SECURE Act releases employers from liability if it selects an annuity provider that meets certain requirements. An ERISA fiduciary can select an annuity provider after engaging in an “objective, thorough, and analytical search” of carriers.
When it comes to the question of portability — what would happen to an employee’s plan who selected the annuity option if an employer drops the annuity option from the plan? — the SECURE Act removes former unpleasant options (including liquidating the annuity) by creating an annuity-only “distributable event.”1
In addition to a death, separation of service, or reaching age 59 ½, removal of an annuity provider from an employer plan allows for distribution or rollover in-kind of the funded 401(k) annuity beginning 90 days prior to the annuity’s elimination as a plan investment option. This is for plan years beginning on or after January 1, 2020.1
Practical Step Advisors Can Take: Bring up annuities with your clients in a new way. Employees may seek the guidance of financial advisors as they consider annuity options. They may want to know how they work and which type may be right for them.
Let those already participating in plans know that they’ll be seeing an estimate (based on their current account balance) of what they could receive monthly with a single or joint life annuity. The employer has immunity related to the income projections. This goes into effect at a later date, after the Department of Labor reviews the certain requirements.
4. Auto-Enrollment for 401(k) Plans Increases from 10% to 15%
Speaking of employer retirement plans, the SECURE Act raises the maximum contribution rate that employers can set for employees participating in auto-enrollment 401(k) plans. In a QACA (qualified automatic contribution arrangement), the employer sets a default contribution rate for participating employees. Even though that maximum is now 15%, employees can change the contribution rate to whatever they see fit.1
Practical Step Advisors Can Take: Inform clients who may be new to 401(k) participation about this increase. Automatic enrollment has contributed to increased participation in employer plans. And automatically increasing contribution rates typically results in more contributions to the plan.1
Also let your clients know that if they choose the employer’s default option, the contributions will automatically increase each year he/she is in the plan.
5. IRA Contribution Change Allows For Longer Tax-Deferred Growth
The new law repeals prohibition on contributions for those age 70½ or older. Now, anyone who is employed (or has earned income) in 2020 can contribute toward a traditional or spousal IRA…indefinitely.
As you likely know, Roth plans have never had age limits for contributions.
Practical Step Advisors Can Take: Encourage older working clients to participate. Even if an employee hasn’t contributed to an IRA in the past, he/she can contribute beginning at any time. The Act allows anyone working and earning compensation to contribute. Of course, contribution limits apply.
This may not apply to many of your clients, but those it does should be relieved to know that they can continue contributing to retirement plans past the age of 70½ as long as they’re still working.
6. Employer-Sponsored Retirement Plans Now Accessible to Long-Term Part-Time Workers
Long-term part-time workers may be looking forward to 2021. That’s when the new law makes employer-sponsored retirement plans available to them. The minimum number of hours someone has to work to be eligible changes to either A.) 1 full year with 1,000 hours worked, or B.) 3 consecutive years of at least 500 hours; which is about 9 ½ hours per week over 52 weeks.
Practical Step Advisors Can Take: Discuss with clients who are long-time part-timers. Prior to the SECURE Act, employers weren’t required to offer participation in their sponsored plan if the employee worked less than 1,000 hours every year, which is about 19 hours per week over 52 weeks.
Part-time workers must be 21 years old by the end of the 3-year period to be eligible for the plan.
7. Penalty-Free Withdrawals for Birth or Adoption
Parents expecting or adopting a child can get financial help from their IRAs without incurring a penalty. Individuals can withdraw up to $5,000 from qualified plans — 401(k) and IRAs — with married couples able to withdraw up to $10,000 penalty-free.2
The withdrawal needs to take place within 1 year from the birth or adoption date of the child. Taxes are still owed on the withdrawal, but it can be reinvested in the future and be treated as a rollover, not taxable income.2
Repayment as a rollover contribution to an IRA is permissible without regard to the 60-day requirement. This is effective for distributions made after 12/31/2019.
Practical Step Advisors Can Take: New parent clients may appreciate knowing of this opportunity. The SECURE Act’s penalty-free withdrawals of $5,000 ($10,000 for married couples) from 401(k) accounts can help defray the costs of having or adopting a child.
If adopting, the child generally needs to be younger than 18 years old or physically or mentally incapable of self care to avoid the 10% penalty.
8. Student Loans Can Now be Paid with 529 Plan Money
Parents can save for their children’s future education using tax-advantaged 529 plans. The SECURE Act expands these 529 education savings accounts. Students can now withdraw up to $10,000 from 529 plans every year penalty-free to pay off student loans or to cover costs associated with registered apprenticeships.2
Normally, taking a withdrawal from a 529 plan to cover non-qualified expenses triggers a 10% penalty on the earnings. Plus, there’s income taxes on the distribution.
Limitations reduce the $10,000 by the amount of distributions, so it’s treated for all prior taxable years. This is effective for distributions made after 12/31/2018.
Practical Step Advisors Can Take: Tell clients they can withdraw 529 savings tax-free to cover qualified education expenses. In a sense, the SECURE Act expands the meaning of “qualified expenses,” which now includes student loan payments and apprenticeship program costs.2
So, leftover 529 plan funds can be used to pay off student loan debt. Or, if college isn’t the right choice post-high school, funds can help set a different path (apprenticeship).
Other highlights of the SECURE Act
Those are the “great 8” facts that advisors need to know, but the new law is loaded with details.
For instance, the definition of “compensation” has changed. For tuition and stipend payments, compensation includes any amount an individual is paid to aid the individual in the pursuit of graduate or postdoctoral study. This is effective for taxable years beginning after 12/31/2019.
For difficulty of care payments, individuals providing foster care and receiving qualified foster care payments may make after-tax contributions. The tax-exempt difficulty of care payments are treated as compensation. This is effective for plan years beginning after 12/31/2015. This change is retroactive; if a client had foster care income in 2019, they could do a prior year IRA contribution based on this change.
Regarding natural disasters, before the SECURE Act, distributions from qualified plans or IRAs before age 59 ½ generally were subject to a 10% penalty tax (unless an exception applied). After the SECURE Act, for natural disasters that occurred between 2018 and 2019, withdrawals are penalty-free up to $100,000 with a ratable income inclusion over 3 years, and repayment is permissible within 3 years. This is considered a rollover for IRAs.
The SECURE Act could boost and protect retirement savings for millions of Americans, and it may prompt a review of income, especially for significant savers who want to reduce future tax bills, either for themselves or their heirs. Smart and efficient retirement tax planning could result in more account growth time and a larger nest egg to pass along.
As much as The SECURE Act can help with retirement planning, current rules may not be helping enough older Americans save what they need for a secure retirement. In fact, many of your clients may not be financially ready to retire. Are Your Clients Facing a Retirement Income Crisis? helps you understand their situations and present valuable options.
Written by: Marshall Heitzman, CFP®, ChFC, FLMI, CPCU, BFA™
Marshall is CUNA Mutual Group's Head of Advanced Planning and has more than 25 years experience in the insurance and financial services industry. He consults Financial Advisors on advanced retirement planning concepts for retirement and wealth management clients.
1Kitces.com, SECURE Act And Tax Extenders Creates Retirement Planning Opportunities And Challenges, December 23, 2019
2SmartAsset, What Is The SECURE Act?, January 14, 2020