In December, Congress passed new legislation known as the SECURE Act (Setting Every Community Up for Retirement Enhancement Act). The new law creates significant retirement-related changes and severely curtails what was known as the “Stretch IRA” provision for new IRA and retirement account beneficiaries. Stretch IRAs have been in the crosshairs of lawmakers for nearly a decade, and in what may go down as one of the few bipartisan acts of last year, Congress finally eliminated what had been a unique tax planning opportunity.
The two most significant changes brought by the SECURE Act, which went into effect January 1, 2020 are: 1) Changing when IRA (and other non-Roth retirement account) owners have to start taking their annual required minimum distributions (RMDs); and 2) Shortening the period over which most new retirement account inheritors / beneficiaries will have to distribute their inherited IRA or Roth IRA.
Note: Most of the changes discussed herein apply to both traditional IRAs and workplace retirement accounts. However, for brevity’s sake, I’ll subsequently refer to all impacted account types as “IRAs”.
Significant Change #1: Required Minimum Distribution Start Dates for Original IRA Owners
If you have an IRA of your own (i.e., a non-inherited IRA) AND you were not required to take a distribution in 2019 , your new required minimum distribution starting date is now the year in which you turn 72 — not the year you turn 70-1/2, as was previously the case. (I’m glad to see that 70-1/2 nonsense gone as that caused as much confusion as anything else I’ve seen!) Otherwise, if you have already started required minimum distributions from your IRA, nothing changes, and you’ll continue taking required minimum distributions as you have been. Remember: Roth IRAs are not subject to required distributions during the original owner's lifetime and that will continue to be the case going forward under the new law.
Significant Change #2: Required Distributions for Inherited Beneficiary IRAs (End of the “Stretch IRA”)
This change applies only to those who will become non-spousal IRA (and non-spousal Roth IRA!) inheritors in 2020 and beyond. If you were the beneficiary-owner of an IRA inherited in 2019 or earlier, the same distribution rules that have previously applied will continue to apply to that IRA going forward, and you can ignore what follows. However, these changes may have an impact on the eventual non-spousal beneficiaries / inheritors of your own IRA.
For most non-spousal beneficiaries inheriting an IRA (or Roth IRA) in 2020 and beyond, there is a new 10-year distribution rule. This new rule impacts both when a beneficiary must start distributions as well as the time frame over which the account must be fully distributed. Essentially, the inherited IRA must be distributed in full by the end of the 10th year following the year of the original owner’s death AND, importantly, there is no requirement to take any distributions prior to that final year. This means a non-spousal inherited IRA owner may choose to spread distributions out over the ensuing 10-years OR they may empty the entire account out in the 10th year — or any permutation thereof.
For the vast majority of non-spousal IRA inheritors, this will dramatically shorten the amount of time they have to preserve an IRA’s tax deferral and will increase the tax cost of the distributions as more IRA income will be bunched up into fewer years. (For example, a 21-year-old beneficiary who inherited an IRA on or before December 31, 2019 would have up to 62 years to fully distribute an IRA, while one who inherits an IRA on or after January 1, 2020 will have only 10 years.) This rule only applies to non-spousal beneficiaries, and there are some subtleties with respect to certain situations that I’ll exclude for simplicity’s sake. (One exception worth a mention: if the non-spouse inheritor's age is within 10 years of the original owner's age, the inheritor will not be subject to the 10-year rule and will instead be allowed to take distributions over his/her single life expectancy as is now the case.) For spousal beneficiaries—regardless of when the account is inherited, they will continue to have the option to defer required minimum distributions until their own required minimum distribution starting date. (One important caveat here: if the non-spouse inheritor's age is within 10 years of the original owner's age, the inheritor will not be subject to the 10-year rule and will instead be allowed to take distributions over his/her single life expectancy as is now the case.)
Importantly, for any client who has a trust named as an IRA beneficiary, the trust’s IRA required distribution language will need to be reviewed by a qualified attorney. The SECURE Act’s elimination of the “Stretch IRA” provision—and along with it, the removal of any distribution requirement until the tenth year after inheritance—may cause a situation at odds with the intent of the original planning. This is something we’ll also raise in our periodic review meetings, but I thought it worth a separate mention here.
Along with the two headline changes discussed above, there were several other changes brought about by the SECURE Act, although these changes will impact relatively few clients. These other changes include: removal of the age 70-1/2 age cap for traditional IRA contributions; expansion of qualified 529 withdrawal definition to include up to $10,000 per lifetime for payment of student loan debt; waiver of the 10% early IRA withdrawal penalty for IRA distributions of up to $5,000 per birth or adoption of a child; expansion of available tax credits for businesses to establish a workplace retirement plan; and the creation of a safe harbor provision for 401k plans that would like to add a lifetime income option for plan participants.
There is one additional change, not specifically related to the SECURE Act, that will go into effect in 2021: an update to the IRS life expectancy tables used for calculating distributions. This will slightly increase an IRA owner's assumed life expectancy and therefore decrease his/her annually required minimum distribution. For example, an 80-year old will see his/her required distribution drop from 5.35% per year to 4.95%, while a 90-year old's will drop from 8.77% to 8.20%. It's a small change, but never-the-less, a positive one.
This short summary is not meant to be a comprehensive discussion of the SECURE Act or its changes but should address most of the retirement-specific issues that are likely to matter to the large majority of our clients.
As we meet with you and our other clients for review, we’ll be cognizant of the changes brought about by the SECURE Act and its impact on each individual client’s situation, and we’ll be ready to discuss accordingly. In the meantime, I hope this short explanation will be helpful. As always, please let Michael or me know if you have any questions on this or if there is anything we can do for you.