Whether you realized it or not a big change was made in the final days of 2019 that will affect your retirement savings in 2020 and beyond. The “Setting Every Community Up for Retirement Enhancement” Act, was attached to an appropriations bill that was rushed through the house of representatives and congress to prevent another government shutdown.
What’s clear is the SECURE Act has major implications for retirement savers that will affect different communities in different ways. What’s also clear is that these new rules will not “enhance” everyone’s retirement.
These are the top 5 things you need to know about the changes resulting from the SECURE Act and how it can affect you. If you want to learn more you can read the full explanation, of the SECURE Act section by section here.
Required Minimum Distributions are starting at age 72
Required minimum distributions (RMDs) from pre-tax retirement accounts like IRAs, 401(k) and 403(b) plans can be a nuisance for many retirees. Every year we hear clients grumbling about having to take money out of their retirement accounts, and pay taxes, when they really don’t want to.
Before this rule change, RMDs generally began in the year you turn 70½. If you are still working after age 70½, RMDs from your current employer’s 401(k) or 403(b) plan may not be required until after you leave your job (unless you own 5% or more of the company).
If you are born on July 1, 1949, or later, the SECURE Act pushes the age that triggers RMDs up to 72 from 70 ½. This means you can let tax deferred retirement funds grow a bit longer before you are required to begin taking distributions and paying taxes on withdrawals.
Why raise the age to 72? Well, for one people are living longer and retiring later. The numbers behind the RMD tables are based on life expectancy and they were originally established so people could take out the required amount annually and not run out of money. While that is debatable, people living and working longer is not.
Save more for longer in your IRA, no age restrictions for making contributions
Under previous legislation, you could contribute to a Roth IRA but not a Traditional IRA after age 70½. Because there are income limitations on Roth IRAs, it meant that some people could not save into either type of IRA once they hit the age limit. With the SECURE Act these age limits have been eliminated.
People are working and living longer, so why not let them contribute to an IRA longer? That’s the thinking behind the SECURE Act’s repeal of this rule that prohibited contributions by taxpayers age 70½ and older.
While the headlines may sound good, you still need to have earned income in order to make contributions. For many, post-retirement income is passive (like rental income), so if you are no longer working or don’t have earned income, you can’t contribute to an IRA in the first place.
IRA Beneficiaries must withdraw all funds and pay taxes within 10-years
Now for some bad news. The SECURE Act eliminates the current rules that allow non-spouse beneficiaries of an IRA (such as children or siblings) to “stretch” required minimum distributions (RMDs) over their lifetime. This will affect many beneficiaries of retirement accounts in the future.
Typically, IRA beneficiaries are younger than the decedent that owned the account. Because of this, distributions calculated over the lifetime of a younger beneficiary yielded smaller required distributions, and therefore less taxes paid by beneficiaries, compared to the original owner.
Well, that’s gone now. Instead, all funds from an Inherited IRA (also known as a Beneficiary IRA) must be distributed to non-spouse beneficiaries within 10 years of the original IRA owner’s death. The rule applies to inherited funds in a 401(k), 403(b) and other defined contribution plan accounts too.
There are some exceptions to the general rule. Distributions over the life expectancy of a non-spouse beneficiary are allowed if the beneficiary is a minor, chronically ill, disabled or not more than 10 years younger than the deceased IRA owner. For minors, the exception only applies until the child reaches the age of majority. At that point, the 10-year rule kicks in.
Spouse beneficiaries of an IRA can still choose to treat the account as their own IRA and potentially delay distributions until they reach age 72.
If you are already receiving beneficiary distributions from an IRA based on your life expectancy, you’re in luck. This new rule only applies to account owners that die after January 1, 2020.
Easier eligibility for part-time employees to participate in 401(k) plans
Everyone should be saving for retirement, including part-time workers. However, under current law employers can exclude part-time employees from participating in the 401(k) who haven’t worked at least 1,000 hours during the year. That’s about to change, but businesses have a full year to prepare for this.
Starting in 2021, the SECURE Act changes the law to guarantee 401(k) plan eligibility for employees who have worked at least 500 hours per year for at least three consecutive years. The part-timer must also be 21 years old by the end of the three-year period. As women are more likely than men to work part-time, this rule change may prove to be particularly beneficial for women in preparing for retirement.
Penalty-free withdrawals for childbirth or adoption
If you have a baby on the way or are about to adopt a child, congratulations! Now it’s time to start thinking about how you’re going to pay for the birthing or adoption costs and the SECURE Act can help. If you have an IRA, 401(k) or other retirement account, the new law lets you withdraw up to $5,000 following the birth or adoption of a child without paying the usual 10% early-withdrawal penalty for distributions before reaching age 59 ½. If you’re married, each spouse can withdraw $5,000 from his or her own account, penalty-free.
Keep in mind you’ll still owe income tax on the distribution, unless you repay the funds within 60-days of taking the distribution (otherwise known as a 60-day rollover).
Although using retirement funds for childbirth or adoption expenses obviously reduces the amount of money saved for retirement, lawmakers hope this new option will encourage younger workers to start funding 401(k)s and IRAs earlier.
There’s a bit of a catch though. You will only qualify for penalty-free withdrawals after your baby is born or the adoption is finalized, and you have one year from that date to withdraw the funds from your retirement account without paying the 10% early withdrawal penalty.
The bottom line…
Overall the SECURE Act should help make saving for retirement a little easier. While we believe the benefits outweigh the drawbacks, the elimination of life expectancy distributions for IRA beneficiaries and nuanced rule changes that are likely to increase annuity offerings in 401(k) plans are rather unwelcome.
Be sure to discuss these changes with your financial advisor and tax accountant to understand how the SECURE Act might impact you.