Financial Planning: Getting Smart About The SECURE Act, Part 2

In last week's column, I discussed three key provisions of the SECURE Act that will likely affect the way you handle your IRA. These provisions went into effect on Jan. 1 and include 1) eliminating the stretch provision on inherited IRAs, 2) increasing the RMD age from 70½ to 72, and 3) allowing individuals older than 70½ to make contributions to traditional IRAs.

This week we are going to dig a little deeper into the SECURE Act. We will first look at a potential trap for IRAs that have trusts as their beneficiaries. We will then highlight some provisions of the SECURE Act designed specifically to help young people.

As I discussed in last week's column, the SECURE Act fundamentally changes the distribution rules for inherited IRAs. If you inherit an IRA after Jan. 1, all assets in your inherited IRA must be distributed before the end of the 10th year following the year of the IRA creator's death. This is referred to as the "10-year rule." There are no required minimum distributions before the end of the 10th year.

If you have designated a trust as the beneficiary of your IRA, the 10-year rule could create unanticipated problems for your heirs. For example, some trusts stipulate that only required minimum distributions will be paid to the trust and that the trust will then pass through any RMDs to the trust's named beneficiaries.

In this case, the 10-year rule means that the beneficiaries will get nothing from the IRA until year 10 and then it will come all at once. Serious tax consequences may result. In any case, if your IRA beneficiary is a trust, have your attorney review the trust language to make sure it still functions the way you intend.

The rule changes for inherited IRAs are included in the SECURE Act under the heading "Revenue Provisions," meaning they are intended to help offset the cost of certain SECURE Act benefits. Some of the benefits are targeting specifically at young people.

Saving for retirement is difficult for a lot of young people. Many wrestle with competing financial challenges and priorities, including starting a family. Given these other priorities, the idea of squirreling money away in an inaccessible retirement account is daunting. To help young families get past this hurdle, the SECURE Act provides for something called a "Qualified Birth or Adoption Distribution," or QBAD.

The QBAD allows a new parent to withdraw up to $5,000 penalty-free from his or her IRA or retirement. To qualify as a QBAD, the withdrawal must be made within one year following their child's birth or adoption and the adopted child must be younger than 18 years of age or mentally or physically incapable of self-support.

Although we do not yet have final guidance from the Treasury Department, a close reading of the SECURE Act seems to indicate that the QBAD limit is $5,000 per child per individual. In other words, if a couple has a child, they can each take $5,000 from their retirement accounts and if they have twins, they can each take $10,000.

The SECURE Act allows parents who take a QBAD to "repay" themselves later. For example, let's suppose Mary has a baby in early 2020 and decides to take a $5,000 QBAD. Let's suppose in 2021, Mary has some extra money and wants to repay her QBAD. In addition to her regular IRA or retirement plan contribution, the SECURE Act allows Mary to re-contribute the $5,000 she took as a QBAD in 2020.

Other provisions of the SECURE Act aimed at helping young people include changes to the rules for 529 plans. Under the act, qualified higher education expenses now include expenses for apprenticeship programs including books, supplies and required equipment as long as the program is appropriately registered and certified by the Department of Labor.

In addition, up to $10,000 of 529 plan money can be used to pay student loan principal or interest. An additional $10,000 can be used to repay student loan debt for each of the 529 beneficiary's siblings. These are per-person lifetime limits.

Changes to the 529 plan rules are retroactive to the beginning of 2019.

Steven C. Merrell is an investment adviser and partner at Monterey Private Wealth Inc., in Monterey. Send questions concerning investing, taxes, retirement or estate planning to Steve Merrell, 2340 Garden Road Suite 202, Monterey 93940 or smerrell@montereypw.com.