The Setting Every Community Up for Retirement Enhancement Act of 2019, more commonly known as the SECURE Act, brings significant changes to retirement plans and individual retirement accounts.
One goal of SECURE is to offer workers enhancements for retirement savings, and the other is to enable employers or providers to be able to offer additional or improved retirement choices and services.
As the name implies, retirement saving vehicles for most American workers must be improved, as many folks rely too heavily on Social Security as their primary, if not only, source of income in retirement. Changes resulting from SECURE might provide some beneficial features to some, both on an individual level as well as on a company-sponsored plan. Here are the most notable changes for individuals.
1. Ability to contribute longer. SECURE has eliminated the contribution cutoff age of 70 ½ to traditional IRAs for those individuals who are still working and earning a salary. Now, contributions to a traditional IRA can be made up to the annual contribution limit ($7,000 in 2020 for workers 50 and older) or 100% of income — whichever is greater — regardless of age.
Many people now are working past the age of 70 ½, so the ability to contribute to IRAs for a longer period of time can significantly impact savings, as this contribution can be made in addition to 401(k) deferrals. In some cases, a tax deduction might also be available. However, if an account owner has taken distributions in the form of a qualified charitable distribution, which is not subject to income tax (up to $100,000), a portion of that distribution might now be subject to taxation if contributions are being deducted.
2. Increased age for required minimum distributions. Beginning in 2020, the age at which you must take distributions from a traditional IRA has been changed to 72 from 70½. As life expectancy has increased, this extension makes good sense, giving individuals an extra year and a half for savings or tax planning, because IRA distributions — except those qualifying for exceptions — are subject to ordinary income tax. This delay also allows a bit of extra time for Roth conversion considerations, as Roth conversions after the beginning of the required minimum distribution date are more complex.
3. Elimination of stretch IRAs. Those IRAs inherited from someone other than a spouse can no longer be distributed over the recipient’s own life expectancy. Now the account must be totally withdrawn within 10 years of the original owner’s death, unless an exception applies. Such exceptions include minor children recipients, disabled beneficiaries and those who are less than 10 years younger than the original account owner.
This acceleration in the withdrawal period for affected accounts might be prompted for additional tax revenue to counteract the delay in age for required minimum distributions.
In any case, you and your client may want to implement a withdrawal strategy for inherited accounts to accelerate payments in years when income or tax rates are lower, since there is now complete flexibility in the withdrawal schedule within the 10-year time period. Although growth compounding might influence individuals to wait until the final year or so to withdraw funds, the tax consequences of that strategy need to be considered. Advisors can add value when considering various scenarios for withdrawals.
4. Penalty-free withdrawal addition. SECURE has added the ability to make a penalty-free withdrawal of $5,000 from a 401(k) or IRA for the birth or adoption of a child, provided the withdrawal occurs within one year of the birth or adoption. And this withdrawal option applies to both parents. It’s worth mentioning that this opportunity can be used if the new parents have insufficient funds or savings that are not readily available.
Repayment is possible as a rollover contribution if funds are redeposited to the account within 60 days of withdrawal. But keep in mind that although the 10% penalty does not apply to the withdrawal, the distribution amount is subject to ordinary income taxation.
Providers or employers also have some additional benefits and options under the SECURE Act. Most notably affected are small businesses that might have been burdened previously by administrative or plan startup costs. Changes for those employers are designed to reduce those burdens and costs. The changes include the following.
1. Annuity choices in 401(k) plans. This option allows an employer to offer annuities, with employer liability mitigated if the underlying insurer fails to meet financial obligations. This choice benefits those workers who would like to convert savings into an income stream for life.
Given the necessary administration of this option, as well as the potential complex nature of an annuity conversion, this capability is expected to be offered gradually over the next several years. Financial advisors should be proactive in explaining these new choices — including the costs — to clients who are interested.
2. Employer tax credits. There are two tax credit opportunities for employers under the SECURE Act. First, a tax credit of up to $5,000 is available to defray a plan’s startup cost, whereas previously the amount was capped at $500. And second, employers will now realize a $500 tax credit when starting a 401(k) or SIMPLE Plan that provides automatic enrollment. This credit is in addition to the startup credit and also will be realized if the employer converts an existing plan to auto-enrollment.
3. Part-time employee inclusion. Good news for the part-timers, as employers now must allow enrollment to those workers who are 21 years of age or older with 1,000 annual hours or three consecutive years of 500 hours of service. Ease of plan administration is also promised. This rule is not effective until 2021.
4. Safe harbor plans for qualified automatic contribution arrangements. Employers typically establish a default contribution rate — the qualified automatic contribution arrangement for employee auto-enrollment. This contribution cap for businesses for such auto-enrollment is increasing from 10% to 15% for safe harbor retirement plans, except for the employee’s first year of employment. The idea behind this is to boost employee savings. Of course, employees can always change the automatic rate or opt out entirely.
5. Multiple employer plans. This feature allows multiple, unrelated small businesses to combine plans, thereby allowing participating employers to share the administrative plan costs. The plan sponsor provides the administration and fiduciary responsibilities.
And finally, although unrelated to retirement plans and IRAs, another change worthy of mention is that the SECURE Act enables 529 plan funds to be used to repay student loans up to $10,000 annually. An example where this might be useful involves a change of 529 plan beneficiary. If a student has excess 529 plan funds after graduation, the beneficiary can be changed to another qualified student to be used for loan repayment purposes.