Executive Summary
Sweeping legislative tax or retirement reforms typically happen only once every decade or so, but the final weeks of 2019 brought the second major piece of Congressional action in the past 24 months, as the SECURE Act (along with a series of year-end tax extenders), which was passed in the House this past summer, finally made its way through the Senate and was signed into law by the President. The legislation will have substantive repercussions as financial advisors help clients plan for their retirements for years to come.
In the context of financial advisors and the clients they serve, the first, and probably most notable change resulting from the SECURE Act, is the elimination of the so-called “stretch” provision for most (but not all) non-spouse beneficiaries of inherited IRAs and other retirement accounts. Under current law, non-spouse designated beneficiaries can take distributions over their life expectancy, but for many retirement account owners who pass away in 2020 and beyond, beneficiaries will have ‘only’ 10 years to empty the account. On the one hand, without any other distribution requirements within those 10 years, designated beneficiaries will have some flexibility around the timing of those distributions; however, certain types of “see-through” trusts that have been drafted to serve as beneficiaries of retirement accounts may find that they’re no longer able to make annual distributions to the trust under the new rules (only to suddenly have both the IRA and trust forcibly liquidated at the end of the 10-year window).
Other notable retirement planning changes under the SECURE Act include lifting the restriction on making contributions to a traditional IRA after age 70 ½ (as long as there is earned income to contribute in the first place), and an age increase for the onset of RMDs from age 70 ½ to age 72. However, as was the case with the IRS’s recent proposal to update the RMD life-expectancy tables, since only about 20% of retirees take no more than only the amount that they’re actually required to take, any changes in the rules around RMDs will have little effect on the remaining 80% who are already withdrawing more out of their accounts than the IRS requires. In addition, the SECURE Act does not change the age at which an individual can make a Qualified Charitable Distribution from their IRA, which remains at age 70 ½ and now creates a unique 1- or 2-year window where IRA distributions may qualify as charitable contributions, but not as RMDs (that haven’t yet begun).
Beyond the changing or elimination of various age-based thresholds for retirement accounts, the SECURE Act also includes an allowance for a penalty-free distribution up to $5,000 for a qualified birth or adoption, the creation of a Fiduciary Safe Harbor for selecting a “Lifetime Income Provider” (i.e., annuity company) for ERISA fiduciaries (thus assuaging at least some liability concerns around using lifetime income annuities in qualified plans), a substantial increase in the tax credit available to small businesses when establishing a retirement plan (as well as a brand new tax credit for small businesses that adopt an “auto-enroll” provision in their retirement plans), an increase in the allowable auto-enrollment “default” 401(k) plan contribution, improved access to employer plans for long-term part-time workers, and a significant reduction in the barriers to creating and maintaining Multiple Employer Retirement plans (which in theory will help to create economies of scale for lower plan costs when a group of small employers band together to provide a retirement plan)… as well as several other miscellaneous, smaller retirement provision changes.
Other notable non-retirement provisions attached to the SECURE Act include a repeal of the TCJA-introduced Kiddie Tax changes (reverting away from a requirement to use trust tax brackets and back to using the parents’ top marginal tax bracket), adjustments to the medical expense deduction threshold (back to 7.5%-of-AGI again for 2019 and 2020!), expanded provisions for 529 college savings plans to be used for Apprenticeships and (up-to-$10,000 of) student loan repayments, and a series of Tax Extenders for the mortgage insurance premium deduction and the higher education tuition and fees deduction.
Ultimately, the key point is that, although not nearly as sweeping as the Tax Cuts and Jobs Act of 2017, the SECURE Act of 2019 makes numerous updates to the rules around retirement plans in an effort to increase access to employer-sponsored retirement plans, and (hopefully) takes a positive step towards addressing the so-called retirement crisis. But as with other legislation in recent years, what legislation may give with one hand, it takes with the other, and in practice, many financial advisors may spend more time dealing with what is lost under the SECURE Act – in particular, the stretch IRA – than what is gained. At the very least, though, financial advisors will be busy in months ahead as they re-evaluate plans for clients impacted by the new and updated provisions introduced by the SECURE Act.
It appeared that as the clock was about to strike midnight last Wednesday, the proposed Setting Every Community Up for Retirement Enhancement (SECURE) Act (Division O of HR 1865) would turn into a pumpkin once again. After months of speculation about the bill’s future, since passing the House in the summer of 2019, it appeared that being stuck in the grind of Washington was a fait accompli.
But at the last moment, a final push by some in Washington (including, no doubt, a fair amount of lobbyists), got the SECURE Act attached to a year-end appropriations bill that Congress ‘had’ to pass (and ultimately did on Thursday, December 19) in order to keep our government up and running.
Thus, the bill which seemed destined to remain in legislative purgatory for the foreseeable future was suddenly whisked back to life, quickly passed by both the House and Senate and sent to the President’s desk to be signed.
In analyzing the extent of the SECURE Act’s changes, they are not nearly as broad and as substantial as the Tax Cuts and Jobs Act passed two years ago. But that said, the changes may be just as impactful to many taxpayers, particularly those with substantial tax-favored retirement savings.
In addition, a second bill included in the appropriations package, the Taxpayer Certainty and Disaster Relief Act of 2019, also has implications for certain retirement savers.
What follows is an analysis of not every section of the legislation, but the major changes made by these laws which are most likely to impact financial advisors in planning for and with their clients.
Ding, Dong, The ‘Stretch’ Retirement Account is Dead (Replacing With A New 10-Year Rule)
One of the most significant changes made by the SECURE Act to impact financial advisors is the elimination of the ‘Stretch’ provisions for most non-spouse beneficiaries of defined contribution plans and IRA accounts (HR 1865, Sec. 401)… a popular retirement-and-estate planning provision that has been under threat of elimination since first proposed in legislation all the way back in 2012.
Under current law for those who have already passed away (or do by the end of 2019), designated beneficiaries (generally, living human beings, and certain qualifying trusts) are eligible to stretch distributions over their life expectancy (or in the case of a qualifying trust, over the oldest applicable trust beneficiary’s life expectancy).
However, for most designated beneficiaries who inherit in 2020 (i.e., where the retirement account owner themselves dies in 2020 and beyond), the new standard under the SECURE Act will be the ‘10-Year Rule’.
Under this 10-Year Rule, the entire inherited retirement account must be emptied by the end of the 10th year following the year of inheritance. Similar to the existing 5-year rule for non-designated beneficiaries, though, within the 10-year period, there are no distribution requirements. Thus, designated beneficiaries will have some flexibility when it comes to timing distributions from the inherited account(s) for maximum tax efficiency… as long as the entire account balance has been taken by the end of the 10th year after death.
Example 1: On January 20, 2020, Josh’s father passed away, leaving Josh his $400,000 IRA. Josh, who is currently age 60, is still working and earns roughly $150,000 per year, but plans to retire in 5 years, at age 65.
Given the fact that Josh’s income will substantially decrease when he retires, it may make sense for him to avoid taking any distributions from the inherited IRA while he is still working (i.e., during the first 5 years of the distribution window provided by the 10-Year Rule). Instead, he can opt to distribute the funds during years 6-10, when he expects his income to be much lower after his wages are gone (and before he begins Social Security benefits).
Eligible Designated Beneficiaries Not Subject To The New 10-Year Rule
Notably, while the new general rule under the SECURE Act will be the 10-Year Rule, there are five groups of designated beneficiaries to which the new 10-Year Rule will not apply.
These beneficiaries, referred to as “Eligible Designated Beneficiaries”, are:
- Spousal beneficiaries;
- Disabled (as defined by IRC Section 72(m)(7)) beneficiaries;
- Chronically ill (as defined by IRC Section 7702B(c)(2), with limited exception) beneficiaries;
- Individuals who are not more than 10 years younger than the decedent
- Certain minor children (of the original retirement account owner), but only until they reach the age of majority.
For these Eligible Designated Beneficiaries, it’s ‘business as usual’ – the same rules that applied to them before the SECURE Act will continue to apply after the SECURE Act. They can take distributions over the beneficiary’s life expectancy (and spousal beneficiaries may still engage in a spousal rollover as well). As a result, the ‘Stretch’ isn’t truly ‘dead’, but it will only live on via a small percentage of post-2019 beneficiaries.
In the case of the “Special Rule for Minor Children”, though, the Eligible Designated Beneficiary category is only a limited reprieve, as such minor children will be able to take age-based requirement minimum distributions… until they reach the age of majority, and then the 10-year rule still ‘kicks in’.
It is important to emphasize that the Special Rule for Minor Children applies only to the “child of the employee [or IRA owner] who has not reached majority”. As such, minor children would appear to be ineligible for similar treatment if a retirement account was inherited from a non-parent, such as a grandparent.
Example 2: Jed is a 40-year-old IRA owner with a 5-year-old daughter. The age of majority in the state where Jed and his daughter live is 21.
Sadly, Jed dies is an auto accident, and leaves his IRA to his daughter. His daughter will have to take ‘regular’ lifetime RMDs, beginning the year after she inherits, until she reaches age 21. Once she turns 21, the 10-year rule will apply, requiring the entire inherited IRA to be fully depleted over the next decade (i.e., by the end of the year in which she turns 31).
New Planning Challenges For Trusts Named As Retirement Account Beneficiaries
It is always good practice for all beneficiary designations of retirement accounts to be periodically reviewed to see if they are still in line with, and best serve, the account owner’s wishes. However, the changes introduced by the SECURE Act will make it even more necessary to review any situations where trusts are named as retirement account beneficiaries.
In general, trusts created to serve as the beneficiary of a retirement account are drafted in such a manner as to comply with the “See-Through Trust” rules, which allow the trust to stretch distributions over the oldest applicable trust beneficiary. Broadly speaking, there are two types of such trusts; Conduit Trusts and Discretionary Trusts. Both types of trust could be unfavorably impacted by the SECURE Act.
For instance, many Conduit Trusts are drafted in a manner that only allows for the required minimum distribution to be disbursed from an inherited IRA to the trust each year, with a corresponding requirement for that amount to be passed directly out to the trust beneficiaries. In light of the changes made by the SECURE Act, for those beneficiaries subject to the 10-Year Rule, there is only one year where there is an RMD… the 10th year!
As a result of this change, Conduit Trusts drafted with language similar to that referenced above might not allow the trustee to take any distributions of the inherited account until the 10th year after death (because prior to that 10th year, any IRA distributions would be ‘voluntary’). And then, in the 10th year, the entire balance would have to come out in one year to the trust… and be passed entirely along to the trust beneficiaries (as a mandated RMD that under the Conduit provisions ‘must’ be passed through). The end result could be what would amount to a very high tax bill, as the entire value of the retirement account is lumped into a single tax year as a distribution to the beneficiary. Not to mention the loss of any protection of such assets (after they are distributed from the trust).
Discretionary Trusts may not fare much better though, if at all. Such trusts often require that all, or a substantial portion of retirement account distributions, remain in the trust (and not distributed out to the trust beneficiaries). In such circumstances, amounts retained by the trust are subject to trust tax rates, which are highly compressed as compared to individual tax rates.
For example, in 2019, trusts reach the highest Federal tax bracket of 37% at just $12,750 of taxable income! Given that such trusts will have, at best, 10 years to spread out distributions from inherited retirement accounts (since an accumulation trust itself would now often be subject to the 10-year rule, as a See-Through-But-Likely-Not-Eligible-Designated-Beneficiary Trust), significant amounts of wealth could evaporate in the form of high trust taxes.
Individuals may not want their beneficiaries to burn through their inheritance (hence the possible need for a trust in the first place), but it is even less likely that they want the IRS to do so instead!
Notably, it is not yet clear whether the IRS will allow all See-Through Trusts to actually see through the trust to an Eligible Designated Beneficiary. The SECURE Act specifically provides that such trusts can (subject to certain rules) be treated as an Eligible Designated Beneficiary when the applicable trust beneficiary is a disabled or chronically ill person. The law is silent, however, as to how a trust benefiting other Eligible Designated Beneficiaries (i.e., a spouse, a minor child, or a beneficiary within 10 year of the deceased retirement owner's age) should be treated. Thus, it remains ambiguous. Future IRS guidance will likely be needed to address this question.
The Effective ‘Stretch’ Date For Collective Bargaining Agreement, TSP, and other Government Plans is January 1, 2022
For the most part, the changes to the ‘Stretch’ rules created by the SECURE Act will impact beneficiaries beginning in 2020. However, Congress did carve out a few exceptions to this rule, as follows:
- Plans maintained pursuant to a collective bargaining agreement have an effective of January 1, 2022 (unless the collectively bargained agreement terminates sooner).
- Governmental plans, such as 403(b) and 457 plans sponsored by state and local governments, and the Thrift Savings Plan sponsored by the Federal government (and in which Congresspersons, themselves, participate) are not impacted until January 1, 2022.
- Annuities in which individuals have already irrevocably annuitized over a life or joint life expectancy, or in which an individual has elected an irrevocable income option that will begin at a later point, are exempt entirely (and simply follow the already-binding contractual provisions of the annuitized contract).
Required Minimum Distributions (RMDs) To Begin At 72
Another big headline from the SECURE Act (Section 114) is a shift to push back the onset of RMDs from age 70 ½ to age 72. It’s not a huge change, but any RMD relief is welcome news for those who don’t want them and will only take them because they are forced to do so.
As an added benefit, people understand the concept of turning 72 a lot more than they do turning 70… and ½ (and figuring out their first RMD age factor, which in turn varied depending on whether their birthday was in the first or last 6 months of the year, due to the ½ year age trigger). Therefore, explaining when RMDs need to begin, and the calculation of the first RMD, should become at least a little bit easier for advisors in the future.
Mirroring current law, individuals upon reaching the requisite age (now age 72 instead of 70 ½) will still be able to delay their first RMD until April 1 of the year following the year for which they must take their first RMD (the required beginning date). Thus, an individual turning 72 on September 2, 2021 can timely take their first RMD until as late as April 1, 2022. However, if the first RMD is not taken in the year an individual turns 72, but is instead taken the following year (by April 1), a second RMD will also still need to be distributed that year (the year the individual turns 73) by the end of the year. But either way, the first age-72 RMD will always be calculated using the age 72 life expectancy factor.
Interestingly, this change actually (slightly) favors those who were born in the first half of the year, as the pushing back to age 72 ‘buys’ them two extra years of no-RMDs as compared to existing law. By contrast, those who are born in the second half of the year, where their first RMD is effectively for age 71 (as they reach age 70 ½ in the year they subsequently turn 71) will see the year in which they must begin taking RMDs shifted back by ‘just’ one year.
Notably, this change to the new required beginning date for RMDs only applies to those individuals who turn 70 ½ in 2020 or later. So even though an individual turning 70 ½ on December 20, 2019 will not yet be 72 in 2020, they will still be required to continue RMDs under the existing rules, and to take an RMD for 2020 (and each year thereafter).
Qualified Charitable Distributions (QCDs) Still Allowed At 70 ½
Since the SECURE Act was first passed by the House of Representatives during the summer of 2019, one of the most common questions has been “Will pushing back RMDs to 72 also mean that QCDs cannot be made until 72?” The answer is an emphatic “No.”
The SECURE Act makes no changes to the date at which individuals may begin to use their IRAs (and inherited IRAs) to make QCDs. Thus, even though an individual turning 70 ½ in 2020 will not have to take an RMD for 2020, they may still use their IRA to make a QCD of up to $100,000 for the year (after actually turning 70 ½ or later). Beginning in the year an individual turns 72, any amounts given to charity via a QCD will reduce the then-necessary RMD as well (while in the prior 1-2 years, it will simply allow the pre-tax IRA to be used for charitable contributions directly on a pre-tax basis).
New Exception To The 10% Early Withdrawal Penalty For Childbirth And Adoption
Section 113 of the SECURE Act introduces a new exception to the 10% early distribution penalty to the mix. More specifically, the exception allows up to $5,000 to be distributed penalty-free from an IRA or from a plan as a “Qualified Birth or Adoption Distribution”.
To meet the requirements of a Qualified Birth or Adoption Distribution, an individual must take a distribution from their retirement account at any point during the one-year period beginning on either the date of birth, or the date on which the adoption of an individual under the age of 18 is finalized.
Given this limitation, a Qualified Birth or Adoption Distribution will only be able to provide financial assistance once the qualifying event has occurred (i.e., account owners can’t take such a distribution to pay for initial adoption expenses prior to the date the adoption is finalized). On the other hand, the rules only stipulate that the distribution must occur after the qualifying event, which means an individual could still take a Qualified Birth or Adoption Distribution after the event to help replace the cash previously spent. In fact, the rules don’t even require that the distribution directly tie to qualifying expenses at all, merely that the distribution occurs after a qualifying event.
In addition, the $5,000 limit is a limit “with respect to any birth or adoption…”, and as such, appears to ‘replenish’ itself with each new birth or adoption (i.e., the $5,000 is a per-child limit). Furthermore, the exception applies on an individual basis. Therefore, if both of a child’s parents have available retirement assets, each can make a Qualified Birth or Adoption Distribution of up to $5,000 for each child born/adopted.
Finally, in the event a parent who took a Qualified Birth or Adoption Distribution is later able to “repay” such amount, they may do so back to the plan from which the distribution was made, or to an IRA. In other words, to the extent prior Qualified Birth or Adoption Distribution(s) have been made, those individuals will have the opportunity to make an additional contribution – over and above the standard contribution limits – to ‘repay’ themselves. Though notably, interested individuals may wish to wait for what will likely be future Treasury Regulations that explain the exact timing rules for such ‘re-contributions’.
Traditional IRA Contributions No Longer Prohibited At (And Beyond) Age 70 ½
In more good news for those closing in on age 70 ½, Section 107 of the SECURE Act lifts the prohibition on Traditional IRA contributions once an individual reaches the year in which they turn 70 ½. Which is significant because under current law, Traditional IRAs are the only retirement account for which contributions are not permitted due to (old) age in the first place!
Thus, beginning in 2020, individuals of any age will be allowed to contribute to a Traditional IRA. The requirement that such individuals have “compensation” – which is generally earned income from either wages or self-employment – to make such a contribution remains, though. As such, in general, only those individuals who are 70 ½ or older and who are still working (or who have a spouse that is still working and are contributing under the Spousal IRA rules), will be able to take advantage of this change.
The SECURE Act also contains an anti-abuse rule that coordinates post-70 ½ deductible Traditional IRA contributions with QCDs. Under the rule, any QCD will be reduced by the cumulative amount of total post-70 ½ deductible Traditional IRA contributions (but not below $0) that have not already been used to offset an earlier QCD. Effectively ensuring that individuals don’t just ‘recycle’ post-70 ½ IRA contributions into subsequent QCDs.
Example 3: Toby turns 70 ½ in 2020, but is still working part-time, earning $15,000 per year. In order to minimize his taxable income, Toby makes a $7,000 (including his over-age-50 catch-up) deductible contribution to his Traditional IRA. He continues to do the same for three more years (for a total of $28,000 of post-70 ½ Deductible Traditional IRA contributions), at which point he retires.
In 2027, Toby has an unusually large charitable streak and decides to make a $40,000 ‘QCD’, his first such distribution, to charity. Despite following all the QCD rules, Toby will ‘only’ be entitled to claim a QCD of $40,000 - $28,000 = $12,000. The remaining $28,000 given to charity can be claimed as an itemized deduction.
Annuity-Related Rule Changes For 401(k) And Other Employer Retirement Plans
Those who have followed the SECURE Act closely are likely to be familiar with the fact that the insurance industry gave it rather full-throated support. And it’s no surprise why – several changes made by the SECURE Act make it much more likely that annuity options will work their way into 401(k) and similar defined contribution plan investment lineups.
Fiduciary Safe Harbor For The Selection Of A Lifetime Income (Annuity) Provider
Of all the annuity-related changes made by the SECURE Act, perhaps the most significant is Section 204, which provides for a Fiduciary Safe Harbor for ERISA fiduciaries selecting a “Lifetime Income Provider” (i.e., an annuity company).
To date, many ERISA fiduciaries have avoided including lifetime income annuities as plan investment options, largely out of fear that, at some time in the future, the annuity carrier could run into financial problems that jeopardize its ability to meet its obligations, and that such a failure could result in a liability for the plan and/or plan fiduciaries for having picked that turned-out-to-fail annuity provider in the first place. In fact, while there is nothing preventing the use of annuities inside 401(k) plans today, concerns like this are a large reason why it’s estimated that less than 10% of such plans include an annuity as an investment option.
The SECURE Act assuages this fear by creating new Section 404(e) of ERISA. This new Section provides that an ERISA fiduciary can meet the requirement outlined by ERISA Section 404(a)(1)(B) – to act “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims” (the “prudent man rule”) – when selecting an annuity provider by engaging “in an objective, thorough, and analytical search” of carriers.
More specifically, fiduciaries will be required to satisfy two requirements when conducting such an annuity provider search.
First, they must review “the financial capability of [an] insurer to satisfy its obligations” and determine that “at the time of the selection, the insurer is financially capable of satisfying its obligations under the guaranteed retirement income contract”.
In what is a concerning provision to some, however, all that a plan fiduciary needs to do in order to arrive at this ‘conclusion’ is obtain a number of written representations from the insurer, itself! Such representations include that the insurer:
- Is properly licensed;
- Has met certain State insurance requirements for the year in question, along with the previous 7 years;
- Undergoes appropriate financial examination no less than once every five years; and
- Will notify the fiduciary of any changes to the above.
So long as a plan fiduciary has obtained these representations from an annuity carrier and has no reason to believe that such representations are inaccurate, they will be deemed to have met the can-meet-their-financial-obligations analysis part of the safe harbor requirement. In addition, such fiduciaries can continue to meet this requirement by obtaining updated representations from an insurer at least annually.
The second requirement of the SECURE Act’s new ERISA fiduciary safe harbor for lifetime income is that the fiduciary is to determine that “the cost (including fees and commissions) of the guaranteed retirement income contract offered by the insurer in relation to the benefits and product features” is “reasonable”. The SECURE Act goes on to emphasize, however, that there is no requirement for a fiduciary to select the least expensive option. Rather, new ERISA Section 404(e)(3) states:
“NO REQUIREMENT TO SELECT LOWEST COST.—Nothing in this subsection shall be construed to require a fiduciary to select the lowest cost contract. A fiduciary may consider the value of a contract, including features and benefits of the contract and attributes of the insurer (including, without limitation, the insurer’s financial strength) in conjunction with the cost of the contract.”
By completing the limited actions outlined above, fiduciaries of ERISA plans are able to obtain a substantial amount of liability protection, as described in new ERISA Section 404(E)(5):
LIMITED LIABILITY.—A fiduciary which satisfies the requirements of this subsection shall not be liable following the distribution of any benefit, or the investment by or on behalf of a participant or beneficiary pursuant to the selected guaranteed retirement income contract, for any losses that may result to the participant or beneficiary due to an insurer’s inability to satisfy its financial obligations under the terms of such contract. [emphasis added]
Portability Of Lifetime Annuity Income Options
While perhaps not as much of a barrier as the potential fiduciary liability (largely alleviated by the aforementioned safe harbor) of selecting an annuity provider as a plan investment option, a second significant issue that has prevented many plans from incorporating them into the investment mix is concerns over portability. More simply, what, for instance, would happen if existing or prior employees had already selected the annuity option, and the employer wanted to drop the annuity as an option from the plan (or merge into another company that didn’t include such an option in their plan)?
Under current law, participants who elected to invest in such options would often be left with a number of unpleasant options, such as liquidating the annuity.
The SECURE Act resolves this situation by creating a new ‘distributable event’ (e.g., separation of service, death, attainment of age 59 ½) that applies just to annuities when they are no longer allowed as an investment option within a plan. In such situations, participants will be allowed to distribute their plan annuity, in-kind, beginning 90 days prior to the elimination of the annuity as a plan investment option.
This provision is effective for plan years beginning on or after January 1, 2020.
Provisions To Encourage The Adoption And Use Of Retirement Plans Amongst Small Businesses
The annuity-related plan provisions were far from the SECURE Act’s only changes for plans. Some important provisions were also made for small businesses to further encourage their adoption and use of employer retirement plans for their employees.
Small Businesses Can Get A (Bigger) Tax Credit For Establishing A Retirement Plan
Under current IRC Section 45E, small businesses are eligible for a credit of up to $500 for up to three years for startup costs related to establishing a small business-sponsored retirement plan, such as a 401(k), 403(b), SEP IRA or SIMPLE IRA. Such businesses are defined (under IRC Section 408(p)(2)(C)(i)) as businesses with 100 or fewer employees receiving $5,000 or more of compensation.
Section 104 of the SECURE Act substantially increases in the potential credit amount available.
For tax years beginning January 1, 2020, the maximum credit available under IRC Section 45E (for up to three years) will be increased to the greater of:
- $500; or
- The lesser of:
- $250 × the number of non-highly-compensated employees eligible to participate in the plan; or
- $5,000.
Example 4a: West End Hardware has recently opened. Its owner is considering establishing an employer-sponsored retirement plan to cover himself, as well as his one employee, who is not highly compensated. If West End Hardware adopts a 401(k) plan, and its one non-highly-compensated employee is eligible to participate, it will be eligible to receive a credit of up to $500.
Example 4b: On The Wings Of Love Wedding Chapel has recently opened. Its owner is considering establishing an employer-sponsored retirement plan to cover herself, as well as her 14 employees, none of whom are highly compensated. If On The Wings Of Love Wedding Chapel adopts a 401(k) plan, and its 14 non-highly-compensated employee are eligible to participate, the business will be eligible to receive a credit of up to $250 x 14 = $3,500.
Example 4c: Abbey is considering establishing an employer-sponsored retirement plan to cover herself, as well as her 35 employees, none of whom are highly compensated. If she adopts a 401(k) plan, and its 35 non-highly-compensated employee are eligible to participate, she will be eligible to receive a credit of up to $5,000 (since the credit is limited to the lesser of $5,000 or $250 x 35 = $8,750).
New Credit For Adoption Of Auto-Enrollment By A Small Business
Auto-enrollment has been a proven way to increase participation in employer-sponsored retirement plans. As such, to encourage small businesses to incorporate such a provision into their plan, Section 105 of the SECURE Act establishes new IRC Section 45T, “Auto-Enrollment Option For Retirement Savings Options Provided By Small Employers”. The Section provides for a credit, separate and apart from other credits (such as the credit for retirement plan startup costs discussed above), of $500.
In order to qualify for the credit, a small business (defined, once again, under IRC Section 408(p)(2)(C)(i)) must adopt an “Eligible Automatic Enrollment Arrangement”, as defined by IRC Section 414(w)(3). In general, such arrangements require plans to treat participants as though they have elected for the employer to make contributions to the plan at a specified percentage of compensation, until affirmatively notified by the participant to do otherwise.
The credit is first available for tax years beginning in 2020, and can be claimed in the year the auto-enrollment option is first adopted by the plan, as well as the two following years (provided the provision continues to be maintained by the plan during those years).
Notably, the fact that the Auto-Enrollment Option tax credit is based on when the auto-enrollment option itself is added – not when the plan is created – means that even businesses that have already adopted 401(k) plans can still earn the credit by adding an auto-enrollment option in 2020 or beyond (if they haven’t already).
Additional Provisions To Increase 401(k) Participation
In recognizing the importance of participation in employer-provided retirement plans, the SECURE Act includes additional provisions to help employers encourage their employees to increase contributions, and to let (some) part-time employees participate when they were previously ineligible to do so.
Maximum Contribution Percentages For 401(k) Automatic Enrollment Increased
As noted above, automatic enrollment has been shown to be a major contributor to increased participation in employer plans. In addition, research has shown that automatically increasing an employee’s contribution rate increases the likelihood that they will contribute more to their plan.
Employers, however, are limited as to the amount of an employee’s compensation that they can automatically elect to defer for them into the employer’s 401(k) plan. Currently, the maximum percentage of compensation that an employer can set as the plan “default” for automatic enrollment is 10%. Beginning in 2020, however, Section 102 of the SECURE Act will allow plans to increase the default percentage to as high as 15% in any year after the first full plan year in which the employee’s compensation is automatically deferred into the plan.
Long-Term Part-Time Workers Provided Greater Access To Employer Plans
Under current law, employers can generally exclude employees from participating in a 401(k) if they have not worked at least 1,000 in a single plan year. This leaves many part-time workers, even those who have worked for many years, unable to participate in an employer’s plan.
The SECURE Act attempts to mitigate this issue by creating a ‘dual entitlement’ system for most employer retirement plans (though certain plans, such as collectively bargained plans, are exempt), in which the ‘old’ 1,000-hour rule still applies, but where employees must also be eligible to participate in the plan if they have worked at least 500 hours in at least three consecutive years. Thus, individuals must be eligible to participate in an employer plan upon completing either requirement.
Notably, part-time workers are not likely to earn as much as full-time workers, and therefore, may not be able to contribute as much to their 401(k)s as such persons. This could, absent other changes, impact certain plan testing such as the testing for nondiscrimination, and to determine if the plan is “top-heavy”. Accordingly, and to alleviate such concerns, the SECURE Act allows plans to exclude individuals from those testing calculations if they are participating in the plan only by virtue of the new 500-hours-for-3-years requirement.
These changes apply to plan years beginning in 2021, but that doesn’t really tell the whole story. That’s because, separately, the SECURE Act does not require an employer to start ‘counting’ a 500-hour year as a 500-hour year for the purposes of this new rule until 2021. Thus, the earliest an employee would be eligible to participate in a 401(k) plan as a result of this change will be in 2024.
Barriers To Establishing/Maintaining Multiple Employer Retirement Plans (MEPs) Significantly Reduced
Multiple Employer Retirement Plans (MEPs) – not to be confused with Multiemployer Retirement Plans – are single retirement plans that are maintained for the benefit of two or more unrelated employers. The primary (potential) benefit of MEPs is that they allow for economies of scale, which should, at least in theory, result in lower costs, with the savings passed along to plans and plan participants.
But while MEPs have existed for quite some time, their adoption has been stymied, primarily due to two factors. First, for many years, the “nexus” rule required the employers participating in the MEP to have a significant common relationship, such as participating in the same trade association. Those rules were loosened via new Department of Labor (DOL) Guidance provided earlier this year, but still require employers participating in a MEP to have either common businesses, or reside within the same geographic locations.
The second critical factor that has prevented MEPs from seeing wider adoption has been the IRS’s “One Bad Apple” rule. In short, the IRS has long held that MEPs are a single plan, and that as such, a disqualifying act by any single employer would disqualify the entire plan. Understandably, this risk kept many employers who would have otherwise considered participating in such plans from doing so.
In the near future, this will no longer be a limiting factor. Section 101 of the SECURE Act provides that in the event a single employer fails to fulfill obligations, the IRS can essentially disqualify that employer’s portion of the plan, while allowing the ‘master plan’ (the MEP) to maintain its qualified status.
Notably, for employers to benefit from the new MEP rules provided for by the SECURE Act, the MEP will have to be administered by a “Pooled Plan Provider”, such as a Registered Investment Advisor. This may provide advisors with new opportunities to serve the retirement plan needs of business owners in a cost-effective manner.
Changes made by this section of the SECURE Act are not effective until plan years beginning in 2021.
Additional Miscellaneous Retirement Provisions Of The SECURE Act
In addition to the headline-grabbing retirement changes, the SECURE Act also makes a number of smaller changes to retirement planning that advisors should be aware of, including:
- Taxable Non-Tuition Fellowship And Stipend Payments Treated As Compensation For IRA Purposes – Beginning in 2020, individuals who have taxable stipends or other amounts paid to them to aid in the pursuit of a graduate or postdoctoral study can use those amounts as compensation for IRA/Roth IRA contribution purposes (SECURE Act Section 106).
- Nondeductible IRA Contributions Can Be Made With Certain Foster Care Payments – Effective upon enactment, individuals who receive “Difficulty of Care” payments (payments where a state has determined there is a need for additional compensation due to an individual’s physical, mental, or emotional handicap) as a “Qualified Foster Care Payment”, and exclude those amounts from gross income, can use such amounts to make nondeductible IRA contributions (provided such amounts don’t exceed the IRA contribution limits when added to amounts contributed based on “compensation” (SECURE Act Section 116).
- No More 401(k) Credit Cards – Effective upon enactment, 401(k) loans may no longer be made via credit cards, or similar arrangements. (Yes, this really was a thing, with growing concern that it was leading to excessive use of 401(k) plan loans, for people who may not have realized the tax consequences for failing to pay it back!) (SECURE Act Section 108).
- More Retirement Plans Can Be Adopted After Year-End – Under current law, if an employer wants to establish a qualified retirement plan for the year, they must generally do so by December 31st of that year (or the last day of the employer’s fiscal year). Section 201 of the SECURE Act amends this requirement for certain plans. Beginning in 2020, employers may adopt plans that are all entirely employer-funded, such as stock bonus plans, pension plans, profit sharing plans, and qualified annuity plans, up to the due date (including extensions) of the employer’s return (SECURE Act Section 201).
Given that these plans are all entirely employer-funded, the biggest benefactors of this change are likely to be business owners planning for their own tax liabilities, and who have few or no employees for whom plan contributions would have to be made.
- Increased Penalties For Failing To File Returns – Penalties for failing to file both ‘regular’ income tax returns and IRS Form 5500, for reporting employee benefit plans, are significantly increased, making timely filing returns more important than ever before (SECURE Act Sections 402 and 403).
SECURE Act’s Non-Retirement-Related Changes
While the bulk of the SECURE Act is targeted at making (what are, in some cases, debatable) improvements to the retirement system, as is often the case, Congress stuffed a few extra ‘goodies’ into the legislation it wanted to address as well. Of particular interest for advisors will be the changes made to 529 plans and the so-called “Kiddie-Tax”.
Qualified Education Expenses For 529 Plan Funds Expanded For Student Loans And Apprenticeships
Roughly two years after the list of qualified education expenses for which 529 plan funds could be used tax-free was expanded by the Tax Cuts and Jobs Act (which, for the first time, allowed up to $10,000 of 529 plan funds to be used annually for K - 12 expenses), Section 302 of the SECURE Act further expands that list.
First, the SECURE Act provides that Qualified Higher Education Expenses include expenses for Apprenticeship Programs that include fees, books, supplies and required equipment, provided the program is appropriately registered and certified with the Department of Labor.
In addition, and likely to be of greater interest to the majority of advisors, is the introduction of distributions for “Qualified Education Loan Repayments” as a qualified higher education expense. Such distributions may be used to pay the principal and/or interest of qualified education loans (as defined in IRC Section 221(d)), and are limited to a lifetime amount of $10,000 (not adjusted for inflation). Notably, in an anti-abuse coordination provision, any plan funds used to pay the interest on qualified student debt will render that interest paid ineligible for the above-the-line deduction for student loan interest under IRC Section 221.
The $10,000 lifetime limit is a per-person limit, and in addition to using the funds in a 529 plan to pay for the 529 plan beneficiary’s debt, an additional $10,000 may be distributed as a qualified education loan repayment to satisfy outstanding student debt for each of a 529 plan beneficiary’s siblings.
This change is effective retroactive to the beginning of 2019.
Kiddie-Tax Reverts To Pre-Tax Cuts And Jobs Act Rules!
Let’s do the time warp again!
Just two years ago, Congress passed the Tax Cuts and Jobs Act. And as part of that sweeping legislation, it changed the nature of the so-called Kiddie Tax, a tax on the unearned income of certain children. Prior to the Tax Cuts and Jobs Act, any income subject to the Kiddie Tax was taxable at the child’s parents’ marginal tax rate. By contrast, the Tax Cuts and Jobs Act made that income subject to trust tax rates.
For those children with more modest unearned income this often resulted in modest tax savings. But for those children with more significant unearned income, the compressed trust tax brackets typically led to a higher tax bill.
Now, just two years later, Congress has issued a mighty call to “Belay that order!”
In a complete and total reversal, the SECURE Act (Section 501), once again, makes any income subject to the Kiddie Tax taxable at the child’s parents’ marginal tax rate. The change is effective for 2020, with an additional kicker… taxpayers can elect to apply the old (or is it new?) rules to the current 2019 tax year, and back to 2018 as well! As such, advisors with clients who have children that had substantial unearned income in 2019 can simply choose to use the new rules (unless the ‘old’ rules at trust tax rates actually were more favorable in the case of extremely affluent parents), and for 2018 advisors should carefully evaluate the potential tax savings that may be achieved by filing an amended return and electing to apply the new/old rules back to that prior year.
Tax Extenders Bill Revives Zombie Tax Breaks… Again!
Congress has once again come through at the last minute to extend certain tax breaks in what, this year, is being called the “Taxpayer Certainty and Disaster Relief Act of 2019”.
Don’t let the name fool you though. Despite what it says, the bill provides little certainty for the future. The following tax benefits for individuals are reinstated retroactively to 2018, and made effective only through 2020:
- The exclusion from gross income for the discharge of certain qualified principal residence indebtedness;
- Mortgage insurance premium deduction; and
- Deduction for qualified tuition and related expenses.
Additionally, the AGI ‘hurdle rate’ that must be exceeded to deduct qualified medical expenses remains at 7.5% of AGI for 2019 and 2020 (it was already lowered to 7.5% for 2018 by the Tax Cuts and Jobs Act), lowered from the previous rate of 10% of AGI in 2017. Notably, this hurdle rate is also applicable to the exception to the 10% early distribution penalty for IRA and employer-sponsored retirement plan distributions.
Included in the Extenders bill, along with the above-referenced items, was the usual cast of characters, ranging from incentives for economic growth to energy production and green initiatives.
Retirement-Related Disaster Relief Provisions Of The Taxpayer Certainty and Disaster Relief Act of 2019
Finally, the Taxpayer Certainty and Disaster Relief Act of 2019 bill provides for Qualified Disaster Distributions from retirement accounts.
Individuals eligible for this relief are those who have principal residences in a Federally declared disaster area, and who suffered an economic loss as a result of that disaster. The disaster must have occurred from January 1, 2018, through 60 days after the enactment of the law.
In turn, Qualified Disaster Distributions for a qualifying disaster event must occur after the date of the disaster (and within 180 days after the bill’s enactment), can be made for up to $100,000 for each disaster, and receive these additional benefits:
- Are exempt from the 10% early distribution penalty;
- Are exempt from mandatory withholding requirements;
- Are treated as distributed evenly, over a 3-year period, unless a taxpayer elects to have the full amount taxed in the year of distribution; and
- May be repaid within 3 years of receiving the distribution.
In addition to the above relief, the Taxpayer Certainty and Disaster Relief Act of 2019 also extends relief to plan participants in the form of enhanced plan loans. The bill both increases the maximum allowable loan amount to $100,000 (from the ‘normal’ $50,000 amount), and to delay loan repayments for up to one year.
Passage of the SECURE Act will bring many important changes to the current retirement system, including the replacement of the lifetime stretch provision with a ten-year cap on required minimum distributions by beneficiaries with inherited retirement accounts, the RMD age requirement going up from age 70 ½ to age 72, and the ability for workers to continue contributing to their IRAs beyond age 70 ½.
Additionally, changes that will impact 401(k) plans are designed to make it easier for small business owners to establish plans for employees (through more flexible investment options and better MEP rules), and to encourage participants to save more (through more auto-enrollment and flexibility for higher auto-enrollment percentages).
Unfortunately, though, while the provisions of the SECURE Act are permanent, the remaining Tax Extenders included alongside the SECURE Act remain temporary, to potentially be revived yet again in 2020 and beyond!
I just came across your article and by far is the most comprehensive one I have seen. I was just asked today whether a beneficiary that is under 70 and 1/2 could make a QCD of 100,000 because the deceased owner was able to do so being over 70 and 1/2.
Thank you
Jeff, I have seen some reference that the restrictions on stretch beneficiaries does not apply to defined benefit plans. Is that accurate?
Can you point me to a Code Section that reflects the new RBD? I looked and found no change to 401 & 408. Thanks.
Did the part about returning to the 7.5% threshold for medical expenses remain in the final version, as signed into law? TY for great review.
@jefflevinecpacfp:disqus Great summary! As far as tracking the new 10 year requirement, will custodians be required to track that or will that be on advisors to make sure the account is liquidated by the end of year 10? I imagine some confusion if inherited accounts are transferred between death and the end of year 10. Do you know who will ultimately be responsible for tracking?
Hi Jeff, if a non-spouse beneficiary is OLDER than the IRA owner… does the non-spouse beneficiary have the choice to stretch or the 10-year rule? Or does it literally only apply to only non-spouse beneficiaries who are 10 years younger?
Jeff,
Thanks for the great article. I’ve been searching the net and this was the clearest and most useful article I have seen on the SECURE Act.
Here’s my situation and a question for you:
An IRA owner dies in 2013 and the beneficiaries of the IRA are Designated Beneficiary trusts for each of his four children, 25% to each, so each can take receive the distributions over their lifetime as dictated by the IRS for inherited IRAs. I am trustee of all of the trusts and am the youngest of the original account owner’s four children.
In 2019 the oldest child dies. The distributions are to take place this month and need to happen in the next few days. The trust document states that the inherited IRA in the trust fbo the oldest child would split into new DB trusts fbo his two children. This is being done now so the stretch provision should be preserved for them.
My question is what happens when one of the beneficiaries of any of the DB trusts(me, either of my two living siblings, or one of my late brother’s kids) dies? Since the original account owner(my father) died before 2020(in 2013) is the stretch provision for any new future beneficiaries grandfathered? Forcing a payout in 10 years, or likely all of it in the 10th year, is exactly the opposite of the desires of the grantor(my father) and would be contrary to the purpose of the trust and its language to stretch out distributions as long as possible. TIA.
With respect to the start-up plan credit/deduction, I have two questions:
1. Would fees paid to a financial advisor to assist with setting up a plan qualify for the deduction?
2. Would owner plans like Solo 401ks and some SIMPLE plans that don’t benefit employees qualify for the credit? Would plans need to benefit employees other than the owner to get the start up and auto enrollment credits?
Thanks!!
Thanks for the summary Jeff. A lot of tweaks by Congress, but still, a pitifully low cap on IRA contributions ($6K or $7K, depending on taxpayer’s age). This compares poorly to those in an employer sponsored plan, Solo 401(k), etc.
For the 10-year rule, does it apply to SEP IRA as well?
Yes, for all designated beneficiaries of ANY IRA, that do not qualify as a Eligible Designated Beneficiary
for the 10k 529 distribution for loans… is that an annual or lifetime amount? great summary!
Lifetime
Jeff,
If someone names the estate or no beneficiary (not designated beneficiaries) as the beneficiary and the owner of the account has already taken RMD’s would the distributions be stretch out over the remaining distribution period of the decreased owner or does the 10 year rule apply? I think this part of the code section for the SECURE Act have been over looked when written.
The SECURE Act did not change the rules for Non-Designated beneficiaries.
Jeff,
Thanks for this. So since the rules didn’t change would the distributions for non-designated beneficiaries (post RMD’s) be able to be distributed over the remaining distribution period or would it be 5 years?
If death occurs on or after the RBD and the beneficiary is a non-designated beneficiary, distributions will continue to calculated using the decedent’s remaining single life expectancy.
Hi Jeff,
With respect to beneficiaries that have an exception to the 10 year depletion requirement, you said they are subject to the old rules. In scenarios where Roth assets are inherited or the decedent had not reached their required beginning date, benes could deplete over their lifetime OR deplete in 5 years under the old rules. For benes that qualify for the old rules, but choose not to deplete overt their lifetime, would they be subject to the 5 year requirement? Or because they are not electing the stretch, it defaults to new 10 year rule? Thanks!!
Eligible Designated Beneficiaries would be able to choose between the 10-Year Rule and life expectancy (assuming death occurs prior to the RBD)
Can someone adopt a profit sharing 401k now (after december 31st, since it’s 2020) for 2019? Or does that only apply next year and going forward?
Unfortunately, no. From the SECURE Act “The amendments made by this section shall
apply to plans adopted for taxable years beginning after December 31,
2019.”
Jeff, any changes to 72(t) distributions? I’ve got an early retiree taking this starting, oh, next week. I calculated the amount before Christmas and was all set to just confirm balances and start the paperwork. But now I’m wondering if there’s something I’m about to find out next week at Heckerling that affects this?
Nope. No changes to the 72(t) rules.
@jefflevinecpacfp:disqus Thanks for another great article – fantastic summary that highlights the key points we need to know with this new legislation
Thanks Dustin!
Does the new 10-year rule also apply to inherited Roth IRA’s? I assume it does.
The 10-Year rule is applied to inherited Roth accounts in the same way it is applied to inherited Traditional accounts
Amazing summary. Thank you for this. One question… are non-designated beneficiaries still on the old 5-year rule to distribute the full account? For example, if one leaves their IRA to their estate (or doesn’t set a beneficiary and the custodian defaults to their estate), does the old 5-year rule apply?
Thanks Tom. Yes, I believe that is the case, with the caveat that the 5-year rule only applies to such beneficiaries if death is BEFORE the required beginning date.
No one has mentioned what seems to be a change in QCDs which reduces the 2020 and later $100 K gift limit by the amount of any earlier QCDs from past years. It sounds like if one has given $ 100 K in the past, no further gifts will be allowed. Is that correct?
No, the 100k amount is an annual limit
On page 616 there is a provision titled “Coordination With QEDs” which talks about the reduction of the annual limit based on previous QED amounts. Can you clarify that a bit?
I think you’re referring to the QCD anti-abuse rule. From the summary above: https://uploads.disquscdn.com/images/ce2cc08f55caf7dbb594d7c74671ffd95a6dd57e38d8ce8c0ee568a1a380e192.png
Great information! What is the definition of “children” for exception to the 10 year distribution rule? Would a grandchild adopted by the grandparents qualify? What about stepchildren? As always, thanks!
Does the 10-year distribution rule for IRAs apply to inherited Roth IRAs?
Kiddie tax rule changes: I’ve heard that I can amend 2018 and use the old rates in 2019, too. Can anyone verify this? I’ve got a poor single parent who has a super-rich kid. The parent lost EITC by claiming kid’s income AND had to pay taxes in ’18 at the higher rate. That sucked. I’m anxious to tell them I can amend, and ALSO to sell some low basis stocks gifted to the kid tomorrow!
I noticed that the deduction for qualified tuition and related expenses has been revived retroactively to 2018 and then through 2020. That change seems to imply that there will be many students doing amended returns? These deductions were not available for the 2018 tax year, but now have been reinstated. Can a taxpayer now amend the return to capture the tuition deduction? If so, how much can be deducted and can it be utilized in conjunction with other education credits currently available? My daughter is is college, is a junior, and we will certainly benefit from doing the amended returns if possible. I hope I am right.
If use of the newly restored provisions would benefit you, you can certainly file an amended return to claim them. That said, it’s possible that you were able to use other education-related benefits instead. You can’t double-dip using expenses for both education credits and the tuition deduction, so it’s possible that this change would not impact your net tax liability. Gotta check and see!
Regarding the new 10 year “stretch” does anyone know if an inherited IRA would need to be retitled as under the current stretch law (eg with the owners name and fbo the beneficiary(s)? Also if there are more than one beneficiary would this need to be done within the same timeframe as under the current law?
Titling would be the same as under the current rules (or else you don’t have an inherited IRA in the first place!).
No changes were made to the Sept. 30th “cash-out date” or the December 31st “Account Splitting” deadline.
I will be turning 70 1/2 April 2020, I have a sep ira, no employees, still working and earing income. It appears l there is not an age limit to funding my sep ira for 2019 and continuing years as long as I have earning? Please clarify. It seems to me as long as I continue working I can fund the sep as well as being forced to withdraw the funds at the same time at age 72.. Sounds odd.
If you’re talking about the Tax Code and it “sounds odd”, you’re probably on the right track. And you are here… SEP contributions are allowed at any age, but once you’re 72, you have to take RMDs
Jeff,
New law changes the rmd at age 72, not 70 1/2, since I will be age 70 1/2 in April 2020. Am correct?
Yes. You will have to take RMDs at 72, regardless of whether you are working or not, as the still working exception does not apply to IRAs (or more than 5% owners, for that matter)
Great article! I’ve read a few reports from news outlets that listed homeschooling as a qualified educational expense under the SECURE Act and referenced that it was a last minute addition to the bill. It is referenced in the House Ways and Means summary of the bill, but I haven’t seen it located anywhere in the bill itself. Do you know if this actually made it in as an amendment, or is any reporting on this likely erroneous?
Homeschooling expenses did not make there way into the final version of the bill.
been wondering about this a well. Still have not seen anything concrete!
Homeschooling expenses did not make there way into the final version of the SECURE Act.
Are you SURE? Because I’m hearing reports that it did. Can’t find it in the 500 page doc, though. Not that it would have a searchable term!
Indeed. I am also aware of several articles which have (incorrectly) stated otherwise, but yes, I am sure.
For individuals already taking an RMD from an inherited IRA will they be “grandfathered” in and maintain distributions through their own life expectancy or will they now be subject to the 10 year rule starting in 2020?
They are grandfathered into the current rules. But their own beneficiaries are not.
What if the successor beneficiary is less than 10 years younger than the original beneficiary. Would successor beneficiaries be able to continue to stretch?
Excellent article! How does this impact special needs trust that are beneficiaries of IRA’s or 401ks? Especially where special needs trust has primary disabled beneficiary and an older contingent beneficiary (to satisfy the “see-through” rules. Will this trust still be able to take advantage of the stretch using the life expectancy of the older contingent beneficiary?
Hey Sam! This is too dense to get into here, and the answer is “it depends”. There were some special rules put in for Special Needs Trusts at the last second, and we’ll be covering those further in an upcoming post. In the meantime, if you need info sooner, consider looking into (new thing) “Applicable Multi-Beneficiary Trusts”.
Excellent summary. Your summaries of these laws are quite often the best I’ve seen on the web.
For an inherited ira going into a non qualified trust, does the 5 year distribution rule still apply, or does new 10 year language replace it? In others does 10 year language only apply to existing qualified stretch?
The language of the SECURE Act appears to make no changes to the rules for non-designated beneficiaries.
@jefflevinecpacfp:disqus
Thanks for a good summary
For those who qualify for the exception to the new 10 year rule, will they still take minimum required distributions under current rules? For example, if the IRA owner dies at age 76 and names his 70 year old brother as beneficiary, the minimum distribution to the brother will be at least at the rate of the deceased brother? Similarly, same situation but decedent is 70 at death and brother is 65. So does the brother have the option of the 5 year rule or using his life expectancy from Table 1, subtracting 1 for each successive year?
Bruce,
The way the law is worded, it makes changes to the rules for designated beneficiaries, except if you’re X,Y, or Z. Beneficiaries within 10 years of the owner are one of those exceptions, so I’d say it’s business as usual for them. Same rules that applied in 2019 still apply. So… yes!
Can we assume the act killed non-qualified annuity streches as well?
We cannot! ? Non-qualified stretch is under 72(s), to which the SECURE Act makes no changes!
Thanks. You guys are the best.
Thank you for the great article about this new law. Can you help with one question on Beneficiary IRAs? If the beneficiary purchases a SPIA with the IRA, does that run afoul of the law and 10 year requirement? Or is that okay because the entire account balance is gone?
Thank you!
Would depend on the type of beneficiary and the annuity. Presumably, though, a beneficiary who is subject to the 10-year rule would be able to purchase a SPIA, so long as that SPIA was a term-certain payout only, and ended before the end of the 10th year after death.
Great summary. Are you sure that the minimum QCD age has not been raised to 72 from 70.5 to coincide with the new RMD age? I have seen conflicting info on that and have multiple folks in our firm trying to get a handle on the new rules. Thanks!
Hard to ever be “sure” about anything when it comes to Congress’s intent, but let’s just say I’m pretty darned confident here. ? QCDs are outlined under 408(d)(8) of the IRC. And the age 70 1/2 date is ‘hard-coded’ into that section. It does not reference you back to the RMD rules. If you run a search for that citation in the SECURE Act, the ONLY thing that comes up is the new anti-abuse rules, which means that age 70 1/2 date was not touched.
Really excellent article — I’m a first-time reader and learned quite a bit
One question: In some articles published before the SECURE act actually passed, there was mention of a $400K exclusion to the 10-year-stretch rule for IRA’s. Since I have seen nothing on this, I’m assuming that provision got axes?
The $400K safe harbor was in the Senate version, but as an attachment to a major funding bill, it looks like there was no House-Senate reconciliation process for SECURE.
This is mostly correct. The final SECURE Act bill that was attached to the Appropriations bill was BASICALLY the House-passed version, but did have a few minor adjustments, such as a provision regarding trusts for disabled/chronically ill beneficiaries.
Happy Holidays, Jeff! Great article and summary. I can’t seem to find out where I can apply for CPA credit-can someone help please? Thanks.
Hi Richard! I’d be happy to help. Email me at [email protected] so that I can check your account and instruct you on how to get CE.
-Rachel
Jeff,
Couple of annuity questions: 1) I assume the education requirement applies to annuities and that variable and fixed indexed annuities will be permitted. (Will a plan be able to offer more than one annuity?) How is a plan participant going to be able to make an educated decision to purchase such a product? 2) When an annuity is distributed, will it be free of the “qualified” wrapper and not need to be rolled into an IRA?
It has to be an annuity that offers lifetime income, so I think it’s fair to say we’ll see a variety of different options present themselves. I see no reason why a plan would not be able to offer more than one annuity option. Lastly, if the annuity is distributed, it would be to an IRA annuity.
Thanks!
Does this bill make the case for or against the affluent who don’t need the funds, converting their traditional IRAs to Roth’s?
I feel like I could make a case either way.
Jim,
Good question. Of course, everything is always a “facts and circumstances” thing when it comes to Roth conversions, but on the whole, I believe that it makes them more attractive. The whole Roth/Not Roth decision is a “when is the tax rate on the income going to be the lowest?” question. And if money now needs to be taken out faster after death, it would stand to reason that in many cases, that will accelerate the taxation. Which makes paying taxes sooner, via Roth conversions, at hopefully lower rates, more attractive. But again, it’s a case-by-case analysis and decision.
Jeff
An article in my will states “each trust created by this Will that is a beneficiary of a tax qualified plan described in this section shall at a minimum, distribute to a beneficiary of such trust minimum distributions required by law”. Does this mean that the trust beneficiares do not qualify for the 10 year stretch out since the SECURE act doesn’t have required minimum distributions and the beneficiares would have to take out a lump sum in year 10?
Michael K’s comments state that “many Conduit Trusts are drafted in a manner that only allows for the required minimum distribution to be disbursed from an inherited IRA to the trust each year” would have issues and not be eligible for the 10 year stretch out. What does he mean by the words “only allows for required RMD’s?
John, re: your first question, I believe that is boiler plate language designed to make sure the trustee does distribute at least the RMD amount so as to avoid the 50% penalty on any part of the RMD not distributed as required.
Re: your second question, I am trustee of such trusts, and the trusts require that the RMD amount be distributed, but no more, thus mandating the IRA distributions be stretched out as long as possible and heirs don’t try to cash out early.
Excellent summary.
It wasn’t clear to me if the “Eligible Designated Beneficiary” MUST follow the old rules, or if they had the option of the ten year rule?
(And if they didn’t have the option of the 10-year rule, does the old five-year rule still apply?)
For example, perhaps I’m in my mid-fifties and plan to retire within the next ten years. I inherit from a sibling. Because we’re close in age, I’m an eligible designated beneficiary. Do I have the option of the ten year rule, and waiting until my planned retirement?
Thanks!
A literal reading of the SECURE Act’s changes seems to indicate that an EDB will NOT have the opportunity to elect the 10-year rule, but I could see IRS clarifying/allowing that via regs.
Great job as this is extremely helpful!
Does the new 10 year rule apply to inherited Roth IRAs? Obviously it wouldn’t be taxed.
Thanks
Yes, it does. But I’d add that in MOST cases the distributions won’t be taxed. But distributions taken in the first half of the 10-year period COULD be taxable, depending upon when the deceased Roth owner established their first-ever Roth IRA.
HI Jeff,
Thanks for the summary!
So – in the event of a Roth IRA is passed to bene’s, and the original owner Roth was only open LESS THAN 5 years (first ever), would the bene (assume non-spouse) need to WAIT for the 5 yr time horizon to pass to not get taxed? how in the world is this stuff going to be tracked with family members? any help or suggestions is great – thank you!
One more question. Previously a spouse had the option of waiting to take RMDs until the decedent would have turned age 70.5. I assume this has also been raised to age 72?
Yep. There is a separate item in the SECURE Act section that changes the RMD age to address just that. Age at which a spouse will have to begin taking RMDs (and the special rule for spousal successor beneficiaries) is pushed back to 72.
Great stuff as always, Jeff.
I’m wondering if a small biz has a SIMPLE Plan already (no plan fees), can they get a tax credit if they switch to a 401k? I would guess, no, but curious about your interpretation.
Can still get the auto-enroll credit, though.
Thanks for this great summary. Could you please expand on the comment “For these Eligible Designated Beneficiaries, it’s ‘business as usual’ – the same rules that applied to them before the SECURE Act will continue to apply after the SECURE Act. They can take distributions over the beneficiary’s life expectancy…” Specifically, is the term of the IRA stretch changed for an eligible primary beneficiary of a Special Needs Trust under the new tax law? My understanding was that under the prior tax law, in the case of a qualifying Special Needs Trust for the benefit of a disabled individual, the post-death RMDs are calculated based on the life expectancy of the oldest of the trust’s underlying beneficiaries (including successor beneficiaries). Furthermore, if one or more of the successor beneficiaries was a charitable organization, there was no possibility of stretching the IRA RMDs over the eligible beneficiary’s lifetime. Under the new tax law, does the period of the stretch depend only on the eligible primary beneficiary’s life expectancy? Can older persons and/or charities now be successor beneficiaries without reducing the period of the stretch?
Great post! Thank you.
The QCD at 70 1/2 is useful info and the discussion in the comments is illuminating.
One minor comment – in the intro, Michael stated that the change in the stretch rule is “only” 10 years. While I appreciate that a 10-year stretch for large IRAs is better than a lump sum or a 5-year stretch, the major bummer of this new change is that, in many cases, it forces beneficiaries to take large distributions when they are in their peak earnings years.
I inherited an IRA from my dad when I was 41. It would have been a major bummer to have to give back a large chunk of this money to the IRS over the ensuing 10 years. 13 years later, the amount I am withdrawing each year is still small enough that the account has grown and I will eventually be able to use the account to supplement my own retirement.
The rule change for Stretch IRAs is wealth tax and it is a windfall for the government.
Aloha,
JR
Did the step up in basis survive?
Still here!
For now. I think it is just a matter of time.
Great article! With respect to the anti-abuse rule for QCDs…..I would imagine only deductible contributions made after 70 1/2 would be subtracted from QCD distributions, correct? Are non-deductible contributions made after 70 1/2 part of the anti-abuse rule?
Thanks Mike. Just deductible IRA contributions are subject to the rule. And notably, QCDs cannot be made with after-tax dollars.
To clarify – am I to understand that, as long as a tax payer (or working spouse) has earned income, deductible traditional IRA contributions are now permissible up to age 72?
Mahalo,
JR
Doesn’t the 10 year rule give the beneficiary of an IRA effectively 11 calendar years in which to take the required withdrawals. They can take the first withdrawal in the year of the original IRA owner’s death and then have 1o calendar years to spread the remaining withdrawals. This might be helpful to avoid tax bracket creep for the beneficiary.
Yep, certainly can be an effective way to get an extra year to spread out the income. Practically speaking, however, it’s going to depend on when, during the year, the death occurs. For instance, if death occurred today, you’d have a tough time getting it to the beneficiary in time for them to take a 2019 distribution, but 2019 would still be the first of those 11 years.
Thank you for this excellent synopsis! Not being eligible for student loan interest deductions, could I open a 529 in my own name, fund it to $10,000, then use that amount to pay off existing student loan balances as long as they are qualified educational loan repayments?
Thanks for the kind words. Don’t see why not, but I don’t know that it would do much good unless you’re getting some sort of state income tax benefit, or unless you thought the growth on a 529 plan contribution would outpace the growth of the loan. Remember, there are no Federal income tax breaks for 529 plan contributions. So putting money in and then immediately taking it out to pay off a loan provides no additional Federal tax benefit.
Unless you fund it with Series EE bonds.
I’ve read that too, but how do you actually get your hard copy EE Bonds into the name of the 529?
Cash them out then deposit. 529 contributions are considered a qualified education expense when it comes to Series EE gains.
There are income limitations
Since there are no age limit contributions, Can you delay rmd in ira similar to 401k if you are working? If you can’t delay rmd, since there is no age limit to contributing, can you be 75 years old and contribute $7000 while working and withdraw your rmd same year?
Correct me if I am wrong, but my understanding is that traditional IRA contributions (through 2019) are not permitted for taxpayers over age 70 1/2, even if they have earned income. I have inquired in this thread to see if the new law extends the contribution age to 72.
There is no “still working exception for IRAs. RMDs must begin in the year that you turn 72 (beginning next year). If contributions are still being made, it will become a bit of a revolving door of IRA money; contributions going in, and RMDs coming out.
Jeff
Yes, this is the same way SIMPLE and SEP IRAs work for those 70.5 and older who make annual contributions. In one end, out the other….
Thank you for this @jefflevinecpacfp:disqus
529 questions:
– could someone use their 529 to pay $10k of their spouse’s student loan debt as well? does not seem addressed in the bill text
– seems it doesn’t matter if siblings of 529 beneficiary are grown or not, right? Meaning that adults with leftover 529 $ could pay off their siblings’ loans up to $10k each using qualified distributions.
Little bit of a hassle, but I believe you could simply change the beneficiary of the 529 to the spouse from the child.
– You should be able to change the beneficiary of the 529 plan from the individual to their spouse in order to use the funds to pay off their student loans.
– Law does not place an age limit for using funds to pay off siblings debt.
Jeff – thanks for a great presentation yesterday. To clarify – the beneficiary’s sibling does not have to have a 529 plan set up for themselves as the beneficiary? A grandparent can use 529 plan money to repay both a student loan for a grandchild who is the beneficiary of the 529 and for a sibling who is not?
You can basically gift a 529 to anyone correct (non-immediate, non-lineal)? I know I have done grandparents to grandchild. The only potential issue is the $15,000 gift tax exclusion, right?
There are limits as to who a 529 plan beneficiary can be changed to. It’s pretty flexible, but it does have to be a qualifying family member.
Hi @jefflevinecpacfp:disqus – thank you for the amazing summary and for all you do for our advisor community!
A softball of a question that I cannot seem to wrap my arms around as it relates to the anti-abuse rules for the post 70.5 deductible IRA contributions and QCDs… if a taxpayer who is 73 in a given year makes a $7,000 deductible IRA contribution and in that same year makes a $7,000 qualified charitable distribution… am I correct in assuming that the QCD is not reported above-the-line but is rather simply an itemized deduction that year?
Furthermore, is it spouse specific? For example, Phil and Joan each have IRAs and are in their mid-70’s… Phil has earned income of $2,000 and Joan makes a deductible IRA contribution to her IRA. Phil in that year makes a $2,000 QCD to his church. Would the anti-abuse results still come into play?
Many thanks and we are looking forward to hosting you for our Secure Act client webinar in a few weeks!
Hey Michael,
Thanks for the kind words. Looking forward to the webinar as well, and to heading down your way again in March.
You’re spot-on for the way the “QCD” would be reported. It just becomes a “regular charitable contribution” deductible as an itemized deduction.
Your second question is a GREAT question. As I read it, the restriction applies to the taxpayer. Therefore, one spouse should be able to make a deductible contribution, while the other spouse makes a QCD. Planning opportunity!
Any reason a one-participant 401(k) plan couldn’t adopt an auto-enrollment feature and get the $1,500 credit ($500/year for 3 years)? As I read the law, I don’t see anything to preclude it. Obviously it’s not the intended target, but that’s a separate question. Thanks!
Great write-up @jefflevinecpacfp:disqus ! This will certainly encourage more Roth conversions for people that don’t want to leave behind a big tax liability. My understanding is that beneficiaries would still need to draw out Roth RMDs within the 10 years of inheritance.
I’m curious to learn what other planners are seeing as the biggest planning opportunities with this bill passing.
Michael-
Just glad they dropped the 70 1/2 half-year thing. talk about nonsense . . .
now, if we could get Congress to dispense with the age 59 1/2 rules……
First, thanks for writing this. As someone who is not a financial planner but is the executor for my parents and siblings, this is very helpful.
Second, I was wondering if you know how the 10-year rule will apply when the initial beneficiary dies within those 10 years. For example, a parent dies and leaves an IRA to their daughter. The daughter dies 6 years later and has not exhausted the balance in the inherited IRA. The daughter leaves the IRA to a niece. What rules apply to the niece for the inherited-inherited IRA?
I can envision 3 (at least) scenarios:
1) The IRA has to be distributed to the daughter’s estate at her death (and taxes paid), then the estate gets distributed by the will.
2) The IRA gets passed down to the niece, but the niece has to take full distribution within the remaining 4 years of the original 10 years.
3) The IRA gets passed down to the niece and the 10-year clock starts over, with the niece getting the full 10 years to take distributions.
Any clarification of this you can provide would be helpful.
Thanks for the kind words! If the 10-year rule applied to the initial beneficiary, the next-in-line beneficiary will just finish out the balance of those 10 years. If the initial beneficiary was able to stretch distributions, then the 10-year period will begin when the next-in-line beneficiary inherits.
Thank you, Jeff. This is the article I came to the internet to read today.
Thanks, Wendy! Appreciate it!
Can you purchase an annuity within an inherited IRA and still meet the 10 year rule of the SECURE Act? I do not want to take the inherited IRA assets during peak earning years when my tax bracket is at its highest.
Can you purchase an annuity within an inherited IRA and still meet the 10 year rule in the SECURE Act….does the annuity purchase qualify as emptying the account.? I am trying to avoid paying taxes on the inherited IRA assets during my peak earning years.
Hi Jeff,
Great article! A question: Regarding the changes to the Kiddie Tax, you referenced “any income subject to the Kiddie Tax” could be taxed at the parents highest marginal rate. My understanding is that you can only apply the parents highest marginal rate if the kid’s unearned income is less than 11k. Is my understanding correct?
Thanks again for these articles. This is by far the best resource I know of for financial planning content!
Thanks for making our lives easier, @jefflevinecpacfp:disqus
Regarding the “Traditional IRA Contributions No Longer Prohibited At (And Beyond) Age 70 ½” section: does it mean one can do the backdoor Roth IRA conversion indefinitely?
Meaning (assuming you have earned income / compensation of at least the Traditional IRA yearly contribution limit):
1) Contribute to a Traditional IRA (beyond 70.5 y/o).
2) Immediately convert it to Roth IRA
3) Rinse and repeat for age 72, 73…etc.
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Thank For Sharing Such A Nice Post