In December 2019, Congress passed—and the President signed into law—the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act is landmark legislation that may affect how you plan for your retirement. Many of the provisions go into effect in 2020, which means now is the time to consider how these new rules may affect your tax and retirement planning situation.
Changes in the law might offer you and your family tax-savings opportunities, but not all the changes are favorable. This article outlines some of the key provisions of the Act and their effects on taxpayers.
Repeal of the maximum age for Traditional IRA contributions
Before 2020, Traditional IRA contributions were not allowed once the individual attained age 70½. Starting in 2020, new rules allow an individual of any age to make contributions to a Traditional IRA, as long as the individual has compensation, which generally means earned income from wages or self-employment.
Required minimum distribution age raised from 70½ to 72
Before 2020, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions (RMDs) from their plans by April 1 of the year following the year they reached age 70½.
Under the new law, individuals do not need to begin taking RMDs until reaching age 72.
Partial elimination of stretch IRAs
For plan participants or IRA owners who died before 2020, both spousal and nonspousal beneficiaries were generally allowed to stretch out the tax-deferral advantages of these plans or IRAs by taking distributions over their lifetimes or life expectancies. In the context of an IRA, this is sometimes referred to as a “stretch IRA”.
However, for plan participants or IRA owners who die beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), distributions to most nonspouse beneficiaries generally must be distributed within 10 years following the plan participant’s or IRA owner’s death. For those beneficiaries, the “stretching” strategy is no longer allowed.
Exceptions to the 10-year rule are allowed for distributions to (1) the surviving spouse of the plan participant or IRA owner; (2) a child of the plan participant or IRA owner who has not reached majority; (3) a chronically ill individual; and (4) any other individual who is not more than 10 years younger than the plan participant or IRA owner. Beneficiaries who qualify under one of these exceptions may generally still take their distributions over their life expectancies as allowed under the rules in effect for deaths occurring before 2020.
Expansion of Section 529 education savings plans to cover registered apprenticeships and distributions to repay certain student loans
A Section 529 education savings plan (a 529 plan, also known as a qualified tuition program) is a tax-exempt program established and maintained by a state or one or more eligible educational institutions (public or private). Any person can make nondeductible cash contributions to a 529 plan on behalf of a designated beneficiary. The earnings on the contributions accumulate tax free and distributed earnings are excludable from taxable income up to the amount of the designated beneficiary’s qualified higher education expenses.
Before 2019, qualified higher education expenses didn’t include the expenses of registered apprenticeships or student loan repayments. But for distributions made after December 31, 2018 (the effective date is retroactive), tax-free distributions from 529 plans can be used to pay for fees, books, supplies, and equipment required for the designated beneficiary’s participation in an apprenticeship program. In addition, tax-free distributions (up to $10,000) are allowed to pay the principal or interest on a qualified education loan for the designated beneficiary, or a sibling of the designated beneficiary.
Kiddie tax changes
In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which made changes to the so-called “kiddie tax” on the unearned income of certain children. Before enactment of the TCJA, a child’s net unearned income was taxed at the parents’ tax rates if the parents’ tax rates were higher than the child’s tax rate.
Under the TCJA, for tax years beginning after December 31, 2017, a child’s taxable income attributable to net unearned income is taxed according to the brackets that apply to trusts and estates. Children to whom kiddie tax rules apply and who have net unearned income also have a reduced exemption amount under the alternative minimum tax (AMT) rules.
The new rules enacted on December 20, 2019, repeal the kiddie tax measures added by the TCJA. Starting in 2020 (with the option to start retroactively in 2018 and/or 2019), a child’s unearned income is taxed under pre-TCJA rules, and not at trust/estate rates. Starting retroactively to 2018, the new rules also eliminate the reduced AMT exemption amount for children to whom the kiddie tax rules apply and who have net unearned income.
Penalty-free retirement plan withdrawals for expenses related to the birth or adoption of a child
Generally, a distribution from a retirement plan must be included in income and, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59 1/2 is subject to a 10% early withdrawal penalty on the amount includible in income.
Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are penalty free. The $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.
Taxable non-tuition fellowship and stipend payments treated as compensation for IRA purposes
Before 2020, stipends and non-tuition fellowship payments received by graduate and postdoctoral students were not treated as compensation for IRA contribution purposes, and could not be used as the basis for making IRA contributions.
Starting in 2020, the new rules remove that obstacle by permitting taxable non-tuition fellowship and stipend payments to be treated as compensation for IRA contribution purposes. This change will enable these students to begin saving for retirement without delay.
The SECURE Act involves many changes and options to consider based on your personal tax and retirement situation. To help you get the most out of the new rules, and avoid potential pitfalls, talk with an expert who can develop custom advice and solutions for you and your family. Please contact us to learn how we can help you navigate this new landscape.
-Your Team at Waldron H. Rand