January 10, 2020. By Olga Okaty

In the final weeks of 2019, two important pieces of legislation – the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act) and the Taxpayer Certainty and Disaster Relief Act of 2019 (the TCDR Act) were passed by Congress and signed into law by the President.  While not nearly as sweeping as the tax reforms enacted by the Tax Cuts and Jobs Act two years ago, both the SECURE Act and TCDR Act present new planning opportunities and challenges for many taxpayers, particularly those who have accumulated substantial savings in tax-favored retirement accounts.

The following overview provides an analysis of the major changes and implications directed by these laws, along with a few strategies taxpayers may wish to consider as they adapt to these changes.

New IRA Rules – Stretch Provision Eliminated: One of the most significant changes affected by the SECURE Act is the elimination of the ‘Stretch’ provisions for most non-spouse beneficiaries of defined contribution plans (401k’s, 403b’s, etc.) and IRAs.  Under this new law, most beneficiaries who inherit such retirement assets in 2020 and beyond will be required to withdraw the entire inherited retirement account by the end of the 10th year following the year of inheritance.  This can mean significant additional taxable income over multiple years for inheritors of pre-tax retirement assets.  However, the new law allows complete flexibility as to the timing of distributions within that 10 year period.  Beneficiaries should therefore work with their advisors and CPAs to carefully plan the timing of distributions to minimize the tax impact, including planning for larger distributions in lower income years or years in which significant deductions may be available to offset additional income.  Additionally, the new 10-year withdrawal rule presents significant challenges for certain trusts named as retirement account beneficiaries, therefore it will be crucial to review estate plans and update beneficiary designations accordingly to ensure any tax burden is minimized while the assets remain protected for any trust beneficiaries.

Designated beneficiaries NOT subject to the 10-year rule include:

  • Spousal beneficiaries
  • Disabled beneficiaries (as defined by IRC Section 72(m)(7))
  • Chronically ill beneficiaries (as defined by IRC Secion 7702B(c)(2), with some exception)
  • Individuals who are less than 10 years younger than the decedent
  • Certain minor children of the retirement account owner, until they reach the age of majority; grandchildren and other related beneficiaries do not receive the same exception

RMD Age Increased to 72: The SECURE Act also shifted the Required Minimum Distribution (RMD) requirement from age 70½ to age 72.  While this change will potentially allow a greater share of retirement assets to remain invested before mandatory distributions begin, this could potentially result in larger RMDs down the road and will require diligent planning and strategies to ensure income remains in the lower tax brackets to the extent possible and that Medicare AGI thresholds are not exceeded which could result in an IRMAA adjustment and higher premiums throughout retirement.  Notably, the SECURE Act did not change the age at which Qualified Charitable Distributions (QCDs) from IRAs are permitted – this remains 70½.  Individuals turning 70½ who are charitably inclined and are looking to decrease RMDs in the future may therefore wish to make QCDs (up to $100,000 annually) in the years preceding the onset of RMDs at age 72 to make pre-tax charitable contributions while reducing their IRA balances and future RMD obligations.

70½ Contribution Age Limit Removed: The SECURE Act also eliminated the restriction prohibiting individuals to make IRA contributions after age 70½.  Such contributions are now permitted for individuals of any age, provided they have “compensation” which is generally defined as income from either wages or self-employment.  IRAs were the only retirement accounts for which such contributions were previously prohibited (most employer plans allow for such contributions), but this change will help facilitate additional retirement and income tax savings for those who may not have access to employer plans or are working part time.   It is important to note, however, that any QCDs will be reduced by the cumulative amount of post-70 ½ IRA contributions.

Qualified Birth or Adoption Distributions Permitted: Early penalty-free distributions from retirement accounts are generally permitted only for limited circumstances or in the event of financial hardship.  However, the SECURE Act expanded this exception now to permit penalty-free withdrawals of up to $5,000 from IRAs or retirement plans as a “Qualified Birth or Adoption Distribution.”  The $5,000 limit is a per-child individual limit (so each parent can take a qualified withdrawal for each child born or adopted), and notably, the new law does not impose any requirement that the funds be utilized for expenses directly relating to a qualifying event (birth or adoption) – only that the distribution is taken after a qualifying event.   The law further permits repayment of these distributions back into the IRA or retirement plan from which the distribution was made in the form of additional contributions above the standard limits.

Expanded “Income” Categories for IRA Purposes: In addition to allowing IRA contributions beyond age 70½ provided there is “compensation”, the SECURE Act also expanded the definition of compensation for IRA purposes to include taxable non-tuition fellowships and stipend payments.  This will enable individuals pursuing graduate or postdoctoral study to take advantage of additional savings and potential taxable income reductions through IRAs or Roth IRAs.

401k Provisions: Many changes enacted by the SECURE act will also impact 401k plans and sponsors, with new regulations designed to facilitate avenues and incentives for additional retirement savings across a broader demographic.  Some of the more notable 401k provisions include the establishment of a Fiduciary Safe Harbor for including annuities in retirement plans (thereby somewhat mitigating plan sponsors’ liability concerns), an increase in the tax credit permitted to small businesses for establishing a retirement plan, a new tax credit for small businesses that facilitate an “auto-enroll provision” in their retirement plans, an increase to 15% in the default permitted auto-enrollment plan contribution, expanded participation in employer plans for long-term part time workers, and various improvements pertaining to Multiple Employer Retirement plans designed to provide economies of scale and incentives a group of small employers to provide a collective retirement plan to their employees.  All of these changes are designed to facilitate avenues and incentives for additional savings

Non-Retirement Provisions: The SECURE act also touched upon some non-retirement provisions, which include:

  • Expanding 529 college savings plan qualified education expenses to include apprenticeships (so long as the program is properly registered and certified with the Department of Labor) and student loan repayments (up to $10,000 lifetime limit)
  • Reversing Kiddie Tax rules and once again making any income subject to the Kiddie Tax taxable at the child’s parents’ marginal tax rate (rather than trust tax rates, as had been mandated previously by the TCJA.) The new law also permits taxpayers to elect to apply the parents’ marginal tax rate to 2019 and 2018 tax years, so parents whose children had substantial unearned income in those years may wish to review with their advisors and CPAs whether an amended tax return may produce potential net tax savings.
  • Permitting Qualified Disaster Distributions from retirement accounts of up to $100,000 for individuals residing in a Federally declared disaster area and who incurred an economic loss as a result of that disaster. The disaster must have occurred between 1/1/2018 through 60 days after the enactment of the new law.  Such distributions will be exempt from the 10% early distribution penalty, exempt from mandatory withholding requirements, and will be treated as distributed evenly over 3 years to help mitigate a large income tax burden unless the taxpayer elects otherwise.

Tax Extenders: The Taxpayer Certainty and Disaster Relief Act of 2019 (TCDA), while not making as many headlines as the SECURE Act, also provided some temporary tax relief by extending or reinstating the following tax benefits for individuals retroactive to 2018 and available through 2020:

  • Exclusion from gross income the discharge of certain qualified principal residence indebtedness .
  • Mortgage insurance premium deduction.
  • Deduction for qualified tuition and related expenses.
  • Extension of the 7.5% AGI threshold that must be exceeded to deduct qualified medical expenses for 2019 and 2020.
  • While various incentives for energy production and green initiatives were extended, credits for solar and electric vehicles were excluded, effectively making such investments and purchases more costly for the time being.

Taking full advantage of these changes will necessitate proactive planning and collaboration amongst advisors, CPAs, and estate attorneys.  Our team at Centerpoint is always available to guide and facilitate these very important discussions.