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SECURE Act of 2019: Good News for Some, Bad News for Others

SECURE Act of 2019: Good News for Some, Bad News for Others

February 18, 2020
So much has been happening in the news the last few months that you might have missed the signing into law of the SECURE Act on December 20, 2019. This legislation provided a major update to laws governing retirement plans and strategies. I want to bring to your attention some of the major provisions that directly affect people saving for and navigating through retirement.

The full name of the law is Setting Every Community Up for Retirement Enhancement Act of 2019. Congress’ intention behind these new regulations are to enhance Americans’ access to retirement savings accounts, whether through Individual Retirement Arrangements (IRAs) or employer-sponsored retirement plans (401(k)s, 403(b)s and 457 plans).

After reading the major provisions I believe that the underlying message to the American saver is that Social Security will not be enough.

I’ll go a step further to say that Congress is communicating that Social Security will not be enough for retirement, especially, if they change it.

A major overhaul to Social Security is probably coming at some point, in my opinion. It is such a political hand grenade that nearly all politicians are probably hoping it will become the problem for the next person holding their elected office. For those currently in retirement and relying on Social Security income, please relax. This act does not change what you will continue to receive from the government. It also does not change future Social Security benefits.

But, regarding the Stretch IRA, everyone may be affected by this. Read this section carefully.

What about the SECURE Act do you need to know that could impact your retirement savings plans and strategies? I’ve broken that into three categories: the Stretch IRA (which has possible implications for all ages), people close to or in retirement, and those still accumulating for retirement.

The Stretch IRA
You probably have not heard of the Stretch IRA concept. This affects non-spousal beneficiaries (recipients, like children) of Traditional IRAs, 401(k)s, and other pre-tax investment accounts. Stretch IRA, Beneficiary IRA, and Inherited IRA are referred to interchangeably in our industry.

If you could inherit a 401(k), IRA or other retirement account from anyone other than your spouse, you are likely going to be affected by the SECURE Act. Prior to the SECURE Act, a non-spousal beneficiary of an IRA had the option of stretching distributions (withdrawals) from this inherited account over their lifetime. The effect of this stretching was to continue the privilege of deferred taxes for your lifetime instead of a set period of years.

To understand the why behind this change we must understand the government’s intent with IRAs and pre-tax accounts—this is an account to encourage you to save for YOUR retirement. It is not intended to be a perpetual tax shelter for your heirs.

Starting January 1, 2020, lifetime distributions have been decreased to 10 years. This, in turn, increases the yearly distribution substantially.

On the flip side, this may affect your heirs if you plan to leave any wealth inside an IRA or pre-tax account to them. The rules are changing significantly. Understanding the tax implications are paramount to ensuring your current wishes are executed after your death. Estate and retirement plans may need to be changed.

If I inherit $600,000 in a Traditional IRA from my Uncle Eddie, prior to the SECURE Act, I was able to open a special IRA called a Beneficiary IRA and take Required Minimum Distributions (RMDs) over my lifetime. This made the annual required withdrawal much smaller than withdrawals that would have been based on my Uncle Eddie’s much older age. I could leave more money invested in the account over a longer period and use the growth (time value of money) in the account to my advantage.

The SECURE Act now requires that a Beneficiary IRA must be emptied of all funds within 10 years of the date of death of the person who gave you their IRA. However, it does not specify a withdrawal schedule. If you want to defer taking money out for 9 years and empty the account in year 10, you can do that.

Why does the 10-year rule matter? Taxes are due on this money and will be included in your earned income total. You will owe federal and state taxes on this money. It may push you into the next higher tax bracket. For example, say you are 30 years old, single, and have earned income of $60,000. For 2020, your federal tax bracket is 22%. You inherit your uncle’s $600,000 IRA in 2020. You decide to take out the money equally over the next 10 years. Your first withdrawal, factoring in a hypothetical 3% rate of return, equals $60,000 with a remaining balance of $556,200*. This pushes you into the 24% tax bracket with a total earned income of $120,000. To get a great explanation of federal income tax brackets, read this article on Nerd Wallet.

Prior to the SECURE Act, your RMD (withdrawal) would have been $11,257.04 with a remaining balance of $606,405.25*. This is almost a $50,000 difference in Year 1.

If you haven’t figured out the why, “Yes, Uncle Sam still wants his money.” And now, he’ll get it sooner. This is expected to increase the government’s tax revenue significantly.

This change sounds like a big deal, and it can be, depending on the amount of money inside the IRA. To reiterate, if you are the one bequeathing the IRA to the next generation, this can be incorporated into your financial plan, but the plan might require some changes to be more tax efficient. For the ones receiving the IRA, you can incorporate this into your financial plan, but you won’t be able to extend the money for use over your lifetime and delay taxes due.

Onto the good news! If you had a beneficiary IRA as of December 31, 2019 and are stretching distributions over your lifetime, you are grandfathered under the new law and your situation will not change. Also, if you inherited a retirement account from someone who died in 2019, you still have the option of a Stretch IRA available to you even if you have not set up your Beneficiary IRA yet to receive the money.

Anyone who dies in 2020 and beyond, and subsequently their heirs, will now be under the new rules of the SECURE Act.

People in or Nearing Retirement

1. The Required Minimum Distribution age has been increased from age 70 1/2 to 72. The Required Minimum Distribution (RMD) is that provision that states all good things like tax-deferral end at some point. If you have money in a Traditional IRA or other pre-tax retirement account (401(k), 403(b), 457), regardless of whether you need it for retirement living expenses, you had to start taking at least a minimum distribution each year after age 70 1/2. These rules prevent individuals from claiming a tax benefit forever. For more info on this tax break, see end** of article.

Now you can delay that start date to age 72. The law states that you must take your first RMD by April 1st of the year, following the year, in which you turn age 72. I normally advise clients to take their first RMD in the year they turn RMD age because if they delay it to April 1st of the following year, in that following year they will need to take two RMDs to satisfy the retirement.

Now the not-so-good news: If you turned 70 1/2 in 2019 you are not grandfathered into the new law. You still must take your first RMD by April 1, 2020.

2. You can now make tax deductible contributions to Traditional (pre-tax) IRAs if you are still working past age 70. Previously Traditional IRA contributions were not allowed past age 70 1/2 even if you were still working. You must have earned income, which was the previous requirement, in order to qualify for a tax-deductible contribution. Things like rental income are passive income and do not qualify.

People Still Accumulating for Retirement

There are not too many changes for those still accumulating for retirement as far as IRAs go. But there are some major enhancements for employers looking to set up a retirement plan at work. If you don’t have a retirement plan at work, talk to your manager and mention these new incentives.

1. Qualified Birth or Adoption Distribution or QBAD
. Given that health care costs in general are steadily increasing, especially the costs of having a baby, Congress decided this might be an easy way to help offset those costs. You can take a $5,000 distribution from your IRA or retirement plan at work to help pay the costs of having a baby or adopting a child. Normally a withdrawal from your retirement account prior to age 59 1/2 will cost you a 10% penalty tax in addition to regular income tax. Now you can take that withdrawal to help pay the cost of childbirth or adoption without the 10% penalty tax. Income tax is still due, however.

It is a reimbursement so you must wait until after the birth before you can take the distribution. Lastly, fur babies (puppies, kittens, and bunnies) do not qualify for a QBAD. Believe me, my pre-teen daughter already asked.

2. Part-time Employees Qualify for 401(k) Plan
. Before the SECURE Act, these retirement plans were not offered to employees who worked fewer than 1,000 hours in a year. Now, the door is open for employees who have either worked 1,000 hours over the course of one full year or to those who have worked at least 500 hours per year for three consecutive years.

3. Incentives for Employers to Establish 401(k) Plans
.The incentive enhancements for employers, and in turn making saving for retirement more accessible for employees, includes greater tax credits and benefits for the business. There is also a revamp in Multiple Employer Plans.

Tax credits for an employer setting up a new retirement plan in 2020 and beyond can reach a maximum level of $5,000 for the year the plan is established. This almost entirely offsets the cost of the setup, thus reducing this barrier to plan establishment.

Multiple Employer Plans or MEPs were designed to get multiple small businesses to band together to sponsor retirement plans for all their employees. This provision in the tax code has existed for years but was not very popular due rigorous requirements for the employers. The most rigorous was that the employers had to be associated in some way, like belong to the same industry. In addition, if one employer did not fully adhere to the plan’s requirements, it would kill the plan for everybody. Congress seems to like to punish everybody for that one bad apple—which is what the provision was previously called.

These requirements have been relaxed substantially and now Congress is encouraging small employers to band together to enjoy the benefits of economies of scale. It’s loosely akin to group pricing discounts for being a Costco member.

Employers can also add lifetime income products to retirement plans that give employees the opportunity to use financial products like annuities that guarantee income over their lifetimes.

I think the Multiple Employer Plan provision could be a huge boon to both small business employers and their employees when done correctly. At Mammoth Financial we are exploring how we might be able to bring this idea to fruition in our community.

In the closing months of 2019, I embarked on a due diligence process to find ways to help people save for retirement but with smaller initial deposits. We’ve found some vendors and savings solutions that can now be started with as little as $100 to open the account and monthly savings as low as $25. This is a very cost-effective way to access IRAs, Roth IRAs, and other investment vehicles designed to help you plan for your financial future.

My 13- year-old son told me the other day, in answer to a question about trash downstairs, “That’s a problem for ‘Future Jackson.’” Funny, yes. But that wasn’t what my not-so-voluntary advice was when I replied to him. It was something along the lines of “There won’t be a Future Jackson living in this house if there aren’t some changes to Current Jackson’s lack of cleaning up his own mess.”

Saving a little is better than not starting at all. Don’t let saving for retirement be a problem for “Future You.”

* Values determined at year end.

** When you initially put the money in your pre-tax retirement account, you received a tax break. You did not have to pay federal or state income taxes on that money. It lowered what you owed. Don’t confuse this with Social Security or Medicare taxes though. If you are an employee, you pay 7.65% on all earned income. There is no tax break on this portion of your taxes. If you are self-employed or an employer, you pay an additional 7.65% in Social Security and Medicare taxes for every employee, including yourself. That brings the federal government to its full take on these taxes which amounts to 15.3% of all earned income for each wage earner.

If you are an employee, this employer-contributed tax on your behalf equates to a benefit, or at the very least, an expense you do not have to pay personally. As a 22-year-old working for American Express Advisors, I had no clue about this. Your employer also pays a federal unemployment tax, state unemployment tax, and worker’s compensation premiums, on your behalf. These vary state to state so this is generalized information. These expenses to your employer should help you evaluate your benefits package when weighing a job change, along with traditional benefits like medical insurance, life insurance, and retirement account matches. The minimum cost to any employer per employee = Salary (hourly wages) + 7.65% payroll tax + state unemployment tax + federal unemployment tax + worker’s compensation insurance premiums + paid time off (if provided) + health care (if provided) + 401(k) maintenance and match (if provided) + life insurance (if provided) + bonus (if provided) + additional benefits (like profit sharing in a 401(k) plan).

*** Cover photo by Stoica Ionela on Unsplash.