In late December, Congress and the President made significant changes to the tax laws affecting retirement plans. I wrote about the earlier version of the legislation, called the SECURE (Setting Every Community Up for Retirement Enhancement) Act, in July. Here, I’ll discuss the final version of that legislation as well as changes to tax laws that were not a part of the original SECURE Act but were included in the appropriations bill (“Further Consolidated Appropriations Act, 2020”) that included the SECURE Act provisions.
The legislation addresses concerns about Americans outliving their money. For example, according to a recent Federal Reserve report, a quarter of non-retired adults, including 13% of workers age 60 and older, have no retirement savings at all.
The legislation is intended to:
- Change retirement account minimum distribution rules
- Change how IRA assets can be used for charitable donations
- Increase access to and participation in retirement plans
- Require the dissemination of information on the income potential of retirement assets
- Ease the process of converting retirement assets to lifetime income
- Repeal certain aspects of the 2017 Tax Cuts and Jobs Act affecting medical expense deductions and children’s income
Changing retirement account minimum distribution rules
Required Minimum Distributions (RMDs) are IRS-mandated withdrawals from retirement accounts. The tax code stipulates specific withdrawal amounts so that most of one’s tax deferred assets are distributed by the end of life (assuming a long life), rather than inherited in tax-deferred form.
Previously, RMDs had to start in the year one turned 70½ for Traditional IRAs and (if you were not still working) for 401(k)s. Now, RMDs begin in the year one turns 72 for those turning 70½ after December 31, 2019. Those who turned 70½ before 2020 will be subject to the old rule.
This change means greater flexibility in starting your retirement withdrawals, and financial planners will analyze the various timing options to compare benefits. For example, starting RMDs at 72 adds 1½ years of tax deferral but concentrates withdrawals in fewer years with higher taxable income in each one. In addition, we often advise Roth conversions between retirement and the start of RMDs. This period is now longer, increasing Roth conversion possibilities. Another consideration is income-based Medicare Part B premiums or IRMAAs. Concentrating income in a smaller number of years could push you into a higher Medicare cost band.
The new law also significantly changes rules for inherited IRAs. Heirs must now withdraw IRA funds within ten years, thereby limiting a technique called a stretch IRA. Associated taxes for inheritors on pretax IRAs will often come sooner and in larger amounts than under old rules. The old rules will still apply to spouse inheritors, chronically ill or disabled beneficiaries, and beneficiaries not more than ten years younger than the IRA owner. The 10-year period will only start once children reach the age of majority. The new rules are in force for circumstances where the IRA owner dies after December 31, 2019. For deaths on or before that date, the old rules will still apply.
Inherited IRA assets can be withdrawn at any time during the 10-year period – there is no set schedule. Your advisor can help you design a withdrawal strategy that meets your specific cashflow needs, while taking tax rates into account. However, the elimination of annual RMDs may create issues for trusts designed to hold inherited IRA assets under the old rules. If your estate plan has this type of trust, be sure to consult with your estate planning attorney.
Changing tax laws on the use of IRA assets for charitable donations
Donating IRA assets to charity can sometimes be advantageous. IRA asset donations are made with pre-tax dollars (equivalent to receiving a tax deduction). Under the new law, people 70 ½ and over can still use this technique for amounts up to $100,000 per year, even though the RMD date is now 72. Charitable donations made at age 72 or later count toward your RMD. However, the donations count less if you made contributions to your IRA after 70½. This is a complicated area of the law and we advise clients to consult with their advisor and their tax professional if they are interested in making charitable contributions from their IRAs.
Increasing access to and participation in retirement plans
Because 401(k) plans have been complex to offer and costly to administer, many small employers do not offer them, or offer 401(k)s with high-fee mutual funds (some employers pay plan administration costs with a portion of these high fees). Under the new law, employers can more easily band together to create multi-employer plans, thereby spreading plan administration costs across a larger base. This should make it much more attractive for large, efficient 401(k) service providers such as Vanguard, Fidelity and T. Rowe Price to serve small employers. Small companies would then have access to better plans at lower cost.
The new law also encourages more businesses to offer 401(k) plans by increasing tax credits available to help offset the costs of establishing a plan, and for companies that implement auto-enrollment. The legislation also increases the percentage of compensation that can be incorporated into auto-enrollment programs.
Additionally, there are now provisions to broaden access to employer-sponsored plans for part-time workers and students receiving fellowship or stipend money.
Various studies suggest that more than a third and possibly as many as half of private-sector workers do not have access to a workplace retirement-savings plan. We believe these changes to 401(k) plan rules will encourage the creation of more 401(k) plans and permit more workers to save in a tax-advantaged manner.
The legislation also allows workers to contribute to traditional IRAs beyond the current age limit of 70½ (workers older than 70½ can already contribute to a 401(k) or Roth IRA). These post-70½ contributions will reduce Qualified Charitable Deductions, as discussed elsewhere in this article.
Disseminating information on the income potential of retirement assets
How much retirement income can you expect based on the assets in your retirement accounts? The new law requires 401(k) plan administrators to produce lifetime income disclosure statements annually to disclose each participant’s monthly income. Participants and their advisors could then combine this assessment with the income projections from their Social Security account to create a summary of their retirement income potential. It will take time for plan administrators to put this change in place. We recommend working with your advisor to understand the income your investments may provide.
Easing the process of converting retirement assets to lifetime income
Today, employers are permitted to offer their employees lifetime income options (e.g., income annuities) in their 401(k) plans, and some employers do. However, many employers do not offer these products because of liability concerns in selecting a provider. The new law reduces this risk for employers, which should increase the prevalence of income annuities in retirement plans.
Sensible Financial recommends income annuities in certain circumstances. We work with our clients to help them determine if these products fit their circumstances.
Other changes to tax laws
Medical expenses in excess of 7.5% of adjusted gross income (AGI) are now deductible for 2019 and 2020, as they were in 2018. Those with significant medical expenses will benefit.
A provision of the Tax Cuts and Jobs Act of 2017 (TCJA) raised the tax rate on children’s income above certain thresholds to the top trust tax rate. The “kiddie tax” is still in place as a deterrent to parents shifting income to their kids to take advantage of lower tax rates. However, the use of the trust tax rate has been repealed. The law now reverts to using parents’ top marginal tax bracket for that type of income.
Other changes not discussed in depth here
The law made other changes which could affect some people. Please be sure to speak with your advisor if you are in the following categories:
- Receiving fellowship or academic stipend income but not otherwise employed
- Repaying student debt or participating in apprenticeships and having 529 plans
- Becoming parents, either through birth or adoption
- Continuing to work after age 59½ with 401a or 457 retirement plans
- Being foster care parents
- Living in a federal disaster area
- Working for church-controlled organizations
- Implementing retirement plans for employees as a company owner
- People can start Required Minimum Distributions later, but heirs will find it harder to stretch the payments. Some trusts may need to be amended.
- There are changes to the rules about using IRAs to contribute to charities.
- Small employers will have lower-cost 401(k) options to offer their employees, enabling more employees to save for retirement
- Employees will have more information to help translate assets (hard to interpret) into income (easy to interpret)
- It will be easier for employers to offer income annuitization to workers
Sensible Financial is incorporating this new legislation into our financial plans and into the advice we provide clients. Please contact your financial advisor if you have questions.