5 Things the SECURE Act Has Changed for Individuals

In December of 2019, the SECURE Act (Setting Every Community Up for Retirement Enhancement) was signed into law, triggering several changes for individual investors and employers that offer or have considered offering retirement plans. The SECURE Act was the latest major financial legislation since the Tax Cuts and Jobs Act of 2017, which also had a significant impact on American taxpayers.

Due to the vast number of changes that SECURE has imposed on both employers and individuals, I’ll first cover what I think are the top 5 changes that individuals, both young and old, need to be aware of.

1. Required Minimum Distributions Now Start at 72

If you are retired, you’re likely aware of the previous rules for Required Minimum Distributions (RMDs), which required individuals to begin withdrawing a percentage of their qualified retirement accounts (IRAs, 401ks, etc.) starting April 1 of the year following the year the individual turns 70 ½. Now, individuals will not have to take distributions until April 1 of the year following the year they turn 72.

I’ve always felt the wording of the RMD rule was incredibly confusing (leave it to the IRS), but I’m glad to see the 70 ½ number has been changed to a whole number of 72. After all, how many of us think about when our 6-month birthdays are?

It should be noted that for your first RMD, you can delay your distribution until April 1 of the year following the year you reach the specified age, now 72. However, all subsequent RMDs must take place by December 31 of following years. Therefore, It’s important to note that although individuals can delay their first RMD until April 1 of the year following the year they turn 72, most will still take their first RMD in the same year they reach that specified age. The reason is that if you delay your first RMD until April 1 of the year following the year in which you reach age 72, you would then have to take two distributions in the year you turn 73.

On the positive side, this change will allow individuals to delay distributions a few more years, allowing their retirement accounts more time for possible tax-deferred growth. However, according to IRS-released data¹, about 20% of all retirement account owners only take the minimum distribution amount required.² If the IRS data is correct, that means approximately 80% of retirement account owners already take distributions either prior to the required starting age or above the required amount. Therefore, this change may only affect a small group of retirement account owners.

2. No More Stretch IRAs

In perhaps the biggest change of this legislation, most non-spouse beneficiaries will no longer be able to “stretch” distributions from inherited IRAs over their life expectancy, as was previously allowed. The old rule has been replaced by a new rule, which states that non-spouse beneficiaries will be required to empty their Inherited IRA over a period of 10 years, with no distributions required until the 10th and final year following the year of inheritance.

The implications of this portion of the SECURE Act could be significant for future beneficiaries of retirement accounts. This may cause those beneficiaries to pay more in taxes, pay those taxes sooner, and subsequently decrease the amount of their inheritance.

While the general rule under the SECURE Act will be the 10-year distribution rule, there are still five groups of people that will be able to take advantage of the previous “stretch” rules. These groups are now known as Eligible Designated Beneficiaries. They include beneficiaries that are the spouse of the deceased, disabled persons, chronically ill individuals, those who are not more than 10 years younger than the decedent, and certain minor children until they reach the age of majority.³

To reiterate, spouses may still take advantage of the “stretch rules” or they may also assume their deceased spouse’s IRA as their own. Also, while the elimination of the stretch provision will go into effect immediately for most, there are a few exceptions which include; certain plans pursuant to a collective bargaining agreement, 403(b) and 457(b) plans, TSP (Thrift Savings Plan), annuities that have already been annuitized, or annuities where an individual has elected an irrevocable income option that will begin at a later point.^{2, 4}

The elimination of the stretch IRA for everyone else is expected to be the source of revenue that will help pay for the rest of the bill.

3. Traditional IRA Contributions Now Allowed Past 70 ½

In a more straightforward provision, traditional IRAs have now caught up to Roth IRAs and 401(k)s, allowing contributions from individuals with earned income after 70 ½.

This should give greater access to retirement accounts for individuals working past age 70 ½ that have no access to an employer-sponsored retirement plan.

4. Qualified Childbirth and Adoption Distributions

SECURE has also provided a way for new parents to ease the potential high costs of bringing a child into the world. Under the SECURE Act, new parents can avoid the 10% early withdrawal penalty on retirement plan distributions taken during the one-year period beginning on the date of birth or the date of adoption (of a child under the age of 18 when the adoption is finalized), with a distribution limit of $5,000.

The $5,000 limit appears to apply to each individual parent, so if both mother and father have retirement assets available, each can take a Qualified Childbirth and Adoption Distribution of $5,000 for each child born or adopted.

This new exception does not, however, exempt account owners from paying taxes on what would have otherwise been taxable distributions. It is the 10% penalty that can be avoided as a result of qualifying distributions.

5. Student Loans Are Now a Qualified Expense for 529s

Last, but not least, 529 College Savings Plans may now be used to pay both principal and interest on student loans, with a lifetime limit of $10,000 per person. Also, 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 will provide additional planning opportunities for families and college students utilizing a 529 plan.

Bottom Line

The SECURE Act has triggered many changes for individuals and small businesses. Be sure to speak to a qualified financial professional if you are unsure if any of these changes might affect you.

Sources 

¹Federal Register of the United States Government; Updated Life Expectancy and Distribution Period Tables Used for Purposes of Determining Minimum Required Distributions. https://www.federalregister.gov/documents/2019/11/08/2019-24065/updated-life-expectancy-and-distribution-period-tables-used-for-purposes-of-determining-minimum

²Kitces Nerd’s Eye View; IRS Proposes New RMD Life Expectancy Tables to Begin in 2021. https://www.kitces.com/blog/irs-proposes-new-rmd-life-expectancy-tables-to-begin-in-2021 

³The IRS has defined what it means to be an Eligible Designated Beneficiary, which includes definitions for each of the five categories listed in the article.

⁴Plans pursuant to a collective bargaining agreement and governmental plans will have an effective date of Jan. 1, 2022 for the new stretch rules. The annuity scenarios mentioned are exempt entirely from the new rules.

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