As with any new and developing tax legislation, careful and diligent planning is required.
In late December 2019, and accompanying a $1.4 trillion spending bill, the Setting Every Community Up for Retirement Enhancement (SECURE) Act became law. This landmark legislation may affect how you plan and save 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.
Here is a look at some of the more important retirement and nonretirement elements of the SECURE Act largely intended to propel your capacity to fund your own retirement savings.
The key provisions of the act have:
- Eliminated the age limit for traditional IRA contributions;
- Increased age limits for required minimum distributions (RMDs) and IRA savings;
- Partially eliminated beneficiaries’ tax-free inheritance of IRAs and 401(k)s, aka Stretch IRAs;
- Eliminated the penalty for IRA withdrawals for a birth or adoption;
- Expanded Section 529 education plans for apprenticeships and to repay certain student loans;
- Reverted the kiddie tax back to its previous version; and
- Defined nontuition fellowship and stipend payments as compensation for IRA purposes.
Repeal of Maximum Age for Traditional IRA Contributions
Old Law: Before 2020, traditional IRA contributions were not permitted once the individual attained age 70½.
New Law: Starting in 2020, the 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
Old Law: Before 2020, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions, or RMDs, from their plan by April 1 of the year following the year they reached age 70½. Before the SECURE Act, the age 70½ requirement had never been adjusted by Congress for life expectancy changes.
New Law: Individuals who attain age 70½ after December 31, 2019, may now delay taking required distributions from their retirement plan or IRA until they attain age 72. If you turned 70½ on or before December 31, 2019, you will have to continue taking RMDs.
Partial Elimination of Stretch IRAs
Old Law: For deaths of plan participants or IRA owners occurring before 2020, beneficiaries (both spousal and nonspousal) were generally allowed to “stretch” out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life or life expectancy (hence the term "stretch IRA").
New Law: For deaths of plan participants or IRA owners beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), distributions to most nonspouse beneficiaries are generally required to be distributed within 10 years following the plan participant’s or IRA owner’s death. So, for those beneficiaries, the "stretching" strategy is no longer allowed.
Exceptions to the 10-year rule are allowed for distributions to:
- The surviving spouse of the plan participant or IRA owner;
- A child of the plan participant or IRA owner who has not reached majority;
- A chronically ill individual; and
- Any other individual who is not more than 10 years younger than the plan participant or IRA owner.
Those beneficiaries who qualify for exceptions may generally still take their distributions over their life expectancy (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
Old Law: A Section 529 education savings plan (aka 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 federal nondeductible cash contributions to a 529 plan on behalf of a designated beneficiary. The earnings on the contributions accumulate tax-free. Distributions from a 529 plan are excludable up to the amount of the designated beneficiary's qualified higher education expenses.
New Law: For distributions made after December 31, 2018 (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. Before the act, qualified higher education expenses did not include the expenses of registered apprenticeships or student loan repayments.
In addition, tax-free distributions (up to $10,000) to pay the principal or interest on a qualified education loan may now go to the designated beneficiary or their sibling, eliminating the need to change the designated beneficiary. A student loan distribution to a sibling of a designated beneficiary is applied to the sibling's $10,000 lifetime limit, not to the lifetime limit of the designated beneficiary.
Kiddie Tax Swings Back to Prior Law
Old Law, Pre-TCJA: In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which made changes to the so-called "kiddie tax," which is a tax on the unearned income of certain children. Before enactment of the TCJA, the net unearned income of a child was taxed at the parents' tax rates if the parents' tax rates were higher than the tax rates of the child.
Old Law, Post-TCJA: Under the TCJA, for tax years beginning after December 31, 2017, the taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. Children to whom the kiddie tax rules apply and who have net unearned income also have a reduced exemption amount under the alternative minimum tax (AMT) rules.
New Law: The new rules under the act repeal the kiddie tax measures that were added by the TCJA. So, starting in 2020 (with the option to start retroactively in 2018 and/or 2019), the unearned income of children is taxed under the pre-TCJA rules, and not at trust/estate rates. Also, starting retroactively in 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. These revised rules are complex and require careful planning. Contact us for further information and guidance.
Taxable Nontuition Fellowship and Stipend Payments Are Treated as Compensation for IRA Purposes
Old Law: Before 2020, stipends and nontuition fellowship payments received by graduate and postdoctoral students were not treated as compensation for IRA contribution purposes, and so could not be used as the basis (for the earned income requirement) for making IRA contributions.
New Law: Starting in 2020, the new rules remove that obstacle by permitting taxable nontuition 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.
Individuals are living and working longer and desire, in many cases, to continue to contribute to their retirement plans while not having to take RMDs until a future date and later age. Other than the elimination of the “stretch” IRA, most of the changes are taxpayer-friendly and should boost your retirement nest egg. However, the SECURE Act creates new planning opportunities from estate and trust planning to life insurance planning, beneficiary designation selection and others. As with any new and developing tax legislation, careful and diligent planning is required. We are always available to discuss the implications to your personal or business tax situations.
For Further Information
If you would like more information about this topic or your own unique situation, please contact Gregory G. Smith, CPA, MST, Steven M. Packer, CPA or Michael A. Gillen, CPA or any of the practitioners in the Tax Accounting Group. For information about other pertinent tax topics, please visit our publications page.
Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.