The new decade brought with it a new tax law, the Further Consolidated Appropriations Act (better known for its non-acronym-based title, the SECURE Act) which became effective on January 1, 2020. This new law makes slight tweaks to Individual Retirement Account (IRA) rules you may have finally memorized yourself while also adding new benefits I believe are aimed at Millennial savers. First, let’s tackle possibly the most impactful result of the SECURE Act on IRAs:
Inherited Beneficiary Distribution Account (BDA) IRA owners may no longer utilize the stretch provision. Previously, a particular class of beneficiaries of IRA and 401k accounts could “stretch” the lives of those BDA IRAs by taking annual distributions over their expected lifetime. Typically, those were non-spousal beneficiaries of decedents who had not yet started taking Required Minimum Distributions (RMDs). Under the SECURE Act, IRAs inherited on January 1, 2020 or later are now subject to a 10-year rule, in which the full balance of the inherited BDA must be withdrawn in full by the end of those 10 years, whether those withdrawals are spread out over the years or all at once during any point by the end of the 10th year.
The potential impact is not insignificant. Consider this brief example: A widower, with the bulk of his wealth in a rollover IRA, passes away on January 1, 2020 and leaves the $1,500,000 account to his 35-year-old daughter, who is married and averages $75,000 adjusted gross income annually. Under the new rules, the heir must withdraw the account entirely within 10 years. Assuming the distributions are spread evenly over ten years, a $150,000 distribution will increase their marginal tax rate from 12% to 24% with the bulk of the distribution being taxed between 22% and 24%.
There are exclusions to the new rule and there are planning strategies to deal with it. This topic requires a bit more attention and detail, which I will cover in a second post on this topic in the coming weeks.
As for other changes to IRAs, forget everything you knew about the IRS’s magical age of 70 ½:
IRA owners must now begin their Required Minimum Distributions (RMD) at age 72. This change is an 18-month extension from the previous age target of 70 ½ years. Those who recently began taking RMDs and are turning 71 in 2020 must continue to take those distributions as mandated by the IRS. Only those IRA account owners who turn 72 on January 1, 2020 or later are subject to the new rule. The Uniform Lifetime Table used to calculate the RMD remains the same.
IRA owners with earned income may continue making IRA contributions beyond age 70 ½. As Americans are living and working longer, they may now save longer as retirement gets pushed back further. Previously, an age cap of 70 ½ years was in place to coincide with the first RMD.
Finally, the SECURE Act is seemingly targeting the Millennial age group with the following:
Early withdrawal penalties from IRAs are eliminated for new parents. This is a minor, but new and creative, benefit to saving in an IRA. Up to $5,000 of distributions within the first 12 months, parents of a newborn or adopted child can avoid the early withdrawal penalty (but not income tax). For young earners who fear that saving for retirement (a far-off life event) could restrict their spending on present day life goals, this provision may bring relief when life throws a curveball. Considering the other exclusions for qualified distributions from an IRA that may be withdrawn penalty-free, saving in an IRA remains an attractive option.
Qualified distributions from 529 plans expand further with student loan provisions. Late last year I described a strategy in reaction to the changes in 529 plan provisions brought about by the 2017 Tax Cuts and Jobs Act, as Kindergarten through Grade 12 school tuition could now be paid by 529 plan distributions. The SECURE Act picks up the slack by allowing up to $10,000 of 529 plan distributions annually to pay off student loan debt.
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