The SECURE Act (Setting Every Community Up for Retirement Enhancement) is now the law of the land. If there’s any constant in retirement planning, it’s change. As soon as you make financial plans based on current laws, they change. This legislation, signed into law with only days left in 2019, will have significant changes in 2020. Retirement savers should take note. Here are some key changes due to The SECURE Act:
Required Minimum Distributions (RMD) now begin at 72
Required Minimum Distributions (RMDs) are withdrawals that must take place when a retirement account owner reaches a certain age. It is hard to believe, but for nearly sixty years, 70.5 was the age to begin RMDs. What’s even more difficult to believe is after 60 years, the age has been increased by a mere 1.5 years. Delaying RMDs to age 72 gives extra time for funds to be invested. In addition, it delays taxable withdrawals. However, this change will have limited benefit for most people.
Historically, the timing of one’s first RMD could be confusing. For example, we don’t often think about our age in 1/2 years. Most of us stopped doing that by the time we were 8 or 9 years old. Adding to the confusion, is the rule that allows one to defer their first RMD until April 1 of the following year. Now that the age is 72, it’s much easier to determine if you need to start Required Minimum Distributions.
Starting in 2020, if you turn 72 during the year, you are required to begin taking RMDs. You are still allowed to defer your first RMD until April 1 of the following year. For example, if you turn 72 on September 19, 2020, you can take your first RMD in 2021 by April 1. Just because you can do something, doesn’t mean you should. If you defer your first RMD, that means you’ll have two RMDs in the same year. This could increase your taxable income and result in higher taxes.
If you turned 70.5 in 2019, you are still subject to RMDs for this year and each year after. Tax penalties for failing to take RMDs are stiff. If you fail to take the RMD by the applicable deadline a 50% penalty can be applied. As an example, consider your RMD for the year was $3,000. If you failed to make the withdrawal, you would owe the IRS $1,500! If you failed to take an RMD or didn’t take the right amount, you will need to file a special tax form. In certain circumstances, the penalty can be waived, but I would never count on that.
SECURE Act Changes RMD Rules For Inheriting Retirement Accounts
One of the great advantages under prior law pertained to inheriting retirement accounts. Historically, non-spouse beneficiaries of a retirement account could stretch their RMDs over their lifetime. For example, assume you inherited an IRA from your sibling, parent, or friend at age 40. Basically, anyone other than your spouse.
Because you inherited the IRA, the law required you to begin RMDs, even though you weren’t 70 1/2. However, you were able to spread those RMDs out over your lifetime. This allowed for the funds to continue to grow over time. Additionally, taxes were minimized because the RMDs were a relatively small portion of taxable income.
All of this has changed. Now when you inherit an IRA from a non-spouse, you are no longer subject to RMDs. Sounds great right? It isn’t. The new rules require the inherited IRA to be fully distributed within 10 years. This could significantly increase the taxes owed on these inherited funds.
Consider the following example: In 2020, you inherit an IRA with $100,000 at age 50 from your parent. You keep the funds invested and pay no taxes for 10 years. Your investment grows at 7% annually and reaches a value of $196,715. Under the new rules you must distribute the full balance of the account. The result is your taxable income for that year just increased by $196,000 on top of other income earned from wages and other investments.
This will require special planning to identify the best time to make the withdrawal(s). For example, you could time the withdrawals to coincide with your retirement or other financial event in a year when your taxable income is reduced.
Roth IRA RMDs And The SECURE Act
Roth IRAs are not subject to Required Minimum Distributions with the exception of inherited Roth IRAs. If you inherit a Roth IRA from a spouse, you can treat it as your own. In other words, you are subject to the same rules as if you were the original owner of the Roth IRA. The main point being you are not subject to RMDs.
Historically, if you inherited a Roth IRA from a non-spouse, you were subject to RMDs. While these RMDs were not taxable, it did serve the purpose of spending down the account. This prevented the accumulation of tax-free funds being transferred to the next generation.
Beginning in 2020, inherited Roth IRAs from a non-spouse will be subject to these updated rules. Non-spouse beneficiaries of Roth IRAs will be required to fully distribute the balance of the account within 10 years as specified earlier. However, because the withdrawals are tax-free, it won’t increase taxable income like traditional IRA and other pre-tax retirement accounts.
Traditional IRA Contributions Now Allowed Beyond 70.5
Historically, once you reached age 70.5 and became subject to RMDs, you were no longer eligible for deductible IRA contributions. Under the new rules, as long as you have earned income, you can make deductible contributions.
This change brings traditional IRA rules in line with other retirement accounts like 401(k) and Roth IRAs. As people are living longer, they are working longer. The SECURE Act now allows workers over 70.5 to continue making deductible IRA contributions.
Other SECURE Act Changes
- Up to $5,000 penalty free withdrawals for “Qualified Birth or Adoption Distribution”
- Annuities now allowed within 401(k) and other employer retirement plans
- Increased eligibility for part time workers access to 401(k) plans
- Larger tax credits for businesses starting retirement plans
- Extended deadlines for companies to establish retirement plans in a given year
- 529 College Savings Plan withdrawals can be used to pay up to $10,000 in student loan debt
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