In the last days of December, Congress passed, and the President signed, an end-of-year appropriations bill, H.R. 1865. In addition to funding the government, the bill contained the “Setting Every Community Up for Retirement Enhancement” Act (the “SECURE Act”), which will impact both individual and employer-provided retirement plans moving forward. In this post, I’ll discuss the effects the SECURE Act will have on individuals. Part 2 covers the SECURE Act’s effect on employer-provided plans.
Required Minimum Distribution Age Now Set at 72
Prior to the passage of the SECURE Act, retirement plan participants and Individual Retirement Account (IRA) owners were obligated to take a Required Minimum Distribution (RMD) by April 1 of the year after they turned 70½. This requirement has been set since the 1960s even as life expectancies have risen. The SECURE Act changes the RMD age to 72. Therefore, required distributions and individuals who turn 70½ after December 31, 2019, must start taking the RMD from retirement plans or IRAs at age 72.
Maximum Age for Traditional IRA Contributions Eliminated
Previously, individuals could no longer make contributions to a traditional IRA once they reached 70½. The SECURE Act eliminated this restriction. Starting in 2020, individuals, no matter their age may make contributions to a traditional IRA, so long as they have earned income.
Stretch IRA Planning Partially Eliminated
Before 2020, when an individual died with a retirement plan or IRA in place, beneficiaries were allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the course of the beneficiary’s life or life expectancy. In the IRA context, this is referred to as a “stretch IRA.”
For deaths of plan participants or IRA owners occurring in 2020 (later for participants in a collectively bargained or governmental retirement plan) and beyond, distributions to most non-spouse beneficiaries are now generally required to be distributed within ten years of the IRA owner’s or plan participant’s death.
Exceptions to this rule are allowed for:
- the surviving spouse;
- a child who has not reached majority;
- a disabled individual;
- a chronically ill individual; and
- any other individual who is not more than 10 years younger than the plan participant or IRA owner.
These individual beneficiaries may continue to take distributions over their life expectancy.
Kiddie Tax Changes
As part of the Tax Cuts and Jobs Act (TCJA) passed in 2017, Congress revised the tax rates applicable to unearned income of certain children, the “kiddie tax,” such that this unearned income would be taxed at brackets applicable to trusts and estates. The alternative minimum tax (AMT) exemption was also reduced for this unearned income.
Among other implications, this created unfair treatment for certain children receiving government payments because they were survivors of deceased military personnel, first responders, and emergency medical workers.
The SECURE Act struck the TCJA provisions applicable to the kiddie tax and returned it to its previous treatment—being taxed at the same rate as the child’s parents, instead of at trust and estate rates—and eliminated the reduced AMT exemption amount.
Expanded Use of 529 Plan Distributions
Section 529 education savings plans offer individuals the opportunity to make nondeductible cash contributions on behalf of a designated beneficiary into a tax-exempt program maintained by a state or one or more eligible educational institutions. The earnings on the contributions are tax-free, and distributions are excluded from income up to the amount of the beneficiary’s qualified higher education expenses, which prior to the SECURE Act, did not include expenses of registered apprenticeships and student loan repayments.
For distributions made after December 31, 2018, tax-free distributions may be taken and used to pay for books, fees, supplies, and equipment for the beneficiary’s participation in an apprenticeship program. Further, distributions (up to $10,000) are now allowed to pay the principal and interest on a beneficiary’s, or a sibling of the beneficiary, qualified education loan.
Expanded Penalty-Free Retirement Withdrawals
Distributions from a retirement plan typically must be included in income, and those taken prior to the participant reaching 59½ is subject to a 10% withdrawal penalty, unless an exception applies.
Beginning in 2020, plan distributions (up to $5,000) used to pay expenses relating to the birth or adoption of a child are penalty-free. Since this amount applies on an individual basis, each spouse in a married couple may receive a penalty-free distribution of up to $5,000.
New “Compensation” Treatment Permits Individuals to Save for Retirement
There is a cap on the deduction an individual may take for contributions to an IRA each taxable year. This cap is set at the lesser of the deductible amount or an amount equal to the individual’s compensation. Prior to 2020, stipends and non-tuition fellowship payments received by graduate and post-doctoral students were not treated as compensation for IRA contribution purposes and, therefore, could not be used as the basis for making IRA contributions. Now, these payments are treated as compensation, which will enable students to begin saving for retirement.
Home healthcare workers whose only compensation is from “difficulty-of-care” payments do not have taxable income because such pay is tax-exempt. Because they did not have taxable income, they could not save in a qualified retirement plan or IRA. The SECURE Act changed the rules so difficulty-of-care payments are now treated as compensation for purposes of calculating contribution limits to qualified plans and IRAs, which will allow these workers to save for retirement. The change is retroactive starting in 2016 for contributions to certain qualified retirement plans.
The SECURE Act brought about many changes in addition to those mentioned above. If you have any questions about how this may affect you or your business, do not hesitate to call a member of the Tax Practice group.