That rustling sound you may have heard in late December was not Santa, nor a late-night Amazon delivery, but rather Congress passing the Setting Every Community Up for Retirement Enhancement (SECURE) Act on December 19, 2019 (which President Trump signed into law the following day).
While most of the SECURE Act’s provisions became effective on January 1, 2020, how do you know if the new law impacts you? Chances are high that some portion of the new law will impact you or your beneficiaries given the net it casts applies to working and retired owners/participants in an Individual Retirement Account (IRA) or employer sponsored retirement plan (such as a 401(k), 403(b), Employee Stock Ownership Plan, or profit-sharing plan), or those that may inherit one of these type plans in the future.
In this post we will cover the two most publicized changes within the SECURE Act: the push back of the start date for Required Minimum Distributions from retirement plans, and the semi-elimination of the ability to “stretch” inherited retirement plan distributions.
In Part 2 you will find information about other provisions of the act, such as the impact of the Act on some estate plans, the Traditional IRA contribution age restriction being eliminated, the impact (or lack thereof) on Qualified Charitable Distributions (or “charitable IRA rollovers” as some know it) as well as college savings 529 plan changes and new ability to use IRA dollars for adoption expenses.
Required Minimum Distribution age: Increased from 70.5 to 72
Previously, Required Minimum Distributions (RMD)* from a retirement account (such as an IRA, 401(k), 403(b), etc.) had to begin no later than the year following the year an account owner reached age 70.5. Adding to what was already a somewhat difficult to understand rule the SECURE Act added another wrinkle by increasing the required start age for some individuals from 70.5 to 72. While eliminating the half-year aspect will likely prove to be simpler in the long-run, first let’s define to whom the new rules do and don’t apply.
Who: If your date of birth is prior to July 1, 1949, then the RMD start date change from age 70.5 to 72 does NOT impact you. Retirement plan owners born before this date reached age 70.5 in the year 2019 and will continue to use the “old” RMD rules.
However, for those born July 1, 1949, and later the SECURE Act pushes back the RMD start date to the year following the year you reach age 72. A quick side note on the phrase “year following the year”: this provision allows the first year RMD to be delayed until April 1st of the year after attaining age 72. Doing so would result in two RMDs being taken that year, (1) one RMD which you delayed from the previous year, for age 72, and; (2) another RMD for the age 73 years.
EXAMPLE: On New Year’s Eve a hypothetical conversation between Bruce Springsteen and Billy Joel turned to the recent SECURE Act provisions. Joel bemoaned his unfortunate luck of having been born May 9, 1949, and thus attaining age 70.5 in 2019. He had completed his very first RMD from his retirement plan earlier that day and been correctly instructed he would need to complete one each year going forward.
Springsteen, panicked upon hearing this news from Joel, phoned his tax professional to inquire about his own RMD for the year and whether he had errantly missed the December 31st deadline. Much to his relief he learned his date of birth (September 23, 1949) afforded him the ability to delay his initial RMD until he attains age 72 in 2021. In fact, Springsteen may choose to delay his first RMD as late as April 1, 2022, though his tax professional reminded him that would necessitate he take two RMDs during 2022 (the age 72, 2021 RMD, and the age 73, 2022 RMD).
The seemingly small age difference of just over four months allowed The Boss to benefit from the new SECURE Act rule, while The Piano Man would need to abide by the “old” rules.
This is a hypothetical example and not intended for any specific person.
Elimination of the Retirement Account “Stretch” Provision for Some…but Not All Beneficiaries
One of the more appealing aspects of retirement plans is the ability for an account owner to pass his/her account to a beneficiary (oftentimes younger) who then could “stretch” distributions over their own life expectancy. The power of years of tax-deferred growth inside the retirement account during not only the original owner’s life, but also a young(er) beneficiary’s life, could be material.
The SECURE Act has diminished this power for many going forward by requiring some, but not all, beneficiaries fully withdraw the retirement account balance by the end of the 10th year following the year of inheritance. Before we delve into the 10-year rule, first let us look at to whom the change applies:
Who: First, the SECURE Act does not apply to retirement account owners having died prior to January 1, 2020. Thus beneficiaries of retirement plans where the owner died on or before December 31, 2019, are “grandfathered” into the former distribution rules.
In addition, five other types of beneficiaries known as “Eligible Designated Beneficiaries” also receive this “grandfathered” status in instances when the account owner dies on January 1, 2020, or later. These groups are spousal beneficiaries, beneficiaries not more than 10 years younger than the decedent, minor children of the account owner (though notably, this is a temporary status as a child must begin the 10-Year payout at the age of majority), chronically ill, and disabled beneficiaries.
Lastly, some state and federal employees will enjoy a two-year delay before the rules take effect for them, allowing some additional preparation time. Retirement plans sponsored by state and local governments, and the Thrift Savings Plan sponsored by the Federal government, are not impacted until a beneficiary inherits an account from an owner that passes away on January 1, 2022, or later. The fact members of Congress are within this group as participants in the government’s Thrift Savings Plan is presented here without comment.
The 10-Year Rule in Practice
If you do find yourself subject to this new 10-Year Rule, take heart, as it does come with a modicum of flexibility. The flexibility stems from the requirement that the retirement account be fully liquidated by the end of the 10th year following the beneficiary inheriting the account. However, there is no stipulation as to the timing of distributions during this 10-year timeframe. This allows beneficiaries to withdraw the account value in ten equal installments, or unequal installments, including (but not limited to) delaying withdrawal of any amount for as long as possible (i.e. until the end of the 10th year).
This flexibility will carry with it the need, and opportunity, for beneficiaries to determine the optimal withdrawal approach based on their own unique financial situation. Factors that will play a key role include a beneficiary’s age, proximity to retirement, projected income over the next 10 years, current and projected tax bracket, as well as the need (or lack thereof) to withdraw and use the inherited retirement dollars.
EXAMPLE: Though we are early in the year 2020 we have already lost a former athlete with one of the more famous accomplishments. Don Larsen (nicknamed “Gooney Bird”) is the only pitcher to throw a perfect game in the World Series. He passed away at age 90 on January 1st leaving behind his wife, son, and two grandsons.
While we don’t know the details of Larsen’s financial life, if he did name his son (Scott, age 57) as a beneficiary of a retirement plan such as an IRA then Scott may be faced with a decision similar to many other beneficiaries.
Assume Scott plans to retire at age 65. Because of his father’s death early in 2020, this gives Scott virtually 11 calendar years to fully liquidate the IRA. In this instance, year 1 for Scott is 2021 and year 10 is 2030, thus setting the liquidation deadline on December 31, 2030.
Scott may find himself weighing his options given, in his mid-50’s, he could be experiencing his own peak earning years and desire to delay distributions as long as possible. With plans to retire at age 65, in 8 years, he could elect to delay distributions until those final two years or choose instead to withdraw the IRA balance in equal installments over the next decade. Some of the deciding factors will be the IRA account value, Scott’s earned income from now until age 65, and how the dollar amount of distributions will impact Scott’s Federal and State tax liabilities.
This is a hypothetical example and not intended for any specific person.
As always, if you have specific questions about the SECURE Act and how it applies to you then reach out to your Bridgeworth advisor, estate attorney, tax professional, or all of the above!
* Upon reaching 70 ½, IRS requires a minimum withdrawal from all IRAs and retirement plans with exception of Roth IRA.
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