On Dec. 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), which is part of the Further Consolidated Appropriations Act, 2020 (P.L. 116-94). The SECURE Act was enacted to expand the opportunities for individuals to increase their retirement savings and simplify the retirement system.
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 how some of the more important elements of the SECURE Act will have an impact on individual taxpayers.
1. Repeals the maximum age for traditional Individual Retirement Account (IRA) contributions
Before 2020, traditional IRA contributions were not allowed once an individual attained age 70½. 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 — generally, earned income from wages or self-employment. This provision puts traditional IRAs on par with Roth IRAs, which do not have an age limitation.
2. Increases the starting age for required minimum distributions (RMDs) from IRAs and retirement plans to 72
Before 2020, retirement plan participants and IRA owners were generally required to begin taking RMDs from their plan by April 1 of the year following the year they reached age 70½. That requirement was first applied in the retirement plan context in the early 1960s and, until recently, had not been adjusted to account for increases in life expectancy. So, if you turn 70 ½ in 2020 or later, you won’t need to start taking RMDs until after turning 72.
3. Limits ‘stretch IRA’ strategies to certain beneficiaries
For deaths of plan participants or IRA owners occurring before 2020, beneficiaries (both spousal and non-spousal) 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 (in the IRA context, this is sometimes referred to as a “stretch IRA”).
However, beginning in 2020 (or later, for some participants in collectively bargained plans and governmental plans), distributions to most non-spouse 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 (1) the surviving spouse of the deceased owner; (2) a minor child of the deceased owner; (3) a chronically ill individual; and (4) any other individual who is not more than ten years younger than the deceased owner. Beneficiaries who fall into those categories may still take their distributions over their life or life expectancy (as allowed under the rules in effect for deaths occurring before 2020).
4. Expands the uses for Section 529 education savings plan
A Section 529 education savings plan (commonly known as a 529 plan or 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 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.
Before 2019, qualified higher education expenses didn’t include the expenses of registered apprenticeships or student loan repayments. But for distributions made after Dec. 31, 2018 (the 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. In addition, up to $10,000 in tax-free distributions are allowed to pay the principal or interest on a qualified education loan of the designated beneficiary or a sibling of the designated beneficiary.
5. Changes the kiddie tax for gold star children and others
In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA, P.L. 115-97), which made changes to the so-called “kiddie tax,” a levy on the unearned income of certain children. The new law said taxable income of children attributable to net unearned income would be taxed according to the brackets applicable to trusts and estates, and reduced their exemption amount under the alternative minimum tax (AMT) rules.
However, this appeared to unfairly increase the tax burden on certain children, including those who were receiving government payments (i.e., unearned income) because they were survivors of deceased military personnel (“gold star children”), first responders or emergency medical workers.
December’s new rules repeal the measures added by the TCJA. 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, which taxes them at their parents’ rates, if those rates are higher than those of the child. And starting retroactively in 2018, the new rules also eliminate the reduced AMT exemption amount.
6. Makes retirement plan withdrawals related to new children penalty-free
Generally, a distribution from a retirement plan must be included in income. And, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59½ is subject to a 10% early withdrawal penalty on the amount includible in income.
Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are penalty-free. That $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.
7. Taxable non-tuition fellowship and stipend payments are treated as compensation for IRA purposes
Before 2020, stipends and non-tuition fellowship payments received by graduate and postdoctoral students were not treated as eligible compensation for IRA contribution purposes, and therefore, could not be used as the basis for making IRA contributions.
Starting in 2020, the new rules remove that obstacle by permitting taxable non-tuition fellowship and stipend payments to be treated as eligible compensation. This change will enable these students to begin saving for retirement without delay.
With a new tax season upon us, McClintock & Associates is available now to assist our clients with any questions regarding the application of the SECURE Act to your individual tax situation. Please feel free to reach out to our Tax Department for assistance.