The SECURE Act: What You Need to Know
For many older and relative higher-income professionals, such as lawyers, doctors, and engineers, retirement savings often form a large part of their overall net worth and play a starring role in their financial security during their retirement years. The Setting Every Community Up for Retirement Enhancement Act, known as the SECURE Act, was passed by Congress and signed into law at the end of 2019. It brought some of the biggest changes to retirement accounts in decades. But with pandemic-related news dominating headlines, you may have missed hearing about this significant law and how it changes some important aspects of retirement accounts.
The SECURE Act’s most significant changes affect the beneficiaries of IRAs who stand to inherit retirement assets after the passing of their parents and older relatives. But there are other important changes retirement account owners (called “participants”), especially those who are in or nearing retirement, need to know.
Delayed Required Minimum Distributions
In retirement, IRA participants (other than Roth IRAs) are required to begin taking distributions annually, the so-called Required Minimum Distributions (“RMDs”). Every dollar distributed counts as ordinary income of the participant. RMDs are usually calculated by your IRA custodian, and for decades, RMDs began in the year the IRA participant attained age 70 ½.
The SECURE Act changes this for many IRA participants who can now begin their RMDs later:
- For anyone born after July 1, 1949, RMDs now need to begin at age 72, not age 70 ½.
- For those born before July 1, 1949, the rules haven’t changed. You still have to withdraw your first RMD by December 31 of the year in which you reach age 70 ½.
‘Lifetime Expectancy’ Payout Is Replaced With a 10-Year Rule
Under prior law, both spouses and non-spouse beneficiaries (such as children and grandchildren) who inherited an IRA were able to take advantage of the “stretch IRA”: their RMDs were distributed over a long period of time, generally over the beneficiary’s own estimated life expectancy. For adult children and grandchildren of a participant, that meant the option to spread out distributions over several decades. Beginning in 2020, non-spouse beneficiaries who inherit an IRA can no longer take advantage of the stretch IRA. Instead, these beneficiaries must generally distribute all IRA funds (and pay income tax on those distributions) within 10 years of the participant’s death. (The SECURE Act did not change the stretch IRA rule for spouses, who still calculate RMDs based on life expectancy.)
Now, non-spouse beneficiaries will generally be paying income taxes sooner than under the previous rules. This means there is a loss of deferral opportunity (the ability to delay taking the full distribution as long as possible) and distributions spread over only 10 years instead of several decades will naturally be larger each year than under prior rules. The additional income from an inherited IRA over a 10-year payout period could push a non-spouse beneficiary into a higher tax bracket in any given year.
There are a few narrow exceptions to the new 10-year rule: minor children and permanently disabled or chronically ill beneficiaries are still allowed to use the life expectancy-based stretch RMDs under prior law. Notably, however, the rules for minor children only apply to minor children - grandchildren of the IRA participant (even if under the age of 18) are not treated the same as minor children and don’t qualify for the “stretch RMD” payout. Grandchildren beneficiaries, even those who are minors, must still use the 10-year rule. And, once a minor child reaches the age of 18, the payout period switches back to the 10-year rule (unless he or she is also permanently disabled or chronically ill). Similarly, at the death of a disabled or chronically ill beneficiary, the stretch RMD payout period ends and the next beneficiaries of the IRA must switch back to the 10-year payout.
Many Elderly Participants May Continue Making IRA Contributions
Under prior law, no contributions were allowed to IRAs once the participant reached age 70 ½. The SECURE Act removed this age restriction. This means elderly IRA participants can continue supplementing their retirement accounts, as long as they are still working or otherwise have sufficient earned income to qualify. For 2020, the annual contribution limit is the lesser of the participant’s earned income or $6,000 ($7,000 if you’re age 50 or older).
The CARES Act Suspends RMDs for 2020 . . .
Finally, the Coronavirus Relief and Economic Security Act (CARES Act), which is best known for providing a myriad of pandemic-related financial assistance measures to individuals and businesses, also affected retirement accounts in 2020. The CARES Act waives the RMD requirement through year end. The waiver also covers 2019 RMDs, which were required to be taken by April 1, 2020 (i.e. first time RMDs that were not distributed in 2019), as well as all RMDs that would have been required for 2020.
The CARES Act suspends RMDs for the year 2020 only. Starting in 2021, RMDs will be calculated and must be distributed as normal. IRA participants will be a year older, and may have larger balances in their IRAs if they made no distributions at all during 2020. This means some IRA participants’ RMDs for 2021 may be a bit larger than they would be if distributions had occurred in 2020.
. . . But the Charitable Rollover Is Still Around
One aspect of RMDs that did not change with the new law is the rule governing Qualified Charitable Distributions. Qualified Charitable Distributions became a permanent part of the tax law at the end of 2016. A Qualified Charitable Distribution counts toward a participant’s RMD in a given year, and all of the funds pass to a charity without adding to the participant’s ordinary income. Even though RMDs are suspended for 2020, IRA owners older than 70 ½ can still take a Qualified Charitable Distribution in 2020. Remember that a Qualified Charitable Distribution must be distributed directly from the IRA custodian to the charitable organization and is limited to $100,000 per taxpayer (so a married couple filing jointly who each have IRAs may gift up to $200,000 of their RMDs to qualified charities without recognizing income on the distribution).
As the timeline for waived RMDs is coming to a close, now may be the best time to consult with an advisor on options available for your circumstances. A member of the Stokes Lawrence Estate Planning practice can assist with your questions.