What’s All the Buzz About?
Given the pervasive chatter about the Setting Every Community Up for Retirement Enhancement Act of 2019 – commonly referred to as the SECURE Act – it’s important to know what the Act’s all about. On March 29, 2019, the House Ways and Means Committee unveiled the Act. While the Act passed the House in a 417:3 vote, its fate is stalled at the Senate and, if passed, it may change your estate planning. The bipartisan bill includes 29 provisions and modifies the requirements for employer-sponsored retirement plans, IRAs, and other tax-advantaged accounts. SECURE stems from concerns that Americans are not financially well equipped enough for their retirement years. In essence, the proposed legislation aims to combat the longevity risk, or an individual’s risk of outliving their retirement assets, by increasing access to tax-favored retirement accounts.
So, What Does That Mean?
With respect to employer-sponsored retirement plans, the SECURE Act modifies current requirements pertaining to various issues, including, but not limited to, multiple employer plans, lifetime income options, automatic enrollment and nonelective contributions, eligibility rules for certain part-time employees, and required minimum distributions. Overall, the bill includes provisions that result in the following:
- Treat certain taxable non-tuition fellowship and stipend payments as compensation for IRA purposes;
- Repeal the maximum age of traditional IRA contributions;
- Treat excluded difficulty of care payments as compensation for determining retirement contribution limits for retirement accounts;
- Allow penalty-free withdrawals from retirement plans for individuals when a child is born or adopted;
- Expand the purposes for which qualified education tuition programs can be used;
- Reinstate and increase the tax exclusion for particular benefits provided to members of volunteer emergency response organizations;
- Increase penalties for failure to file tax returns; and
- Increase information sharing to administer exercise taxes.
Specific Implications of the SECURE Act
Practically speaking, these provisions would impact various existing rules related to tax-advantaged retirement accounts. For instance, such changes would:
- Make it easier for small businesses to set-up “safe harbor” retirement plans for employees;
- Provide tax credits of $500 per year to employers that create 401(k) or SIMPLE IRA plans with automatic enrollment of employees;
- Offer retirement plans to part-time employees that work either 1,000 hours per year or have worked 500 hours for three consecutive years;
- Encourage plan sponsors to include annuities as an option in workplace plans by reducing liability in the event the insurer cannot meet its financial obligations;
- Change the age at which retirement plan participants must begin taking RMDs; and
- Expand the purposes for which Section 592 education savings accounts can be used, including covering up to $10,000 per year of qualified student loan repayments.
- Though all of the above items are important, the most talked about changes are the delayed starting age for RMDs, the allowance to make IRA contributions after age 70 ½, and the impact on “stretch” IRAs.
RMDs Delayed to Age 72
Today, an IRA owner must begin taking RMDs after turning age 70 ½. The current rules require that an IRA owner must take a distribution no later than April 1st of the year after the year he or she turns age 70 ½ and continuing each year thereafter. Under SECURE, the date of an IRA owner’s first RMD is delayed to age 72. This change is said to be fueled by the fact that many individuals are working during the latter years of life and, therefore, are still earning an income from their employment. In turn, the proposed starting age of 72 years old is aimed to provide retirees more discretion as to when they take their RMD and delay it, if desired. The retiree could still choose to take distributions earlier; however, by delaying RMDs from beginning at age 70 ½ to age 72, the actual RMDs will be larger than if the individual had started taking distributions at a younger age.
Traditional IRA Contributions After Age 70 ½
The Act would also allow for individuals to make contributions to their traditional IRAs after reaching the age of 70 ½. As it currently stands, the law has allowed individuals over the age of 70 ½ to make contributions to a Roth IRA, but prohibits such contributions to a traditional IRA. In light of many Americans continuing to work after retirement, coupled with the longevity risk, SECURE would allow contributions to a traditional IRA beyond reaching 70 ½ years old.
Impact on “STRETCH” IRAs
Though many of the above provisions have been described as a step in the right direction, many professionals in the industry caution that the bill is far from a cure-all for current retirement challenges. Prior to the SECURE Act, IRA distributions could be “stretched” to non-spouse beneficiaries, which, in turn, allowed children of IRA owners to take advantage of significant income tax breaks. Under that strategy, IRA owners would name individual IRA beneficiaries and created inherited IRAs for each of them. Each beneficiary would then take RMDs based on their age. However, under the Act, unless an exception applies, distributions must be withdrawn within 10 years of the death of the IRA owner. For taxable IRAs, the timing of distributions within the 10 year period will be based on various factors, including the beneficiary’s other income and expenses, business losses in a pass-through entity, charitable contributions, and Qualified Plan contributions.
NAMING A TRUST AS AN IRA BENEFICIARY
A Revocable Living Trust can also be an IRA beneficiary, if it qualifies as a “look-through.” However, in such cases, under SECURE, distributions are still subject to the 10-year rule. To meet the requirements as a “look-through,” following criteria must be satisfied:
- The trust must be valid under state law and become irrevocable upon death of the account owner;
- The trust document must identify individual beneficiaries that are natural persons; and
- The trustee must provide all require trust documentation to the IRA custodian no later than October 31st of the year after the death of the IRA owner.
- Of note, the trust taking the distribution for a taxable inherited IRA may result in an increased tax burden due to higher trust income.
EXCEPTIONS TO THE 10-YEAR RULE:
- The spouse of an IRA owner – An IRA owner’s spouse is permitted to rollover the decedent’s IRA to their own IRA and stretch distribution over their own lifetime.
- Children under 18 – A child under the age of 18 is excluded from the rule; however, once the child reaches the age of 18, he or she must take distributions within 10 years.
- Disabled or chronically-ill beneficiaries.
- Beneficiaries of an age within 10 years of the age of the decedent.
Here’s how it would work under the old rules: Joe, a grandfather, owns an IRA worth $2 million. He leaves it to his granddaughter, Jane, who is 25 years old. Under the old rules, Jane could “stretch” the distributions from that IRA over the course of the remainder of her life, or nearly 60 years. But, under the rules of the SECURE Act, Jane would be prohibited from “stretching” the distributions. Instead, Jane would be required to withdraw the entire balance of the IRA by the time she reached age 36, or within 10 years of death of her grandfather.
In addition to IRAs (both traditional and Roth), the 10-year rule would also apply to other qualified plans with balances, which includes all defined contribution plans – 401(k), 403(b), 457(b), 401(a), Profit-Sharing Plans, ESOP, Cash Balance Plans, and lump-sum distributions from defined benefit plans. So, absent one of the above exceptions, when a beneficiary is left a qualified plan with a balance, the beneficiary must take distributions within 10 years. Because of these potential changes, proper management of distributions for designated beneficiaries will become even more important under SECURE.
But, Don’t Bank on SECURE
In May 2019, the bill passed in the U.S. House of Representatives by a staggering vote of 417:3. At that time, some anticipated a quick Senate passage; however, it appears those expectations were very optimistic. Today – months later – the bill is on hold at the Senate. In general, when a bill reaches the Senate, it goes through a similar process it went through in the House. In particular, the bill is discussed in a Senate committee and then reported to the Senate floor for a full schedule of debates and votes. However, a bill can bypass that process when the Senate unanimously agrees to pass the bill. At this juncture, several Senators have taken issues with various provisions of the bill as it stands. In turn, this could redirect the bill from the fast-track of passing in the Senate via unanimous consent to the longer process of committee consideration, followed by report to the Senate floor for debate, vote, and even potential amendment, which would require its return to the House to vote again on the amended version. Overall, the process could be quite lengthy given the current status. And, to top it off, given the concerns raised by certain Senators, it’s also possible that SECURE, as it’s written today, may not pass at all! So, as the old adage goes, don’t count your chickens…or, in this case, don’t bank your retirement plan on it passing just yet.
Despite all of the commotion surrounding the SECURE Act and its current status, the fate of the bill is very uncertain. However, even if it passes, exemptions will still exist, and the passage of the bill will not be the end of stretch IRAs. Viable alternatives will also still be available, such as investing in Section 7702 plans. Of course, this area involves issues and complexities that are not discussed here. Despite eligibility, the above strategies may not be appropriate for your financial situation, so it’s important to consult your tax or financial professional to review these items and determine what is best for you under the most current rules and regulations.