On May 23, the House passed a bill that could drastically change the rules of retirement.
It is referred to as the “Setting Every Community Up for Retirement Enhancement Act of 2019,” or “SECURE.”
These sweeping changes affect traditional IRAs, 401(k) plans, inherited IRAs, required minimum distributions, college savings plans, student loans and filter into many other aspects of personal financial planning.
The bill passed the House by a margin of 417 to 3. It is expected to pass in the Senate and has good momentum for being signed into law by President Trump. If enacted, this legislation will mark another substantial reform that will affect the wallets of all American families.
Here is a preview of what’s likely to come and some planning tips:
Required Minimum Distributions (RMD)
The bill proposes the age for beginning mandatory required minimum distributions be raised to age 72 from 70 1/2.
The age for RMDs was first enacted in the 1960s and has never been adjusted. This extra time would allow investment accounts, such as IRA and 401(k) accounts, to grow tax-deferred for another year or two and potentially increase the longevity of retirement resources.
However, the current lower personal income tax rates enacted by the Tax Cuts and Jobs Act of 2017 are scheduled to sunset in 2025. Therefore, it may be to your advantage to take required distributions at these lower tax If you turn 70 1/2 before Jan. 1, 2020, you will not be eligible to delay your required minimum distributions. This will affect a large percentage of taxpayers; further guidance can be expected.
Repeal of the IRA contribution age limit
In order to make a traditional IRA contribution, an individual must have earned income and be under age 70 1/2. This legislation would repeal the age limit, leaving earned income as the only requirement for making a contribution.
To receive a tax deduction on IRA contributions, individuals must have earned income below certain thresholds if they are considered active in an employer plan. A spouse could also qualify for a contribution to his/her account based on the income of a working spouse. In essence, everyone would be eligible to make traditional IRA contributions as long as one spouse has earned income. However, the tax deductibility of that contribution depends on other factors.
It is important to note that RMDs will still likely be required each year on the amount of the contribution, just as it is now. However, the tax savings on the contribution amount could outweigh the taxes on the smaller amount required to be distributed.
Inherited tax-deferred accounts
This kicking of the tax can down the road will have finally come to an end with this bill. This legislation puts a lifespan on the “stretch IRA” provision and it could have serious tax consequences for your beneficiaries. The “stretch IRA” has finally been stretched to its limits.
Under current law, individuals who inherit retirement accounts have the ability to take distributions over their lifetime. If the original beneficiaries do not withdraw all of the funds over their lives, the second line of beneficiaries could “stretch” the same funds over theirs, and so on, potentially lasting for generations.
The new legislation puts an end to that.
After Dec. 31, 2019, the first line of beneficiaries would be required to withdraw all of the funds within 10 calendar years. This applies to all beneficiaries other than the surviving spouse, disabled or chronically ill beneficiaries, minor children and individuals who are not more than 10 years younger than the account owner.
From a wealth transfer planning standpoint, you may want to carefully balance how much you place in tax-deferred investment accounts, taxable accounts and Roth accounts. This balance will help ensure that your wealth stays in the family in the most tax-efficient way.
Employer Retirement Plans
There are significant changes to the employer plans with this bill.
A few highlights:
Retirement plan statements would be required to provide a lifetime income illustration showing the amount of monthly income a participant could reasonably expect to receive based on current contributions.
Annuities would be an available vehicle for 401(k) plans. The idea here is to have this behave similarly to traditional pension plans that guarantee a stream of lifetime income. However, the potentially higher costs, stability of the backing insurance company, potential liability of the employer and other fine print deserve a high degree of scrutiny prior to implementation.
Small businesses could band together to enroll in a single pension plan referred to as a “pooled plan” or “multiple employer” 401(k) plan. The multiple employer plan would be available to companies of varying industries regardless of common interest or association. This could lower the cost barrier for small businesses to offer the benefits of 401(k) plans to their employees. The employers could even shift some liability to investment firms that act as a fiduciary.
Andy Drennen is a Certified Financial Planning™ professional and member of the Financial Planning Association of Greater Kansas City. He is a vice president and portfolio manager at Central Trust Co.