There’s a new bill in the pipeline, and there are some significant potential impacts to retirees and anyone planning for retirement. There are favorable and some not-so-favorable changes, but we are well-positioned to help with strategies to address any impacts if the bill becomes law.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 has passed the House (417-3) and currently sits in the hands of the Senate. The Senate has a similar bill, which may mean a melding of the two for the final version. While nothing is final until the presidential pen hits the signature line, experts agree that some form of the bill is likely to pass. This means we should start planning for potential impacts for our clients – after all, planning is what we do.
A full legislative bill is a lot to digest, so we will highlight the most notable provisions impacting individuals.
Increased Required Minimum Distribution Age
Under current law, participants are generally required to begin taking required minimum distributions (RMDs) from their qualified retirement accounts and traditional IRA’s beginning at age 70 ½ so the IRS can finally collect taxes after letting you minimize your taxable income all those years. Failure to take the distribution results in a hefty fine: 50% of the missed RMD forked over to the IRS. This presents a problem for retirees who don’t need the full RMD and for whom taking the distribution may push them into a higher tax bracket.
This new bill recognizes that the existing RMD rule was first applied back in the 1960’s and hasn’t quite kept up with increases in life expectancy. As such, the SECURE Act increases the required withdrawal age from 70 ½ to 72. The Senate version of the bill goes even further and does not require participants to begin taking distributions until age 75.
What this means: Delaying the age at which you are required to start taking distributions means there is more time to employ strategies that seek to reduce the eventual RMD. One of the advanced planning strategies we assist clients with is Roth Conversions. As you can imagine, there’s enough information on that strategy for a whole separate blog. Luckily, we have one: https://www.apcm.net/blog/financial-planning/time-now-roth-conversions/. In short, if the strategy makes sense given current and future tax brackets, individuals can convert traditional IRA funds to a Roth IRA. They pay the tax now and let the Roth funds grow tax-free. This has the added benefit of reducing the traditional IRA account balance in preparation for future RMDs, while keeping the funds invested for retirement.
Removal of Age Limitation on Contributions to Traditional IRAs
The new legislation also eliminates the prohibition on contributions to a traditional IRA once an individual has reached age 70 ½. As many Americans are living and working longer, there needs to be a retirement-savings vehicle that matches this trend, which is what this bill seeks to achieve.
What this means: Two things. For high-income earners, this provision allows individuals to continue to make non-deductible traditional IRA contributions longer and and employ the Roth Conversion strategy outlined above. For individuals still working and for whom the Roth conversion strategy may not be beneficial, this provision allows for a longer timeframe for accumulating retirement savings.
Allowing Long-Term Part-time Workers to Participate in 401(k) Plans
As it stands, employers may exclude part-time employees who work less than 1,000 hours from a defined contribution plan. This does not allow certain individuals, such as parents who are staying home part-time to take care of young children, or individuals slowly phasing into retirement by continuing to work part-time, to take advantage of an employer match or contribution.
Under the SECURE Act, employers maintaining a 401(k) plan will be required to have a dual eligibility requirement (except in the case of collectively bargained plans): an employee must complete either one year of service (1,000 hours) or three consecutive years of service of at least 500 hours per year. If the employee meets the latter eligibility rule, the employer may exclude them from nondiscrimination testing and application of top-heavy rules.
There’s a catch. The government never gives away anything entirely for free, so where does the funding for the new bill come from?
Elimination of the Stretch IRA
Remember all that talk about RMDs beginning in your 70’s? Such is not the case for Inherited IRAs. When a non-spouse beneficiary inherits an IRA, he or she must take an RMD each year. The amount of the RMD depends on the account value, age of beneficiary, age of decedent, and IRS life-expectancy tables. Under current law, beneficiaries can opt to use the original accountholder’s age/life expectancy figure or their own. It is typically more advantageous for young beneficiaries to use their own age to minimize the required distribution and related taxes. The ability to stretch the distributions over the beneficiary’s (usually longer) life expectancy minimizes required distributions and allows greater flexibility in tax bracket management.
Under the SECURE Act, inherited IRA’s must be completely paid out by the end of the tenth calendar year following the year of the employee or IRA owner’s death. Individuals with exceptions to this rule include: surviving spouse of the employee or IRA owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the decedent, or child of the decedent who has not reached the age of majority.
We think this is one of the most important provisions of the bill, as it would have major consequences for large IRAs and the effectiveness of certain types of trusts and life insurance options. We do not want to jump the gun, but we do have strategies in mind to address planning considerations prompted by this provision. We will keep you informed and plan to follow up with a separate blog should the bill become law.
Meghan Carson, CPA
Associate Financial Advisor
APCM Wealth Management for Individuals