What Is The SECURE Act and What Could It Mean For Your IRA?
Recent federal legislation on the SECURE Act means big changes for Americans with traditional individual retirement accounts, or “IRAs.”
The SECURE Act stands for “Setting Every Community Up for Retirement Enhancement.” It was signed by President Trump in December 2019 and took effect on January 1, 2020.
In addition to new provisions affecting small businesses and 401(k) accounts, the SECURE Act brings about big changes for traditional IRA account holders and their heirs. Here are three provisions you’ll want to be aware of when managing your retirement account, as well as your estate plan.
#1: No More Age Cap on IRA Contributions
Before the SECURE Act was passed, you could not contribute to a traditional IRA after age 70 ½. But, with the current SECURE Act status, if you turn 70 ½ and if you’re still working after January 1,
2020, there is no longer an age limit on your ability to contribute to a traditional IRA.1 The original rule still applies if you turned 70 ½ on or before December 31, 2019.
For some retirement account holders, this change to IRA contributions may create new opportunities for a Roth IRA conversion. Before considering converting your traditional IRA to a Roth IRA, it would be wise to refresh your memory on the difference between a traditional and a Roth IRA.
A traditional IRA consists of pre-tax dollars. You pay no tax when putting money into your traditional IRA, but you will pay a tax when withdrawing distributions. A Roth IRA consists of post-tax dollars. As per Roth IRA rules, you will pay tax on your income before putting money into the account, but you’ll pay no taxes when you begin receiving distributions.
Thanks to the SECURE Act, it is now possible to start a traditional IRA, or contribute to an existing one, using pre-tax dollars after age 70 ½. Some savers may wish to convert those dollars to a Roth IRA and never pay tax on them again.
A “Roth IRA conversion” simply means a transfer of funds from a traditional IRA to a Roth IRA.2 Keep in mind, with tax implications, that you will be required to pay taxes on the amount you move into the Roth IRA. Consult with a qualified financial advisor or certified financial planner to help you budget for this.
Once you complete a Roth conversion and pay the initial transfer tax amount, you will pay no taxes on future distributions or potential investment earnings.
#2: New Minimum Age for RMDs
The traditional IRA is what we call a “tax-deferred account.” As noted above, that means you pay no taxes on the account until you take money out. Unfortunately, Uncle Sam won’t wait forever. He wants to know when he’ll be able to start collecting taxes on your hard-earned dollars.
That’s why the government sets a minimum age when you’re required to withdraw distributions from the account — whether you need the money or not. This is what’s known as the required minimum distribution or “RMD.”
Before the SECURE Act, the old law said you had to start taking your RMDs (and paying taxes on them) by April 1 in the year after you turned 70 ½. Please note that this rule still applies if you turned 70 ½ in 2019 or earlier.
But starting in 2020, the SECURE Act raises the minimum RMD age to 72. Now you can wait until April in the year after you turn 72 before withdrawing that first distribution and sending Uncle Sam’s share of it to the IRS.3
#3: No More Stretch IRA
Suppose you inherit a traditional IRA from your parents, grandparents, or another relative other than your spouse.
Before the SECURE Act, you could lower your taxes by “stretching” distributions from that inherited IRA over the course of your anticipated life expectancy – hence the term, “Stretch IRA.” If you left your own IRA to any non-spousal beneficiaries, they could do the same.
Under the SECURE Act, it’s a whole new ball game for inherited IRAs. Non-spousal beneficiaries must now take all distributions within 10 years of inheriting the IRA. This could take the form of a single lump sum, or withdrawing 1/10 of the money each year for 10 years.
The new law also names five categories of beneficiaries who are exempt from the new 10-year rule:
- Surviving spouses. If you inherit the IRA from your spouse, you may stretch the distributions over more than 10 years. However, if your child inherits the account after you pass away, they would be required to liquidate within 10 years.
- Minor children up to age 18, or students up to age 26. Once they reach adult status, they will have 10 years to take distributions. “Reaching adult status” means turning 18, completing higher education, or turning 26 if they are still in school.
- Beneficiaries who are within 10 years of the deceased account holder’s age. An example would be leaving your IRA to a sibling who is less than 10 years older or younger than you.
- Chronically ill beneficiaries. For purposes of the SECURE Act, a “chronic illness” is a condition that leaves the beneficiary of the IRA unable to perform at least two activities of daily living (ADLs). It also includes any severe cognitive impairment that requires substantial supervision.4
- Disabled beneficiaries. The SECURE Act defines a “disability” as any condition that prevents the heir from engaging in “any substantial gainful activity” — essentially meaning they are unable to work. The impairment must also be expected to result in his or her death or “to be of long-continued or indefinite duration.”4
In other words, having a condition such as diabetes would not automatically qualify an heir for the exemption, unless it affects their ability to hold gainful employment or perform basic ADLs.
It is important to speak with a qualified estate planning attorney to review how best to pass along your legacy to those you care about. If you have named a trust as the primary beneficiary of your Traditional IRA, you may need to revise that plan to avoid the 10-year requirement. A Charitable Remainder Trust may be another option for helping heirs avoid unnecessary taxes. You’ll also want to work with a certified financial planner to review the beneficiaries on your accounts under the new SECURE Act. For some individuals, a Roth conversion from a Traditional IRA may be appropriate for leaving tax-free dollars to your heirs.
Do you have questions about how the SECURE Act may affect you and your loved ones? Please contact The Resource Center today. Our financial advisors will help you create a plan that meets your needs. We
also invite you to join our complimentary, monthly “Estate Planning Basics” workshop held in conjunction with Springfield estate planning attorney Will Worsham. No matter where you are in your retirement savings journey, this workshop will help you get started on an estate plan that will work toward your long-term goals and the financial security of your loved ones.
Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and The Resource Center are not affiliated companies. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Investing involves risk, including the potential loss of principal.
Please remember that converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences including (but not limited to) a need for additional tax withholding or estimated tax payments, the loss of certain tax deductions and credits, and higher taxes on Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA. It is generally preferable that you have funds to pay the taxes due upon conversion from funds outside of your IRA. If you elect to take a distribution from your IRA to pay the conversion taxes, please keep mind the potential consequences, such as an assessment of product surrender charges or additional IRS penalties for premature distributions. 00626469