With the decline of traditional pensions, most of us are now responsible for saving money for our own retirement. In today’s do-it-yourself retirement savings world, we rely largely on 401(k) plans and IRAs. However, there are obvious flaws with the system because many working Americans still won’t have enough savings to last their retirement, and some have no savings at all. In an attempt to address this gap, the U.S. House of Representatives passed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) by a practically unanimous vote of 417-3 last May. There has been little progress in the Senate since then, as several “holds” on the bill prevented it from being voted on by unanimous consent. To get you ready in case this bill becomes law, we’ve highlighted some of the most notable ways the SECURE Act could affect your retirement savings. Learn them now, so you can start adjusting your retirement strategy right away if it is enacted.
RMD START DATE DELAYED TO AGE 72
Under current law required minimum distributions (RMDs) from IRAs, 401(k), 403(b) and other employer-sponsored retirement plans generally have to begin the year you turn 70 ½. If you work past age 70½, RMDs from your current employer’s 401(k) aren’t required until after you leave your job, unless you own at least 5% of the company. Under the SECURE ACT this will change to age 72. This allows your retirement funds grow an extra 1½ years before tapping into them. For taxpayers that decided to delay claiming Social Security benefits until age 70, this could also help avoid being pushed into a higher tax bracket or triggering higher Medicare Part B premiums for a bit longer.
NO AGE RESTRICTIONS ON IRA CONTRIBUTIONS
Americans are working and living longer, so the SECURE Act would repeal the rule that prohibits contributions to a traditional IRA by taxpayers age 70½ and older. For older workers you can continue to put away money in a traditional IRA if you work into your 70s and beyond ($7,000 if you are 50 or older, $6,000 if under age 50).
ELIMINATION OF THE “STRETCH” IRA
Under current law, non-spouse beneficiaries that inherit an IRA can “stretch” required minimum distributions over their remaining life expectancy. Since some beneficiaries may be significantly younger, this allows them to “stretch” the IRA’s existence for much longer, potentially for several decades. Under the SECURE Act there would be a 10-year time limit for a non-spouse beneficiary to defer the distributions and income taxes on an inherited IRA. It will force taxation of retirement plans that are inherited in the first year or no later than 10 years from the inheritance. For beneficiaries that are working during that 10-year period, you will likely pay substantially more taxes on the IRA assets than if you had the ability to stretch those taxable distributions over a longer time period. There are exceptions for non-spouse beneficiaries who are disabled, a minor, or chronically ill. Distributions for these exceptions would be over their life expectancy, although the exception for minors would end once they reach the age of majority with the final distribution to be taken within 10 years. The new rules would only apply to IRA owners who pass away after December 31, 2019. In other words, existing inherited IRAs would be grandfathered.
Spousal beneficiaries continue to be able to delay the inherited account’s required minimum distributions (RMDs) until the end of the 72nd year of the deceased spouse instead of age 70 ½ before this new proposed law. For younger spouses that need income, they will still be allowed to take distributions penalty-free if they are younger than 59½. If the spouse doesn’t need income, they can still roll it over into their own IRA and delay distributions until age 72.
PENALTY-FREE WITHDRAWALS FOR BIRTH OR ADOPTION OF CHILD
The legislation would permit withdrawals for qualified birth and adoption expenses and avoid the 10% early-withdrawal penalty. The limit on the distribution would be $5,000 and would need to be claimed within one year of the birth or adoption. You would still owe income taxes on the distribution.
MULTIPLE CHANGES FOR 401(K) PLANS
Although most large employers have retirement plans for their workers, the same can’t be said about small businesses. That’s why the SECURE Act contains several provisions designed to help more small businesses offer retirement plans for their employees. The legislation would allow for small employers to band together in an “open” 401(k) multiple-employer plan (MEP), which would help reduce costs and administrative duties that each employer would otherwise bear alone. To help with the start-up costs of establishing the plan, the SECURE Act increases the business tax credit limit to a maximum of $5,000 from $500. Also an additional $500 tax credit would be available for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment, and would be available for three years. The credit would also be available to employers that convert an existing plan to an automatic enrollment design.
In addition to making it easier for employers to start offering retirement plans, the bill would also allow more workers to participate that were not allowed to previously. Part-time workers who work either 1,000 hours throughout the year or have three consecutive years with 500 hours of service would be able to participate in 401(k) plans. The part-timer would also have to be 21 years old by the end of the three-year period.
Currently you may know how much is in your 401(k), but it doesn’t really tell you how much you can take out in retirement and how long it might last. The SECURE Act would require 401(k) plan administrators to provide annual “lifetime income disclosure statements” to plan participants, which shows how much money you could get each month if your 401(k) balance was used to purchase an annuity. It also would make it easier for 401(k) plan sponsors to offer annuities and other “lifetime income” options to plan participants by taking away some of the associated legal risks. These annuities would be portable, too. So if you left your job, you would be able to roll over the 401(k) annuity you had with your former employer to another 401(k) or IRA and avoid surrender charges and fees.
SOME HELP FOR STUDENTS
Under current law, stipends and non-tuition fellowship payments received by graduate and postdoctoral students are not treated as compensation and cannot be used as the basis for IRA contributions. The legislation removes this obstacle to retirement savings by taking such amounts into account for IRA contribution purposes. Tax-advantaged 529 accounts could also be used for qualified student loan repayments (up to $10,000 annually).
Although we don’t yet know what the final version will include (or if it will become actual law), it’s a good to speak with your financial and/or tax advisor to help prepare for anticipated changes.
Presented by Carl Holubowich, CFP®