The SECURE Act Passed, But What Does it Mean?

Congress passed the SECURE Act last week, as part of a larger spending bill. It will become effective on January 1, 2020. You might not have read very much about it, or know how it affects you. Maybe we can help.

SECURE stands for “Setting Every Community Up for Retirement Enhancement.” That might have been a tongue-twisting stretch to get a catchy acronym, but you’ll never have to know the Act’s full name again. Just know that it will affect most Individual Retirement Accounts, 401(k) and other retirement accounts.

Among the changes are some affecting people who are already in minimum-withdrawal territory. Other changes affect people named as beneficiary of a retirement account. Let’s look at some of those new rules.

Changes for people over age 70½

If you turned 70 before July 1, 2019, the changes will not affect you directly. Your minimum withdrawals will continue on the same schedule. Of course, if you just barely reached 70½, you may not have made your first withdrawal. You will still need to start as if the new law did not exist.

The primary affect on people over age 70½ will be in beneficiary designation choices. We’ll describe those changes in a moment.

There is, though, one other change worth mentioning. There is no longer a prohibition on people over age 70½ making contributions to their IRAs. Of course, an IRA contribution is only deductible to the extent of employment earnings. That may mean the permission to deposit into an IRA after age 70½ is less valuable than it might seem.

Changes for people who already inherited retirement accounts

Once again, there are no changes for this group. If you are already taking minimum distributions based on your own life expectancy (or someone else’s), you will continue to apply the same rules. The SECURE Act does not change existing arrangements.

If the retirement account you inherited came from a spouse, you might have chosen to roll it over into your own retirement account. In that case, the new rules will apply to the beneficiary you name. Your minimum distribution requirements will also change under the new law.

Changes for people not yet 70½

The SECURE Act makes big changes for almost everyone else. Those changes start with the minimum distribution requirements.

Under prior law, the owner of an IRA, 401(k) or other retirement account normally had to begin withdrawing money from the account at age 70½. There were a handful of exceptions, but for most people that age was the starting point. Now the age for minimum distributions has been raised to 72.

That means that younger retirement account owners will have either one or two additional years to begin making withdrawals. Why the difference? Because distributions do not begin on your 72nd birthday, but at the end of the year in which you turn 72. That might be one or two years later than the year in which you turned 70½, depending on whether you were born in the first or second half of the year.

A related change was announced by the Internal Revenue Service earlier this year. It is not part of the new legislation, but will have a related effect on retirement planning. If it goes into effect on January 1, 2021, as planned, it will reduce the amount of required withdrawals for retirement account holders.

For example, under current rules a person turning 72 would have to withdraw 3.9% of their IRA and 401(k) balances. The new proposed tables would reduce that percentage, to a little less than 3.7%. The gap widens over time, too: a 90-year-old would have to withdraw about 8.8% of their remaining IRA balance under current rules. That figure would drop to under 8.3% after the anticipated 2021 change.

The IRS proposal will have to be retooled in light of the SECURE Act passage. Still, expect the changes to become effective in 2021.

Changes for IRA/401(k) beneficiaries

By far the most talked-about part of the SECURE Act is the elimination of what are usually called “stretch” IRAs. Let us explain.

Under the prior rules, beneficiaries of an IRA, 401(k) or most other retirement plans could choose how to withdraw their inherited money. The default rule was that the money must be withdrawn within five years. But most beneficiaries could use their own life expectancy — or even the original IRA owner’s statistical life expectancy — to schedule their withdrawals.

That meant that naming a teenager as beneficiary of an IRA could reduce the withdrawals to less than 1.5% of the balance each year, at least for the first few years. Since the remaining 98% (or more) continued to grow tax-free, the financial benefit was substantial.

Now that teenager will (in most cases) have just ten years to withdraw the entire IRA balance. That does not mean 10% per year, incidentally — they just have to empty the account within ten years.

That will have a significant effect on retirement account beneficiary planning. It will often (but not always) mean that it makes more sense to name individuals as beneficiary rather than trusts for the benefit of the same individual. It probably means most people should review their retirement account beneficiary designations in light of the new law.

Note that this change has a significant effect on another group of people: those who moved substantial assets into a Roth IRA account. Under the old rules, distributions from a Roth IRA were untaxed, and the beneficiary could withdraw the money over their own life expectancy. The 10-year limitation significantly reduces (but does not eliminate) the income tax benefit previously enjoyed by the beneficiary.

Exceptions to the 10-year payout rule

There are a number of exceptions to the 10-year payout presumption in the Secure Act. For some beneficiary designations, in fact, the old 5-year rule still applies. But for others — including special needs trusts — the previous life expectancy tables will continue to work.

This is complicated, so pardon us for simplifying it somewhat. But naming a special needs trust is likely to give the trustee the opportunity to delay withdrawals just like the rules before the SECURE Act. For many account holders, this change will flip the presumptions that they considered when making their original beneficiary decisions.

The new law also contains some provisions simplifying the division of IRA/401(k) accounts when a trust is named as beneficiary. Altogether, it confuses the already complicated decisions about when to name a trust and when to leave an IRA directly to individual beneficiaries.

What should you do next?

Does the SECURE Act mean  you need to come in for a consultation before the first of effective date of the new law? No. But it likely means you need to review your estate plan next year if you answer any of these questions in the affirmative:

  • Have you named a trust as beneficiary of your IRA, 401(k), 403(b) or other defined-contribution retirement account?
  • Is your retirement account a significant portion of your estate?
  • Did you name (or consider naming) your grandchildren as beneficiaries in order to minimize the income tax consequences of inheriting your retirement account?
  • Are you over age 70 and still working in order to increase your savings?
  • Do you have substantial money in a Roth IRA account?
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