Why you need to understand the SECURE Act

Allworth CEO Scott Hanson explains the impact of the SECURE Act on you.

 

We’ve received inquiries from clients, along with several calls to our radio programs, from people who are concerned about the impact the SECURE Act will have on their retirements.

While the new law is certainly nothing to panic about, it’s also true that some people will feel its effects more than others.

Right up front let me say that I like many parts of it.

But, as these things generally do, it probably goes a little too far in some ways while not going quite far enough in others.   

The “Setting Every Community Up for Retirement Enhancement" Act of 2019 made its way through the House and Senate in the summer and fall and was signed by President Trump on December 20^th, 2019.

That’s its “flyover” legislative history.

Digging deeper, the SECURE Act actually does some bold things.

Among them are that it:

• Delays the start of retirement account required minimum distributions until age 72
• Removes age restrictions on IRA contributions
• Eliminates the Stretch IRA provision

Of course, the above is by no means a full accounting of the law, but as for what are three of the most relevant concerns for our clients and readers, it’s a great place to begin.

So, what does it really do and how could it impact you?

• It delays the start of required minimum distributions (RMDs) until age 72

Depending on your tax and savings situation, this is potentially big.

With the continued decline in the number of companies offering traditional pensions, most people are now 100% responsible for funding their retirements.

To do this, most of us contribute to pre-tax retirement accounts such as 401(k)s and Traditional IRAs.

Pre-tax, or “tax-deferred,” of course means the government hasn’t collected taxes on your contributions or the subsequent growth.

Well, it should come as no surprise to any of us that the government eventually wants to get paid.

Until now, when you reached age 70½, you’ve been required to take what are called required minimum distributions from your qualified retirement accounts.

The amount you must withdraw is based on a complex formula that seems like it was developed in a NASA lab, but if you’ve saved a lot of money, these withdrawals, or distributions, can be huge.

And, because of the way the withdrawal amounts are calculated—and depending on your tax bracket and other sources of income—these mandatory withdrawals can be of such a size that they bump you up into a higher tax bracket.

Now, we sometimes recommend that clients withdraw money from these accounts before the onset of RMDs to mitigate the tax bump, but that’s on a case-by-case basis.

Simply, when done correctly, for people who’ve saved well, forward-thinking tax planning that includes tapping these retirement accounts before RMDs kick in can save you thousands of dollars.  

But, taken at face value, the SECURE Act’s stipulation that RMDs now can wait until you reach age 72 is potentially a huge boon to savers.

18 months (the difference between age 70½ and 72), might not seem like a lot, but it will allow the money in your account(s) to continue to grow before you’re forced to use it.

• It removes age restrictions on IRA contributions

We’re working longer than ever before, so we should be able to contribute to our IRAs longer.

The Federal Government agrees.

In the past, you could not contribute to a Traditional IRA after the age in which RMDs began (70½). 

The SECURE Act changed this.

For the tax years going forward, you can contribute to your Traditional IRA for as long as you have taxable income.   

Now, it’s important to note that this change is being grandfathered in. The deadline for making IRA contributions for last year (2019) is April 15^th of 2020. (However, you can’t make contributions if you turned age 70½ by December 31^st of 2019, but you will be able to make contributions for future tax years.)

• It eliminates the Stretch IRA provision

As mentioned above, the government has decided to wait an additional 18 months before it requires you to tap into your tax-deferred retirement accounts.

With people living and working longer, it’s the logical thing to do.

But that means even more delayed tax revenue.

So, how are they going to make up for it?

By going after non-spouse IRA beneficiaries.

In the past, the law allowed non-spouse IRA (and 401(k)) beneficiaries to “stretch” distributions from an inherited account over their lifetimes.

In some instances, this allowed the money in that IRA to grow tax-deferred for decades.

With the new law, the entire inherited IRA must be liquidated within 10 years.

While potentially a setback or burden for non-spouse IRA beneficiaries, the law is expected to raise an additional $15.7 billion in tax revenue in the first decade alone.[i]

I’m happy to say that for beneficiaries who are minors, disabled, or chronically ill, the government has included exceptions to the above rule change.

A few additional points to consider.

I generally like the SECURE Act, including its stipulation that part-time employees who work at least 500 hours a year for three straight years (previously, it was 1,000 hours) are now eligible to participate in employer-sponsored 401(k) plans. 

Some of the potentially negative effects of the new law relate to the fact it makes it less restrictive for some people to borrow from their 401(k)s, and that it makes it easier for 401(k) plan sponsors to offer more complex and potentially more expensive investment vehicles in their plans.

As always, please speak with your advisor so you understand how the SECURE Act will impact you, and so you can adjust your approach to investing and saving accordingly.

 

[i] https://www.marketwatch.com/story/the-secure-act-changes-the-way-people-will-inherit-money-are-you-affected-by-the-new-rules-2019-12-27