At the end of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. Many of the provisions became effective at the beginning of 2020 and their nuances are now coming into focus. Below we will briefly explore some of the more important provisions and how they may affect retirement and other savings plans.
Age for Required Minimum Distributions (RMD): Prior to 2020, anyone reaching 70 1/2 years old was required to begin taking distributions from non-Roth IRAs and 401(k) plans. The SECURE Act increased this age to 72 years old generally for those who attain age 70 1/2 after 2019.
Note: The rule that allows up to $100,000 of RMDs to be used for charitable contributions to qualified charities is still applicable for the those reaching the age of 70. If you do not have enough deductions to itemize, this is an excellent way to contribute funds without recognizing income on the RMDs. However, the amount that can be excluded from income may be impacted by IRA contributions made by those older than 70 1/2 under new provisions discussed below.
Quicker Distributions for Inherited IRAs: Historically, non-spouse beneficiaries of inherited IRAs have generally been required to take out funds over their life expectancy (using IRS tables). The SECURE Act changes that to a 10-year payout for IRAs inherited after 2019. The beneficiaries that are excepted from this general rule include: spouses, minor children, disabled or chronically ill persons and those who are less than 10 years younger than the decedent. We encourage you to review your beneficiaries for plan assets.
There are no changes to the payouts of inherited plans that began prior to 2020.
Penalty-Free Retirement Plan Withdrawals for Birth/Adoption: For those under the age of 59 1/2 who otherwise would be subject to a 10% penalty for withdrawing funds from their retirement plan, the SECURE Act allows penalty-free withdrawals for the birth or adoption of a child. The total cannot exceed $5,000 per parent ($10,000 per couple if both have enough plan assets). The amount withdrawn would still be taxable unless repaid within 60 days of distribution.
There are other exceptions to the penalty that have been around for years that remain in place, including distributions in connection with permanent disability, first time home buying ($10,000 limit) and health insurance for unemployed individuals, among others.
No More Age Limit for IRA Contributions: The SECURE Act eliminates the age cap on IRA contributions. Beginning for tax year 2020, taxpayers who have earned income can continue to contribute to traditional IRAs even after attaining the age of 70 1/2.
More Employees Can Join 401(k) Plans: Employers will now be required to allow certain employees previously excluded from participating in 401(k) plans to participate. This generally includes employees who have worked 500 hours per year for at least three consecutive years. An employee who has completed 1,000 hours of service during a plan year also cannot be precluded from participating in the 401(k) plan. However, other limitations for participation, such as requiring that a participant reach the age of 21, may still apply.
Employers should review plan documents and discuss new nondiscrimination rules with their third-party administrators to ensure proper compliance with this and other provisions.
Tax Credit for Retirement Plans of Small Employers: The SECURE Act provides for a tax credit of up to $5,000 for small employers (generally one that has no more than 100 employees) starting a retirement plan. This credit is equal to 50% of certain start-up costs incurred for each of the first three years of the plan (up to $5,000 each of the first three years). It is generally limited to $250 per non-highly compensated employee eligible to participate. An additional $500 credit is available annually for a three-year period if a small employer plan allows for automatic enrollment. .
Increased Penalty for Failure to File Retirement Plan Returns: Beginning with returns due after 2019, the failure to file retirement plan returns (Form 5500 series) will result in a penalty of $250 per day they are late, not to exceed $150,000. There are additional penalties for failing to register the plan and for improper notification of plan changes. While there is a mechanism for getting the penalties waived under reasonable cause exceptions, it may not be easy under the SECURE Act.
Use 529 Plan Funds for Student Loan Repayments: Up to $10,000 of funds in a 529 Plan can be used to pay towards student debt over the course of the student’s lifetime, pursuant to the SECURE Act. A distribution can be made under this provision to the designated beneficiary and his or her siblings, each of which has a $10,000 lifetime limit.
Changes to the “Kiddie Tax:” Prior to the Tax Cuts and Jobs Act (TCJA), effective in 2018, children under the age of 19 or full-time students under the age of 24 were generally taxed at their parent’s tax rate on certain unearned income (interest, dividends, capital gains etc.). For 2018, the rates were changed under TCJA to the same rates that trusts and estates pay, whereby the maximum tax rate of 37% federal is reached at income of $12,950. This TCJA provision, often called the “kiddie tax,” was repealed under the SECURE Act and now the prior rules apply again. A taxpayer can elect to apply the pre-TCJA rules on an amended return for 2018, if beneficial.
As always, your Williams Benator & Libby tax team is here to answer any questions you have on these provisions and will continue to monitor tax law changes as they are proposed and passed.