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SECURE Act Upends Retirement, Estate Planning

Last update on: Jun 16 2020

The SECURE Act rolled through Congress in late December and was signed into law on Dec. 20. It is time to adjust your retirement and estate plans to both the good and bad sections of the law.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act makes major changes in retirement plans, especially 401(k)s and IRAs. Here’s a review of the key provisions for my readers and how you should respond to them.

No age limit on IRA contributions. Since the beginning of traditional IRAs, contributions haven’t been allowed after age 70½, even if the owner still was working. There has been no age limit on Roth IRA contributions.

The SECURE Act removes the age limit, allowing contributions to traditional IRAs regardless of your age. The change applies to tax years after 2019.

Keep in mind that to make a contribution to either type of IRA during the year, you must have at least an equivalent amount of “earned income,” meaning income from a job or self-employment. Investment income and pensions don’t count.

Later starting date for RMDs. The starting date for required minimum distributions (RMDs) is changed from 70½ to 72. I never saw an explanation why years ago Congress chose 70½. The half-year starting point confused many people. With life expectancy increasing, people working longer and to end the confusion, Congress decided to delay RMDs until age 72.

But the change is forward-looking. Those already obligated to take RMDs have to continue. Only those who turn 70½ after December 31, 2019, are affected by the new law. So, if you turned 70½ in 2019, you have to take that first RMD by April 1, 2020 (if you didn’t already take it). If you turned 70½ previously, you have to keep taking RMDs on the old law’s schedule.

Annuities in 401(k)s. Economists and many financial advisors (including me) say most people should have a portion of their retirement in annuities that pay guaranteed lifetime income. But few people do that, and very few 401(k) plans offer annuities among their payout options.

The SECURE Act aims to change that. Many employers say their 401(k) plans don’t include annuities because the legal risks are too high. They don’t want to be sued if a plan member thinks the employer should have selected a different annuity or insurer and especially if the insurer has financial problems.

The new law reduces an employer’s fiduciary liability for the choice of annuity or insurer. The SECURE Act also provides that a plan member can take the annuity with him or her after leaving the employer without paying a penalty. In other words, the annuities will be portable. You’re likely to see annuity options added to 401(k) plans in the coming years.

Large employers probably can negotiate annuity deals that are better than those you can obtain in the individual annuity market. The bad news is not all employers will do that. Consider any annuity option you’re offered through a 401(k) plan, but compare it to the payout you’d receive from annuities available
in the individual market. As I always say regarding annuities, be sure to shop around.

The end of the Stretch IRA. A key provision of the SECURE Act is the end of the Stretch IRA. I’ve been advising about the war on the Stretch IRA for several years, and longtime readers should be well prepared for this. The Stretch IRA is an inherited IRA in which the beneficiary takes full advantage of the IRA’s tax deferred compounding of income and gains.

For years, the beneficiary limits distributions, taking RMDs based on his or her life expectancy. The IRA could last, or stretch, for decades before funding major life expenses such as children’s college expenses or the beneficiary’s own retirement. It could even pass to a third generation owner. That’s ended by the SECURE Act. Most inherited IRAs need to be distributed fully within 10 years. The beneficiary can wait until the end of the 10th year to distribute the full account or can take distributions on any schedule over the 10 years.

The rule applies to both traditional IRAs and Roth IRAs. The traditional IRAs will be fully distributed and taxed within 10 years. The Roth IRA distributions still will be tax free, but the money will lose the tax-free compounding of future income and gains after 10 years.

The anti-Stretch rule doesn’t apply to an IRA inherited by a surviving spouse, a disabled person, a chronically ill person, a minor child or someone fewer than 10 years younger than the original IRA owner. When a minor child inherits an IRA, the 10-year clock starts running after he or she reaches the age of majority in his or her state of residence. Note that grandchildren don’t qualify for an exception to the 10-year rule. Only children of the IRA owner qualify for the exception.

The SECURE Act is especially punitive when a trust is named as the IRA beneficiary, because trusts jump into the top tax bracket at a low income level. The effective date is December 31, 2019. The anti-Stretch IRA rules apply to the IRA of anyone who passes away after the end of 2019. If Congress had passed the law as initially intended last summer, IRA owners would have had about six months to rearrange their IRAs and plan for the end of the Stretch IRA.

Now, there’s no planning or grandfather period. You need to act immediately to adapt your plans to the SECURE Act. I’ve covered this issue fully in the past. In the July 2019 issue I gave my readers a warning and a full range of options to achieve the equivalent of a Stretch IRA, or even better results, despite the SECURE Act.

I’ll be exploring and explaining these strategies and some new ones in detail in coming issues. It is important for anyone whose plans included at least giving your heirs the option of using the Stretch IRA to review the July 2019 issue and begin selecting your alternative. Also, any IRA owner who named a trust as the IRA beneficiary needs to meet with an estate planner soon to revise the plan.

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