SECURE Act – RMD Changes

The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 (the “Act”), which notably modifies Required Minimum Distribution (RMD) rules, went into effect January 1, 2020. Below are the five things that many people need to know. This is just an overview to get an idea of the overall rules. The previous distribution percentage is as follows: Age % distribution 10           1.4% 20           1.6% 30           1.9% 40           2.3% 50           2.9% 60           4.0% 70           3.6% 80           5.3% 90           8.8%

1. (Section 401, Modifications to Required Minimum Distribution Rules), if you leave a retirement plan (IRA, 401k, 403b) to your descendants (or receive an inherited retirement plan), they will generally no longer be able to take the proceeds over their life expectancies, rather the maximum deferral period will be ten years. Relevant details:

• This does not apply to leaving the retirement plan to your spouse.
• This does not apply to those who have already inherited a retirement plan. (opened before 12/31/2019)
• This does not apply to a beneficiary who is a disabled person, a chronically ill person, a minor child or someone fewer than 10 years younger than the original IRA owner. For minors, the exception only applies until the child reaches the age of majority. At that point, the 10-year Rule kicks in.
• If a trust is named as a beneficiary of your IRA, the SECURE Act may have further negative consequences. There are two types of IRA trusts, conduit and accumulation.  A conduit trust passes the IRA distributions, if worded correctly, to the IRA beneficiaries.  If you do not want your beneficiaries to receive your entire IRA after ten years, then consider an accumulation trust.   With an accumulation trust, the trust dictates how much the beneficiary will receive.  The downside of the accumulation trust is that the IRA distributions will be taxed at trust tax rates which are the highest income tax rates.  In 2019, the Federal income tax rate reached 37% at only $12,751 of taxable income.  For those needing an accumulation trust, a Roth conversion is essential.  However, you must have sufficient assets in nonretirement accounts to pay the income taxes on the conversion.

2. (Section 114, Increase in Age for Required Beginning Date for Mandatory Distributions) there is a small, yet favorable, change. For those who are not yet 72, RMDs (Required Minimum Distributions) from retirement plans will now begin at age 72 rather than age 70½. QCDs (Qualified Charitable Distributions) continue to have a 70½ start age.
3. (Section 106, Repeal of Maximum Age for Traditional IRA Contributions) there is another small, yet favorable, change. For those over age 70½ who have earned income you can now contribute to an IRA.
4. In the spending bill itself, but not the SECURE Act, the change in the “kiddie tax” (basically tax on unearned income for a child under 18, or under 24 and a full-time student) that was made by the 2018 Tax Cuts and Jobs Act (TCJA) is repealed. Those earnings will again be taxed at the parent’s marginal rate as they were previously rather than at trust tax rates.
5. Unrelated to this bill, beginning in 2021 the IRS is changing its life expectancy table for the calculation of RMDs. To use just two examples, previously an 80-year-old using the standard table would have used a life expectancy of 18.7 years but in 2021 it will be 20.2. A 90-year-old will change from 11.4 to 12.2. Not a huge change.
6. There was no change to the 50% tax penalty for failure to take an RMD, which could be very significant if distributions by the designated beneficiaries (DBs) are planned to be taken in the 10^thyear but the 12/31 date at the end of year 10 is missed.

An unofficial new term for the financial services profession is “Suggested Minimum Distribution (SMD).” The SMD is merely the account value on 12/31 of the prior year divided by the number of years left before the 10-Year Rule deadline. If DBs take the SMD each year, the tax implications of the 10-year Rule may be minimized.

THE ACT SECTIONS

THE SETTING EVERY COMMUNITY UP FOR RETIREMENT ENHANCEMENT ACT OF 2019 (THE SECURE ACT)

TITLE I: Expanding and Preserving Retirement Savings

SEC. 101. MULTIPLE EMPLOYER PLANS; POOLED EMPLOYER PLANS. – Allows two or more unrelated employers to join a pooled employer plan. SEC. 102. INCREASE IN 10 PERCENT CAP FOR AUTOMATIC ENROLLMENT SAFE HARBOR AFTER 1ST PLAN YEAR. – the maximum 401(k) contribution for employers using an automatic enrollment safe harbor plan is increased from 10% to 15%. SEC. 103. RULES RELATING TO ELECTION OF SAFE HARBOR 401(k) STATUS. – simplification of safe harbor rules. SEC. 104. INCREASE IN CREDIT LIMITATION FOR SMALL EMPLOYER PENSION PLAN STARTUP COSTS. – increases the tax credit for small businesses who set up a retirement plan. SEC. 105. SMALL EMPLOYER AUTOMATIC ENROLLMENT CREDIT. – provides a small tax credit for employers who set up a new plan with automatic enrollment. SEC. 106. CERTAIN TAXABLE NON-TUITION FELLOWSHIP AND STIPEND PAYMENTS TREATED AS COMPENSATION FOR IRA PURPOSES. – grad student payments are now considered “earned income” so they can fund an IRA (or, more likely, a Roth IRA). SEC. 107. REPEAL OF MAXIMUM AGE FOR TRADITIONAL IRA CONTRIBUTIONS. – covered above. SEC. 108. QUALIFIED EMPLOYER PLANS PROHIBITED FROM MAKING LOANS THROUGH CREDIT CARDS AND OTHER SIMILAR ARRANGEMENTS. – makes plan loans less convenient (this is a good thing). SEC. 109. PORTABILITY OF LIFETIME INCOME OPTIONS. – necessary change because of section 204 below. SEC. 110. TREATMENT OF CUSTODIAL ACCOUNTS ON TERMINATION OF SECTION 403(b) PLANS. – allows in-kind distribution of terminated 403(b) plan balances. SEC. 111. CLARIFICATION OF RETIREMENT INCOME ACCOUNT RULES RELATING TO CHURCH-CONTROLLED ORGANIZATIONS. – clarifies that church-controlled organizations can have retirement plans. SEC. 112. QUALIFIED CASH OR DEFERRED ARRANGEMENTS MUST ALLOW LONG-TERM EMPLOYEES WORKING MORE THAN 500 BUT LESS THAN 1,000 HOURS PER YEAR TO PARTICIPATE.SEC. 113. PENALTY-FREE WITHDRAWALS FROM RETIREMENT PLANS FOR INDIVIDUALS IN CASE OF BIRTH OF CHILD OR ADOPTION. – $5,000 limit and it can be repaid to the IRA later. SEC. 114. INCREASE IN AGE FOR REQUIRED BEGINNING DATE FOR MANDATORY DISTRIBUTIONS. – 72 instead of 70.5 SEC. 115. SPECIAL RULES FOR MINIMUM FUNDING STANDARDS FOR COMMUNITY NEWSPAPER PLANS. – helps small newspapers by making the pension funding less stringent. SEC. 116. TREATING EXCLUDED DIFFICULTY OF CARE PAYMENTS AS COMPENSATION FOR DETERMINING RETIREMENT CONTRIBUTION LIMITATIONS. – allows home healthcare workers to treat “difficulty of care” payments (which are exempt from taxation) as “earned income” so they can fund an IRA or Roth IRA.

TITLE II: Administrative Improvements

SEC. 201. PLAN ADOPTED BY FILING DUE DATE FOR YEAR MAY BE TREATED AS IN EFFECT AS OF CLOSE OF YEAR. – allows plans to be set up after the end of the year for the previous year (as SEPs have long allowed). SEC. 202. COMBINED ANNUAL REPORT FOR GROUP OF PLANS. – allows plans that are basically the same to file consolidated Form 5500. SEC. 203. DISCLOSURE REGARDING LIFETIME INCOME. – requires employers to show plan participants what income their plan balance is likely to generate in retirement. Most individuals have unrealistic expectations, so this is a helpful change for employees although it is (slightly) more work for employers. The DOL is to provide a model disclosure. SEC. 204. FIDUCIARY SAFE HARBOR FOR SELECTION OF LIFETIME INCOME PROVIDER. – employer retirement plans can more easily allow annuity options. Many folks think this may open the door to sales of poor insurance products within 401(k) plans (much as 403(b) plans are chock-full of terrible investment options). Giving support to this view is how happy insurance companies were with this provision and how hard they lobbied for it. SEC. 205. MODIFICATION OF NONDISCRIMINATION RULES TO PROTECT OLDER, LONGER SERVICE PARTICIPANTS. – protects the benefits of participants in closed retirement plans. SEC. 206. MODIFICATION OF PBGC PREMIUMS FOR CSEC PLANS. – changes funding rules.

TITLE III: Other Benefits

SEC. 301. BENEFITS PROVIDED TO VOLUNTEER FIREFIGHTERS AND EMERGENCY MEDICAL RESPONDERS. – one-year repeal of the SALT (State and Local Tax) limit but just for a very small group. SEC. 302. EXPANSION OF SECTION 529 PLANS. – allows 529 funds to be used for registered apprenticeships and up to $10,000 of qualified student loan repayments.

TITLE IV: Revenue Provisions

SEC. 401. MODIFICATION OF REQUIRED DISTRIBUTION RULES FOR DESIGNATED BENEFICIARIES. – covered above. SEC. 402. INCREASE IN PENALTY FOR FAILURE TO FILE. – increases the failure to file penalty to the lesser of $400 or 100% of the amount of the tax due. SEC. 403. INCREASED PENALTIES FOR FAILURE TO FILE RETIREMENT PLAN RETURNS. –applies to employers. SEC. 404. INCREASE INFORMATION SHARING TO ADMINISTER EXCISE TAXES. – the IRS can share information with U.S. Customs and Border Protection to help collect the heavy vehicle use tax.

HOW TO REDUCE IMPACT

The following are ideas to reduce the tax impact of the 10-year distribution period:

1. Roth contributions and Roth conversions – Roth conversions are taxable to the extent of deductible IRA contributions, but Roth distributions are never taxed.  During your lifetime, it is worthwhile to do a Roth conversion if you will be in the same or higher tax bracket when your IRA RMD (Required Minimum Distributions) start.  Including the benefits to your heirs, a Roth conversion may be worthwhile even if you are in a higher tax bracket now than when IRA RMDs start.
2. In a low tax year, consider withdrawing more than your IRA RMD and gifting the excess to your children.
3. Consider multigeneration trusts where the primary beneficiaries are your children and grandchildren.
4. If you are charitably inclined, consider naming a charity as your IRA beneficiary.  Your children can be the trust beneficiaries of your non-retirement assets.
5. If you are charitably inclined, consider naming a charitable remainder trust as your beneficiary with the annual payment going to your children and the remainder after a set period to the charity.  Charitable remainder trust payments can be made up to 20 years vs 10 years for inherited IRAs.

Note:  for both 4 and 5 – giving to charity does not enhance your child’s wealth.  Charitable beneficiaries are only recommended for those whose goal is to leave some to charity.

6. The following would only apply to clients where 1) both spouses have large IRAs, 2) each spouse can live off their IRA alone, and 3) the children are and will continue to be in high tax brackets.  If you fall into this rare group, consider naming your children as primary beneficiaries of each of your IRAs.  There is no benefit if you both die in the same year, but you could increase the inherited IRA distribution period from ten to 20 years.  For example, if one spouse dies in the year 2020 and the second spouse dies in 2030, the beneficiaries would be able to take one IRA over ten years then the second IRA over another ten years for a total of 20 years.

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