As Americans were getting ready for the holidays and Congress was in the midst of a partisan impeachment battle, lawmakers stunningly came together to pass the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019). The SECURE Act appeared to be derailed last fall but passed the Senate while attached to the latest spending bill on December 19. This piece of legislation passed the House overwhelmingly earlier last year in a 417-3 vote. Multiple provisions will impact American’s investments and taxes in the new year both advantageously and adversely.
Small Business 401(k) Tax Credits
Not long ago, 401(k) plans were only for large organizations. Through technology, small businesses are now able to offer efficient and affordable 401(k)s for employers to attract and retain employees, provide a vehicle for business owners to build wealth, and save money in taxes. As it should, the government believes employees benefit when businesses offer retirement plans. To encourage small businesses to offer new 401(k)s, tax credits for those businesses have been increased. For small businesses offering a new 401(k) plan, the SECURE Act increases the tax credit up to $16,500 over a three-year period depending on the number of eligible employees and if automatic enrollment is offered.
Required Minimum Distribution
As Americans save into their employer sponsored retirement plans and IRAs, they usually make pre-tax contributions. In addition, retirement accounts grow tax-deferred. Up until this year, investors who held money in retirement plans had to start taking a required minimum distribution (RMD) by the April 1st following the year they turned 70.5. The amount of required minimum distribution was determined using a life expectancy factor along with the value of the account as of the prior year. The SECURE Act has moved the age investors must start taking the RMD back to the April 1st following the year they turn 72. In addition, the life expectancy table used to calculate the required minimum distribution will reflect a longer life expectancy resulting in a lower amount of required distribution. This change will not impact investors already taking the RMD. Those individuals who turn 70.5 this year can now wait to take their RMD making 2020 the year of the lost required minimum distribution.
There are additional benefits to investors. Up until this year, investors could not contribute to a Traditional IRA after the age of 70.5. Under the SECURE Act, investors can now contribute to a Traditional IRA at any age given they meet the criteria to make contributions.
The ability to take a distribution up $5,000 without a 10% tax penalty has been expanded to include the event of a qualified birth or adoption.
Removal of “Stretch” Inherited IRA Provisions
Until now, this article has focused on the tax benefits to Americans of the SECURE Act. Prior to this year, non-spouse beneficiaries of retirement plans were required to take an annual distribution over the course of their life expectancy. In other words, they were able to “stretch” the amount they would have to take out and pay taxes on over a long period of time. To pay for these tax benefits, the SECURE Act takes away the ability of non-spouse beneficiaries who inherit retirement accounts to “stretch” the required minimum distribution over their life expectancy. A son or daughter who inherits a retirement account from a parent must now take the entire amount out within 10 years. This will greatly accelerate the rate of distribution and taxes paid by a beneficiary and produce a greater need for investment and tax planning. Spouses who inherit retirement accounts are still able to rollover the inherited amount to their own retirement accounts and take the distribution over their life expectancy.
Plan for the Changes
The positives or negatives of the SECURE Act depend on what lens you look through. Many Americans will benefit from the changes contained in this bill while others will not. Knowledge of the changes will allow for planning to adapt to these new laws. Every financial situation is different which requires a different plan for each situation. As Francis Bacon is attributed to saying, “Knowledge is power.”