The SECURE Act and the Effects on Financial Planning

Political risk! A man made variable of financial planning which requires advisors to always pay attention to the news, as well as the activities of state and federal governments. Death and taxes being the only two guarantees in life, at least we all have a little control over our own demise. Taxes, on the other hand, are practically out of our control once we pull down the lever in the voting booth.

We must constantly be aware of our tax situation and how new laws change the rules. While most tax law changes are small in nature, and can be ignored by the majority of the population, an occasional change is far reaching and requires major alterations to financial strategies. The Tax and Jobs Act is the most recent, and most publicized, Congressional action in recent history relating to tax laws. Last month the SECURE Act was passed and earns the silver medal for having the greatest affect on personal finance over the last decade. This month’s ‘For Your Consideration’ looks at the new legislation and the major points which will affect financial planning strategies.

The Setting Every Community Up for Retirement Enhancement Act of 2019 was passed by the House in July 2019, the Senate in December and signed into law shortly thereafter. The goal of the legislation is to increase access to tax-advantage accounts, savings methods and investment strategies to help citizens prepare for retirement. The idea is to make retirement savings easier and increase participation in order to combat increasing longevity in the population.

As it is with every other American, it is ingrained in me to have a feisty political opinion about any legislation, its political purposes and the ramifications of policy. But I will leave my politics out of this discussion and broadly say that this legislation is ‘a very good start’ with ‘a few eyebrow raising details’. What follows is a synopsis of the more important parts of the act and the financial planning ramifications they present.

**Please note: These changes begin on January 1st, 2020 and do not affect any accounts or actions prior to that date.

Changes which pay for the plan, but may negatively affect financial strategies

Elimination of the ‘Stretch IRA’

The details: This is a big change for financial planning and a detriment to estate planning. Under previous regulations, beneficiaries of retirement plans are given the option to take required minimum distributions based on their own life expectancy. This allows inherited accounts to grow and beneficiaries to control the tax consequences of inherited accounts.

Under new law, a ‘10-Year Rule’ is required, forcing beneficiaries to take out the entire balance within 10 years (in whatever amount they want in each of the ten years, as long as the balance is exhausted by the tenth year).

“Eligible Designated Beneficiaries’ are excluded from this rule and include:

  • Spousal beneficiaries

  • Qualified disabled beneficiaries

  • Chronically ill beneficiaries

  • Individuals who are no more than ten years younger than the decedent

  • The rule also doesn’t affect beneficiary IRAs established before 2020.

The effects on financial planning: The provision is essentially a type of estate tax for the middle class. It forces IRA account balances to be exhausted in a much less tax efficient manner. For individuals who place a high-level of importance on giving tax efficient funds to heirs and charities, it becomes vital to have an estate plan in place that wisely earmarks IRA funds to the right beneficiaries in order to limit tax consequences. For charitable individuals the Qualified Charitable Distribution is now much more attractive.

Increased penalties for not filing tax returns

The details: The law increases penalties for not filing personal or business returns or for filing returns late.

The effects on financial planning: This shouldn’t be the impetus for changing your behavior! You should already be filing your taxes on time!

Changes that help older savers

Required Minimum Distribution Begin at age 72

The details: Individuals, who have not reached age 70 ½ by the end of 2019 may now wait until age 72 before being forced to take Required Minimum Distributions. All other requirements related to RMDs remain the same.

The effects on financial planning: More time to plan is always a good thing. The increased RMD age allows savers to combat the tax consequences of RMDs by having up to two extra tax years to implement Roth conversion strategies, early distribution strategies, etc. As a bonus, Qualified Charitable Distribution will still be allowed starting at age 70 1/2, giving added firepower to individuals looking to combat the issue of an over funded IRA.

Traditional IRA Contributions allowed past age 70 1/2

The details: The Secure act lifts the prohibition on Traditional IRA contributions once someone is 70 ½. To combat increased longevity, this provides people who choose to continue to work in their 70s, and do not have access to an employer sponsored plan, a tax savings method to continue to save funds for retirement.

The effects on financial planning: This provision is a change to a law that shouldn’t have existed in the first place. If you have earned income, you should be able to contribute to your own retirement. This provision now provides the option and is good for all older workers.

Efforts to increase retirement savings participation

Changes to ‘full time work status’ and Safe Harbor rules

The details: Under current law employers are allowed to exclude employees from participating in employer plans if they work less than 1,000 hours in a single ‘plan year’. Changes require employers to allow participation among workers who work at least 500 hours per year in the previous three years. However, this rule does not begin until 2021, making relevant employees ineligible until 2024.

The effects on financial planning: For part time workers who have the means to contribute more towards retirement than the IRS allowed IRA limits, this will provide a method to increase pre-tax retirement savings.

Increase to allowable default contributions

The details: 401(k) default contribution limits increased from 10% to 15% of an employee’s income. This is the amount of money that employers can set the ‘default contribution rate’. The default rate is the percentage of income that a plan automatically sets as an employee’s savings rate, unless the employee opts out. The goal is to automatically increase participants’ savings amounts.

The effects on financial planning: While I’m a fan of ‘encouraged savings’ I also understand the importance of cash flow. It’s my hope that any default savings plan will help savers recognize that pre-tax saving has minimal affect on your cash flow. However, participants need to be aware of default settings if cash flow is tight.

Education stipends qualify for tax efficient retirement savings

The details: Individuals who have taxable stipends paid to them to aid in the pursuit of graduate or postdoctoral study can use those amounts as a compensation source to qualify for retirement savings.

The effects on financial planning: This gives professional students a greater ability to jump start retirement savings by qualifying for retirement savings without having the previously required amount of earned income.

Miscellaneous changes to retirement accounts

Qualified birth or adoption distributions

The details: In addition to current allowable expenses, retirement account funds can be used for childbirth and adoption expenses without a 10% penalty being assessed for early withdrawal. The law caps distributions for expenses at $5,000 per child.

The effects on financial planning: While I always encourage savers to look for other avenues to pay for non-retirement expenses, this is good news for individuals who need alternative sources to pay for family planning expenses.

Non-retirement account changes

529 accounts can be used to pay for student loans and apprenticeships

The details: Expands the allowable expenses that qualify for ‘Higher Education Expenses’ and the use of 529 funds to include ‘Apprenticeship Programs’ that require fees, books, supplies, equipment, etc.

The effects on financial planning: This reduces savers concerns that 529 funds are ‘locked up’ for collegiate use only and expands the ability to use 529 funds for other life start-up expenses. This change makes 529 accounts more attractive for education planning, life planning and estate planning.

Kiddie Tax fixed – reverted to pre-Tax Cuts and Job Acts rules

The details: An error in the language of the 2017 Tax and Jobs Act lumped passive income for minors with trust income. The result was an incredibly high tax rate on the gains in minority trust accounts. The legislation fixed this issue and minority account income is now back to being taxed at the parents’ income tax rate.

The effects on financial planning: This is a good thing for parents who want to save for their children and consider goals beyond education. The law once again makes saving into UGMAs and UTMAs an attractive option.

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