Secure Act and How It Impacts the Tax On IRA
Brad Smith • Feb 10, 2020
The Secure Act, also known as Setting Every Community Up for Retirement Enhancement Act, besides encouraging employers who were reluctant to invest in wealth management plans earlier, is an easier and cheaper plan to administer. There is one big anti-taxpayer change included in the act that will make the financially comfortable population and estate planners
think twice. In this article, we will cover all the major aspects of the act, especially those that will impact individuals and small businesses.
Increasing the age limit on Traditional IRA Contributions
Prior to Secure Act, individuals were not allowed to make contributions to a conventional IRA for the year at or after the age of 70 ½. The Secure Act allows retired individuals to delay availing required minimum distributions (RMDs) until the age of 72. There exists no age restriction on Roth IRA contributions and the Secure Act has maintained this rule.
The Change
Anyone who becomes taxable after the year 2019 will not be subject to age restrictions on contributions to conventional IRAs. Individuals can make contributions after the age of 70 ½ starting from the year 2020.
Key Point
If you want to make a contribution for the year 2019 tax year, it has to be done before 15th April 2020. However, if your age is 70 ½ or older by Dec 31st, 2019, you cannot contribute for 2019. This law allows you to make contributions for the tax year 2020 and ahead.
Implications for IRA Qualified Charitable Distributions
Individuals who have crossed the age of 70 ½ are allowed to make a qualified contribution to charities straight from their IRA(s). This limit of the contribution amounts to $100,000 per year. These contributions are known as ‘Qualified Charitable Distributions’ or QCDs. Any QCDs made in 2019 will have the $100,000 limit condensed for the year by the total amount of deductions applicable for prior taxable years due to the amendment of the Secure Act. In simple words, the QCD allowance can be reduced due to the deductible IRA contributions made for the year you turn 70 ½ or older.
People who turn 70 ½ in 2020 will not be asked to take out RMDs until they turn 72. If you want to withdraw annual required minimum contributions (RMDs) from taxed retirement accounts such as traditional IRAs, 401(k) accounts, SEP accounts or anything that falls in the same category. This rule is not applicable to Roth IRA(s) that is registered with your name.
Prior to passing the Secure Act, the first RMD was applicable when you turned 70 ½. There was an option of delaying the first payout till April 1 of the same year. If you chose to delay the payout, there had to be two RMDs withdrawn instead of one. This means that the first payout would be by the 1st April deadline and the second one will have to be by 31st Dec. The first payout will be for the previous year and the second will be for the current year.
There is an exception
for people who are still employed by the time they are between 70 ½ and 72 will not have to pay 5% to their employer and delay withdrawing RMDs from the plan till the time you’ve retired.
The Change
By default of the New Law, the age limit for withdrawing RMDs has been increased from 70 ½ to 72. This development is applicable to people who cross 70 ½ age limit after 2019. For those who turn 70 ½ before 2020 will not be able to take advantage of the increased age limit.
Key Point
As mentioned, if you haven’t withdrawn your initial RMD for 2019 and turned 70 ½ the same year, you must do it before 1st April 2020. Failure to do so will result in a 50% penalty on the shortfall. The second deadline for taking out the second RMD for 2020 tax year is Dec 31st, 2020.
Disadvantages of the Secure Act
The law eliminates the Stretch IRAs for beneficiaries who are not spouses. This is disadvantageous to other dependents such as your children and grandchildren. It also impacts your financial security negatively. The Act also requires non-spouse beneficiaries to empty the inherited accounts by 10 years of the account owner’s demise. This is a considerably big change for those who are financially comfortable and don’t require their IRA balances for their post-retirement years but want to utilize them for their non-spouse dependents in the long term.
Before the new law was passed, there was no time limit for non-spouse beneficiaries to drain the account. Anything that you inherited from your father or grandfather could be used over a long period of time.
If there is $100,000 balance left in the IRA Account to a 45-year-old non-spouse beneficiary, they will lose about $200,000 of tax benefits over the life expectancy of the child.
The rule that allowed individuals to reap the tax benefits of their father or grandfather’s IRA account is known as the ‘Stretch IRA’ strategy. The Stretch IRA strategy works in favor of inherited Roth IRAs because the income through those accounts can increase and can be withdrawn without the federal income tax being applied to them. A stretch Roth IRA could secure you from paying a federal income tax for a number of years but the new rule reduces this advantage.
The 10-year-rule limit beneficiaries from enjoying a federal tax-free income beyond 10 years. This development does not apply to beneficiaries who are suffering from serious illnesses or are disabled. It also does not apply to anyone who is less than 10 years younger to the account owner or those beneficiaries who are under 18. The exceptions do not apply to relatives. Please contact us here
if you need any help with this.
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