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SECURE Act Brings About Significant Changes to IRAs

December 20, 2019
Estate Planning Advisory

One hundred dollar bill with lock and chainAs we reach the end of 2019 and prepare to flip the calendar to 2020, Congress and the president have finally passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act. The act brings about significant changes to federal tax law impacting individuals and business owners alike. Here are some of the law's most significant provisions:

Removes Some Stretch Distributions for Inherited IRAs

This is a long-expected change that significantly impacts what an IRA beneficiary receives upon the death of the account owner. Under current law, any traditional IRA account owner must begin taking required minimum distributions (RMDs) from the IRA upon reaching age 70½. If the account owner dies after that age, any funds remaining in the IRA at the owner's death may be inherited, with the RMDs being paid out to the heir over his or her life expectancy in most cases. This stretch enabled a younger beneficiary to grow the inherited IRA substantially (and tax-free), sometimes over many decades.

As a result of the SECURE Act, most beneficiaries will be required to distribute the entirety of an inherited IRA over a 10-year period. The writing has been on the wall since 2014 when the Supreme Court declared that an inherited IRA in the hands a non-spouse beneficiary was not a retirement account in the bankruptcy context (Clark v. Rameker). However, RMDs payable to the following persons still qualify for the stretch:

  • Surviving spouse of an account owner
  • Person who is not more than 10 years younger than the account owner
  • Minor child of the account owner
  • Disabled person
  • Chronically ill person

These new RMD rules apply to retirement accounts whose owners die after December 31, 2019.

Increases RMD Ages

As noted above, under current law, any traditional IRA owner must begin taking RMDs upon reaching age 70½. Under the SECURE Act, this age has been raised to 72, providing for a slightly increased period of tax deferral as well as greater clarity given the lack of half-birthday celebrations.

Removes Age Limitations on Traditional IRA Contributions

Under current law, while an individual could contribute to a Roth IRA without any age restriction, contributions to a traditional IRA were disallowed upon attaining age 70½. As a result of the SECURE Act, any individual may continue contributing to a traditional IRA throughout his/her lifetime with no age restriction.

The benefit of the removal of the contribution age restriction is significantly muted when read in conjunction with the removal of the stretch distributions for non-spousal beneficiaries above. Nevertheless, the removal of age restrictions on contributions presents an attractive tax deferral opportunity for the septuagenarian wage earner with a younger spouse who is named as the IRA's beneficiary.

Adds Penalty-Free Distributions for Birth of Child or Adoption

As a default rule, withdrawals from retirement accounts prior to age 59 1/2 are subject to income tax on the withdrawn amount plus a 10 percent penalty. The SECURE Act provides a specific carve-out from the penalty if the funds – up to $5,000 – are withdrawn in order to pay expenses associated with a qualified birth or adoption. You'll still pay income tax on the funds withdrawn but only if they aren't repaid.

Adds Qualified 529 Plan Expenditures

The Tax Cuts and Jobs Act signed into law back in December 2017 permitted 529 account funds to be used for the payment of K-12 education expenses on behalf of the account beneficiary. The SECURE Act further expands the list of permissible uses of 529 funds to include costs associated with registered apprenticeships and student loan repayments.

Unfortunately, Michigan residents are still in a strange limbo with regard to using 529 account funds to pay K-12 education expenses as Michigan has not amended state law in coordination with the change in federal law. As a result, while withdrawals from 529 accounts for K-12 education expenses are explicitly qualified withdrawals under federal tax law, they may or may not be qualified expenses under Michigan state law. This position is further complicated by the presence of the Blaine amendment in Michigan's constitution requiring that no money be appropriated from the state treasury for the benefit of any religious sect. If the Michigan Department of Revenue determined that withdrawals for the payment of K-12 education expenses were not qualified, any income withdrawn from the 529 account would be subject to income tax as ordinary income along with a 10 percent penalty.

Enhances Small Employer Access to Retirement Plans

Congress previously authorized the creation of the SIMPLE (1996) and SEP (1978) IRAs in an effort to improve access to retirement accounts for small employers. In the SECURE Act, Congress acknowledged that those previous efforts produced some success but left room for improvement. The new law should increase the willingness of small employers to participate in pooled retirement plans by softening the impact for an employer when another employer in a pooled plan fails.

The act also increases the credit for plan start-up costs, which will make it more affordable for small businesses to set up retirement plans. The existing $500 credit is increased by changing its calculation from a flat dollar amount to the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of nonhighly compensated employees of the eligible employer who are eligible to participate in the plan or (b) $5,000.

The SECURE Act will bring about both opportunities and complications for individuals planning their own financial futures as well as employers seeking to maximize their attractiveness to potential employees. Please consider reaching out to a member of Varnum's Estate Planning, Tax or Employee Benefits Practice Team with any questions.

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