The SECURE Act provides more part-time employees with access to tax-friendly workplace retirement plans like 401(k)s. Signed into law by President Trump on Dec. 20, 2019, it also lets individual retirement account (IRA) holders save in these plans indefinitely with tax-deferred growth. In addition, the SECURE Act makes it simpler for employers to place annuities into their retirement plans. Annuities can offer guaranteed income streams in retirement. But because annuities and other aspects of this sweeping new law can be complex, it’s best to discuss how the SECURE Act may affect you with a financial advisor. Most changes take effect January 1, 2020 while some begin in 2021.
The SECURE Act Expands Access to Employer-Sponsored Retirement Plans
The SECURE Act stands for Setting Every Community Up for Retirement Enhancement. And many provisions of this law aim to do just that.
For starters, the SECURE Act lets businesses provide part-time employees with access to 401(k)s or other workplace retirement plans if they’ve worked at least 1,000 hours throughout the year or 500 hours throughout three consecutive years.
The new law also incentivizes small businesses to establish auto enrollment for these plans. Small businesses can now claim up to $5,000 in tax credits each year to cover 50% of their start up costs for retirement plans. Before, they could claim only $500.
In addition, small businesses can claim a new $500 annual tax credit for 50% of their startup costs in building auto-enrollment features into their 401(k) and SIMPLE IRA plans. They may claim the credit for up to three years.
And starting in 2021, businesses from different industries can join forces and pool in the costs of creating retirement plans for their employers under one plan provider. By banding together, these businesses may compete for better plans previously available to only large employers. Beforehand, only businesses with similar characteristics could establish multi-employer plans.
These provisions can open the door to tax-deferred retirement savings for more workers and even freelancers. In fact, data from the U.S. Bureau of Labor Statistics released in 2018 indicated that only 55% of the American adult population participated in a workplace retirement plan.
So if you meet the new criteria, you may want to start asking your employer about retirement benefits.
The SECURE Act Simplifies Access to Annuities
The new law makes it easier for companies to include annuities in their retirement plan investment options. While there are several types of annuities, they generally aim to convert people’s retirement savings into a predictable lifetime stream of income during retirement.
Previously, many employers avoided including annuity products in their plans because they would be held liable if the insurance companies providing those annuities could not live up to their claims guarantees. Now, the burden rests solely on the insurance company. Still, employers must carefully examine annuity providers with solid track records.
Employees should also seek the guidance of financial advisors when considering these options. Ask one about how annuities work and which type may be right for you.
SECURE Act Changes IRA Rules and Permits Longer Tax-Deferred Growth
The SECURE Act eliminates the age cap for IRA contributions. Beforehand, you’d be prohibited from contributing to your IRA after turning age 70.5. Now, anyone who’s employed or has earned income can contribute toward an IRA indefinitely.
Furthermore, the new law increases the required minimum distribution (RMD) age on traditional IRAs to 72. Previously, you had to begin taking a certain amount of withdrawals from your IRA beginning at age 70.5.
If you don’t take your RMD, the IRS hits you with an excise tax equal to 50% of what the applicable RMD should have been. The new rules now give you more time to grow your retirement savings before you need to begin taking a bite out of your nest egg.
The SECURE Act Eliminates the “Stretch Inherited IRA”
As with any tax law provision, however, not everyone will come out winning.
Beginning in 2020, the law requires non-spouse beneficiaries of IRAs to take full payouts within 10 years after the death of the initial account owner. This applies to 401(k)s and other defined contribution (DC) plans as well. That means some non-spouse beneficiaries may miss out on tax-deferred growth that could have stretched decades.
Taking the full payout can also trigger major tax hits on non-spouse beneficiaries depending on their tax bracket. Also, keep in mind that tax cuts in the Trump Tax Plan are scheduled to expire at the end of 2025. So unless Congress makes the tax brackets permanent, many Americans may go back to the higher Obama-era tax brackets.
Still, the SECURE Act does preserve the stretch inherited retirement account for spouses. The mandatory payout rule also won’t apply to minors until they’ve reached the age of majority, at which point, they have 10 years to empty the account they inherited. Additionally, people who meet the government definitions of disabled or chronically ill can stretch out withdrawals for their lifetime. Beneficiaries who are not more than 10 years younger than the original account holder at time of death are also allowed to take distributions under the old rules.
For those who inherited IRA from an original IRA owner who died before January 1, 2020, there are no changes required to the current distribution schedule.
But anyone whose estate planning involved a trust that would hold the stretch IRA should discuss their options with a financial advisor. It may be beneficial to convert the traditional IRA to a Roth IRA or to change the trust.
Penalty-Free Withdrawals for Childcare Costs
If you’re expecting a child or are adopting one, you can now withdraw up to $5,000 penalty free from qualified plans like 401(k)s and IRAs to cover the costs of raising your kid. This rule applies to your spouse as well. So that’s a combined penalty-free withdrawal of $10,000 for married couples.
You have one year from the birth of the child or adoption date to take advantage of a penalty free withdrawal. But keep in mind you’d still owe taxes on the withdrawal itself. However, you can reinvest the withdrawal in the future and the IRS would treat it as a rollover and not taxable income.
If you’re adopting, the child generally needs to be younger than 18 years old or physically or mentally incapable of self care to avoid the penalty. Under previous circumstances, you generally couldn’t take any kind of withdrawal from a qualified plan before reaching age 59.5 without facing a 10% penalty.
The SECURE Act Allows You to Pay Student Loans with 529 Plan Money
The new law also relaxes restrictions around 529 college savings plans. Students can now withdraw up to $10,000 penalty free from 529 plans to pay off student loans every year.
529 plans are tax-advantaged vehicles designed to help parents save for their children’s future education. They can withdrawal these savings tax-free to cover qualified education expenses.
But taking a withdrawal from a 529 plan to cover non-qualified expenses would trigger a 10% penalty on the earnings portion in addition to ordinary income taxes on the distribution. The SECURE Act expands the meaning of qualified expenses to include student loan payments and costs of apprenticeship programs.
This means families can now use leftover 529 plan funds to help their graduates pay off student loan debt or put them on a different path if they end up deciding college is not the right choice after high school.
Students and Caregivers Can Contribute More to Retirement Plans
The SECURE Act states that “amounts paid to aid the pursuit of graduate or post-doctoral study or research (such as a fellowship, stipend or similar amount) are treated as compensation for purposes of making IRA contributions.”
This provision essentially allows graduate students to contribute more to retirement plans or open new ones such as IRAs. Why? In general, retirement contributions toward qualified retirement plans can’t exceed total compensation. And if you don’t have compensation, you can’t contribute at all. But the new rules expand the definition of compensation to include many of the types of payments that graduate students receive to help them pursue their studies.
In addition, the law also tweaks compensation to include most “difficulty of care” payments that foster care providers receive from state programs to look after disabled people in the home of the caregiver.
The Bottom Line
The SECURE Act could boost and protect retirement savings for millions of Americans. Many of its provisions aim to increase access to workplace retirement plans and encourages companies to establish them. But some rules can limit savings potential and increase the tax burden on inheritors of IRAs. It’s best to discuss these rules with a financial advisor who can help you take advantage of its pros and avoid the cons.
Retirement Savings Tips
- If you want to talk strategy with a qualified professional, we can help. Use our advisor matching tool. It recommends up to three local advisors based on your personal needs and preferences.
- Increase your contributions to your IRA. The SECURE Act allows you to save longer, thereby taking more advantage of tax-deferred growth. If you don’t have one, check out our report on the best IRAs around. These standout for low fees, robust investment options and more.
- Not sure about how to build your retirement savings portfolio? Use our asset allocation calculator. You can view different investment mixes based on your risk tolerance.
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