There are many traditions surrounding the start of a new year. Some leave you jumping for joy, others can leave you jumping up and down in frustration. As with every new year, a wave of new laws went into effect across the country on January 1, including big changes to IRA and 401(k) rules that could affect your estate plans. If you’re not sure how to make heads or tails of the new legislation, fear not. Our founder, Ben Neiburger, is not only an acclaimed attorney, but also a CPA. That means he’s fluent in legalese as well as tax minutiae. Here’s his guide on what you need to know.
The “SECURE Act” (Setting Every Community Up for Retirement Enhancement Act)
The Setting Every Community Up for Retirement Enhancement Act, or the SECURE Act, is designed to encourage people to save for retirement. However, it could force workers to change their existing plans. Here’s why:
- Changes to distributions from inherited IRAs: This is a big one. Previously, a non-spouse beneficiary, like a child, who inherited a retirement account could choose whether to stretch out distribution of the funds over the course of his or her lifetime (the so-called “stretch” IRA).
For instance, if a 25-year-old inherited her grandmother’s $1 million IRA, according to Forbes, her distribution would be roughly $17,482 based on her estimated life expectancy of an additional 57.2 years. Plus, if the estimated interest on that IRA was, say, 7%, the $1 million would grow to about $1.75 million in 10 years, and would likely continue to grow, tax-free, for the rest of her life.
However, the SECURE Act removes the option to stretch out distribution and now requires full disbursement of an inherited IRA within 10 years. This represents a major change in tax policy, one that makes IRA bequests less valuable over a lifetime. Under the new provision, the same 25-year-old’s post-IRA assets would be worth about $1.01 million rather than $1.75 million. That’s a sizable difference.
If your estate plans incorporated these stretch IRAs, it’s critical to update the language in them to avoid creating problems for your beneficiaries down the road. The new law applies to anyone who inherits an IRA after January 1 of this year.
Note: There are a few exceptions for certain beneficiaries, including surviving spouses, people with disabilities, minor children and those less than 10 years younger than the IRA account holder.
- Repeal of maximum age for traditional IRA contributions: As Americans live longer, an increasing number continue working beyond traditional retirement age. This legislation repeals the age restriction on worker contributions to traditional IRAs. As of January 1, you can now make contributions after reaching age 70½. This same rule regarding age limits applies for contributions to 401(k)s and Roth IRAs.
The new law also increases the age when retirees need to start taking “Minimum Required Distributions” (RMD) from their retirement plans. Prior to 2020, participants were typically required to start taking distributions at age 70½. This was a way to ensure they spent their retirement savings during their own lifetimes, rather than using the funds for estate planning purposes to transfer wealth to beneficiaries. However, because the age requirement (which was first applied in the early 1960s) was never adjusted as life expectancy increased, the SECURE Act has now increased the required minimum distribution age from 70½ to 72
So what does all this mean for you? The new law allows you contribute to your retirement plan longer and take distributions later, so it may change your planning decisions.
- Penalty-free withdrawals from retirement plans for individuals in case of birth or adoption: Parents who just had a baby or adopted a child may now have a new source of money to help with related expenses. The SECURE Act allows qualified individuals to make an early withdrawal of up to $5,000 from their retirement accounts without the previous 10% penalty on these deductions. That means a couple could potentially withdraw up to $10,000 penalty-free, if each parent has a separate retirement account.
- Treating excluded difficulty of care payments as compensation for determining retirement contribution limitations: Many home healthcare workers don’t have a taxable income because their only compensation comes from tax-exempt “difficulty of care” payments. Without taxable income, they aren’t able to save for retirement in a defined contribution plan or IRA. The new law allows them to contribute to a retirement plan or IRA by increasing the contribution limit to include difficulty of care payments.
The bottom line is that the SECURE Act makes significant changes to many longtime retirement plan rules and makes a number of important tax changes, as well. Be sure to have an experienced attorney review your estate plans as soon as possible, especially if you’re using a stretch IRA as a planning tool. If you need a hand, give us a call at 630-782-1766 or get in touch here.