The SECURE Act: Elimination of the Stretch IRA and New Rules for Younger Participants
On January 1, 2020, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) became law and it significantly and fundamentally alters retirement in the United States.
The SECURE Act potentially affects anyone with a defined contribution plan, which includes 401(k)s, defined benefit pension plans, individual retirement accounts (IRAs), and 529 college savings accounts. Practitioners only had a few short months in which to acclimate to the SECURE Act and begin incorporating into estate planning documents.
The purpose of the SECURE ACT is to increase access to tax-advantaged accounts, prevent older participants from outliving their assets, and help younger participants start saving more and at an earlier age. A portion of the SECURE Act addresses the grim outlook for many workers who do not have access to workplace retirement accounts due to lack of qualifying work type, hours or wages. It also attempts to remedy the factors that make it economically or administratively impossible for small businesses to offer such plans to their employees. The main focus of this article is the elimination of the stretch IRA provision and the SECURE Act’s impact on younger participants.
Elimination of the Stretch IRA Provision (and New Distribution Rules)
The term “stretch” refers to how monies are taken out after the participant dies. It applies when taxes have not been paid on the monies in the IRA (pre-tax dollars), and the monies in the IRA are taxed when your children or beneficiaries withdraw it from the IRA. The elimination of the stretch IRA provision, which previously allowed non-spouses inheriting retirement accounts to stretch out disbursements over their lifetimes, is significant. The SECURE Act modifies the required minimum distributions (RMDs) upon the death of the account owner and the new rule generally requires the balance to be distributed within ten years following the account owner’s death. Section 401(a)(1). Section 401 excepts the following from the ten year distribution rule:
- the surviving spouse,
- disabled or chronically ill individuals,
- individuals who are not more than ten years younger than the account owner, or
- the child of the account owner who has not reached the age of majority. Section 401(a)(2).
This change is expected to generate an estimated $15.7 billion in additional tax revenue.
The SECURE Act also pushes back the age at which retirement plan participants need to take required RMDs from 70½ to 72, for those who are not 70½ by the end of 2019. Section 114. The House of Representatives has acknowledged that the RMD age of 70½ was decided in the 1960s and has not been updated since to reflect the fact that Americans are living longer.
Finally, the SECURE Act eliminates the maximum age for traditional IRA contributions, which was previously capped at 70½ years old. “As Americans live longer, an increasing number continue employment beyond traditional retirement age,” the House Committee on Ways and Means recognized in a summary of the bill. It does not provide a new age cap.
The SECURE Act profoundly affects retirement by eliminating the stretch IRA provision, changing the rules affecting RMDs, and eliminating the age cap for IRA contributions, but it also affects younger participants in a variety of ways.
How the SECURE Act Affects Part-Time Employees, Students, and Younger Participants
The SECURE Act now expands retirement plan access to part-time employees that worked less than 1,000 hours per year. Under the old rules, employers did not have to invite workers who work less than 1,000 hours every year to participate in a retirement plan, but the SECURE Act drops the threshold for eligibility down to either one full year with 1,000 hours worked or three consecutive years of at least 500 hours. Section 112(a)(1). The failure to extend such plans to part-time employees was found to particularly disadvantage women as they are more likely to work part-time, proving especially harmful for their retirement. Section 112 attempts to remedy that.
The SECURE Act also provides benefits unique to students. Specifically, it now permits stipends and non-tuition fellowship payments received by graduate and postdoctoral students to be treated as compensation and thus permitted for IRA contribution purposes. Section 106(a). It also allows for the use of tax-advantaged 529 accounts for qualified student loan repayments (up to $10,000 annually). Section 303(b).
The SECURE Act also creates a new early withdrawal penalty tax exemption of up to $5,000 from an IRA to use for childcare costs in the year after adopting or the birth of a child. Section 113(a). This provision allows the individual to pay back the money and helps parents with the high costs of caring for new children.
Finally, the SECURE Act prohibits credit card-based loans, which, by making loans too easy, resulted in too many withdraws from qualified plans, and which were found more common amongst younger workers. Section 108(a).
The SECURE Act is intended, among other things, to help younger participants begin saving earlier in their working careers, help them save more throughout their working years, and avoid penalizing them for life events that typically occur at or near the beginning of one’s career.