SECURE Act – Changes to Retirement Plan and IRA Rules – No More Big “Stretch”, Work Longer, Contribute More 

Right before Saint Nicholas’ Christmas visit, President Trump signed the “Further Consolidated Appropriations Act, 2020” to provide necessary funding to keep the federal government running through September 30, 2020. Included in the Appropriations Act was an additional piece of legislation commonly referred to as the “SECURE Act” (the full title is “Setting Every Community Up for Retirement Enhancement Act of 2019”).

The SECURE Act contains numerous provisions affecting the administration and operation of qualified retirement plans and individual retirement accounts (“IRAs”).  Those admin and operational changes will not be discussed here. This brief post will highlight some of the new rules of which individuals should be aware. These new rules are designed to encourage additional savings toward retirement, and they accelerate the distribution of certain retirement benefits for inherited accounts.

It’s been no secret that the US retirement system is in serious trouble, with the result that most workers must work longer and must supplement Social Security with personal savings. The SECURE Act acknowledges this with certain of its changes, making it look more and more likely that retirement at age 65 will indeed become a relic of the past.

Changes to Required Minimum Distributions for Plan/IRA Participants and Beneficiaries

Generally, an individual who participated in a qualified retirement plan was required to take so called “required minimum distributions” (RMD) by April 1 of the year following the year in which he or she reached age 70½ or terminated employment, whichever was later.  As for the owner of a traditional IRA, he or she must commence minimum distributions by April 1 of the year following the year in which the owner attains age 70½, regardless of employment status. The SECURE Act increases the RMD age to 72 for both retirement plans and traditional IRAs. This change is effective for individuals who attain age 70½ after December 31, 2019. In plain English, if you had not yet reached age 70½  by the end of calendar year 2019, your new required beginning date for RMDs will be age 72. On the other hand, if you attained age 70½ by the end of 2019, your required beginning date is not changed by the SECURE Act and you must begin taking out RMDs at age 70½.

“Stretch” is Now Shorter for Inherited Accounts

“Stretch” distribution rules have also been changed by the SECURE Act.  This change is the biggest tax revenue generator in the SECURE Act and will hit some taxpayers hard.  The change is wrought by the removal of the so-called “stretch” provisions with the result that many beneficiaries of inherited retirement accounts will face higher taxes and a shorter distribution period. Here’s a bit of background.  Generally, qualified retirement plans and IRAs may permit the distribution of a designated beneficiary’s interest to be made over the beneficiary’s remaining life expectancy.  At death the person or persons named as a beneficiary are able to take the required annual minimum distribution over their own life expectancy. Since the calculation is “reset” to a younger life expectancy the distributions are “stretched out”, thus referred to, for example, as the “stretch” IRA.

The SECURE Act modifies the minimum distribution requirements for defined contribution plans and IRAs by requiring that all distributions be completed by December 31 of the tenth calendar year following the year of death of the plan participant or IRA owner.  Thus, under the new rule, almost every beneficiary who inherits a retirement account (IRAs, 401(k)s and even Roth IRAs) in 2020 and later years will have to empty the entire account within 10 years after the year of death, unless the beneficiary is a “qualified eligible beneficiary.”  Generally this is a beneficiary who, as of the date of the participant’s or IRA owner’s death, is a surviving spouse, a minor child (until reaching the age of majority), a disabled or chronically ill person, or any person not more than 10 years younger than the decedent. The new distribution requirements generally apply with respect to plans inherited from decedents who die after December 31, 2019, subject to certain exceptions for governmental plans, employees subject to collective bargaining agreements and annuity contracts in effect on the date of enactment.

Now is the time to review your beneficiary designation on IRAs and defined contribution plans.  Make sure that your beneficiary designations are still in line with your intended goals in light of the shorter time frame for distributions under the SECURE Act.  For some individuals, planning could be as simple as naming a spouse as beneficiary rather than a child or grandchild since the surviving spouse retains the ability to stretch the tax benefits of the IRA over his or her lifetime.  Another possible strategy to consider is examining whether it may be beneficial to increase the number of beneficiaries to spread (and potentially minimize) the tax impact over the 10-year distribution period.

IRA Contributions – Contribute More Despite Your Age and Help for Graduates!

The SECURE Act gives good news to savers.  It removes the prohibition on contributions to an IRA by individuals who have attained age 70½. This means that depending on various factors (e.g., income, filing status, earned compensation, and active status in a qualified plan), individuals working past age 70½ can contribute to an IRA (deductible or non-deductible). With this change, the individual after age 70½ may now contribute up to US$7,000 as a deductible contribution to an IRA and along with a spouse, the couple could contribute a total of US$14,000 per year, if they meet certain requirements. The change applies to IRA contributions made for taxable years beginning after December 31, 2019.

Another nice change is that taxable income attributable  to amounts paid to individuals for graduate and postdoctoral study can now be treated as compensation for purposes of making IRA contributions. This change applies to IRA contributions made for taxable years beginning after December 31, 2019.

Americans Abroad

For many US taxpayers residing abroad, retirement savings is often very difficult. US expatriates often struggle with retirement planning simply because they are working for foreign employers and thus not eligible for contributions being made into the US Social Security program. Many are not given a pension plan by their employers and must devise a way to save for retirement. Unfortunately, I see that a number of expatriates make the mistake of investing in foreign mutual funds, life policies, savings plans, portfolio bonds and similar fund arrangements to save money for retirement. Such investments typically are a big mistake due to US tax rules that make them completely inappropriate investments for the US individual.  So-called PFIC rules will often eat up this type of foreign investment in punitive taxes and interest charges, leaving the expat in the poorhouse. Given the significant tax complexities, Americans must be well advised before investing in the offshore market.

Quite often the best solution toward retirement savings for the US person living abroad is the tried and true.  That means using what is available and unquestionably legitimate, for example an IRA (traditional or Roth).   For the American abroad, though, certain complexities come into play. For example, in order to contribute to an IRA, the individual must have earned income. For the American abroad, this means that the earned income must be above the so-called Foreign Earned Income Exclusion (FEIE), which for 2020 is US$107,600 and above the housing exclusion amount assuming one can use this exclusion.  Any income that is excluded from income taxes as a result of either of these two tax breaks is not considered earned income for IRA contribution purposes.  The IRA would be available only on foreign wages or net self-employment income that exceeds the FEIE and housing exclusion amounts.

The rules get more complicated on account of contribution limits, catch up contribution limits and spousal IRA contributions. Make sure you take professional advice to avoid the pitfalls if you are an American overseas and planning for your retirement savings.

 

Posted January 23, 2020

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