Changes made in 2019 have affected a lot of people’s retirement accounts and how they work for their beneficiaries. It’s important for anyone with an IRA to know how the Secure Act and Cares Act affect their IRA because the changes are both good and bad.
The SECURE Act and Your IRA
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on December 20, 2019. Changes under the SECURE Act have both good and bad points, which have many people confused. These changes include:
Repeal on Age Restriction for Contributions
Before the ACT passed, you couldn’t contribute to your traditional IRA after you reached 70 ½. Now, you can continue making contributions after this age, which is beneficial for people that continue working after they reach 70 ½ age.
You will need to have eligible compensation to be able to make these contributions.
New 10% Early Distribution Penalty Exception
Exceptions are now given for adoption expenses along with the birth of a child. If you take distributions before 59 ½, any portion of the distribution that is taxable is subject to a 10% additional tax.
This is a steep penalty, and since most people don’t realize that they’ll suffer a 10% penalty until they do their taxes at the end of the year.
Under the new rules, there is a $5,000 exemption per participant if you want to take money out for qualified adoption or birth expenses. The changes are beneficial for anyone that plans to adopt or have a child and needs to find some way to pay for these expenses.
Death of the Stretch IRA
People save in retirement accounts because of tax deferment. You can allow compound interest to work for your retirement account and grow your money more without paying taxes now.
If you die, your beneficiaries can also leverage this same deferment to a certain extent.
Prior to the SECURE Act
A designated beneficiary could stretch distributions for your life expectancy. For a beneficiary, this was highly desirable because assets would remain in the account and grow year-over-year and only have to pay beneficiary required minimum distributions.
The practice was a great way to build wealth.
With a Roth IRA, the distributions became tax free with a qualified event, such as the death of the owner. For many beneficiaries, this was one of the most devastating changes under the SECURE Act.
The SECURE Act changed it so that the stretch IRAs now requires beneficiaries to drain the account in the first 10 years after the account owner’s death. The rule is in place for most non-spouse beneficiaries.
Distributions are optional from year 1 – 9, but if you don’t drain the account, you must increase it by the end of year 10.
A few exceptions are if the beneficiaries are:
- Chronically ill
- Minor child
- Spouse of the deceased
Even with a minor child, once the child hits the age of majority, the account is switched to the new 10-year period.
A lot of articles seem to miss on exception, which is if the beneficiary is no more than 10 years younger than the account owner. You’ll be able to take a distribution of the account over your lifetime.
What does this mean for you?
The stretch is available for older beneficiaries, which is a nice perk that is offered to eligible for certain beneficiaries. For any beneficiaries that are listed above, the stretch exists otherwise the SECURE Act does remove the stretch IRA.
Qualified Charitable Distributions (QCD) and Why You May Want to Make Them
QCDs shouldn’t be tied into your required minimum distributions. You can begin QCDs as long as you’re 70 ½ at the age of distribution. The Cares Act allows you to make a QCD without needing to take a required distribution.
A lot of financial managers are excited with changes to the QCD because, under the old rules, if you took a distribution from your retirement account, any pre-taxed amount is included in your income.
The exception is if you make a QCD to an eligible charity.
It’s vital that the charity be eligible because if the distribution is made to the charity, the distribution will be tax-free. You can do this up to $100,000 per person each year. Churches are included in this tax-free distribution treatment.
Note: Under the SECURE Act, you don’t have to start taking out your required minimum distribution (RMD) until you’re 72.
CARES Act and Its Importance to Your IRA, 401(k), etc.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act also has some important changes for your retirement accounts. Under the CARES Act, the RMDs aren’t required for 2020.
Under the CARES Act, if you lost your employment or income, you can take up to $100,000 in distributions from your account in 2020. You won’t need to claim 100% of the distribution on your taxes, but you can spread it across three years instead.
You’ll also not have to take a penalty due to the coronavirus-related distribution.
Qualifying for the distribution requires you to be a qualified individual, which falls into the following categories:
- Test positive for COVID-19 (you, household member, etc.), or
- Have your income, or a household member negatively impacted due to the coronavirus
If you took someone into your home this year, you could take this benefit if the person is experiencing hardship because of the pandemic.
The IRS hasn’t mentioned how they will verify that your claims are true.
The CARES Act isn’t subject to that 10% early distribution penalty mentioned earlier.
Note: Many 401(k) plans don’t allow this distribution. You may be able to treat the distribution as a coronavirus distribution.
RMDs and 2021 Possibilities
A lot of advisers were uncertain of what changes may occur in 2021 as the pandemic lingered and even surged to start 2021. There was lot of speculation that there may be some RMD benefits, but this doesn’t seem to be the case as of April 2021.
It seems that those 72 or older will have to resume their RMDs in 2021, with a few changes to keep in mind:
- You can postpone your 2021 RMD to April 1, 2022, but you will need to take two RMDs and risk having to pay higher taxes if the distribution puts you into a new tax bracket.
- It’s expected that new legislation will take place in 2021, so you may want to hold off on your RMD because it’s possible that they could be affected.
- Life expectancy tables have been updated by the IRS and will affect your RMD. The changes will reduce a 72’s first RMD by 6.57% under the change.
Congress has also signaled some interest in pushing the starting age for an RMD up to 75 years old, but it remains to be seen whether this type of legislation will be approved.
If you’re turning 72 this year, you will have to take your first RMD by April 1, 2022.
Overall, the SECURE and CARES Acts have changed IRA RMDs and have some tax advantages. If you’re confused about the changes, speaking to an adviser can add some clarity and help you make the most out of your retirement accounts.
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