What is the SECURE Act?
The SECURE Act was put into action on January 1st, 2020. SECURE stands for ‘Setting Every Community Up for Retirement Enhancement’. One of the main goals of this act is to encourage more employers to set up retirement plans and encourage more employees to participate, so that Americans are more prepared for their retirement.
Let’s break it down into the important changes:
Benefits for long-term part-time workers
Because of requirements for how many hours an employee must work in a year, most part-time workers were not able to participate in their employer’s retirement plan. The SECURE Act has made participation an option for long-term part-time workers. In addition to qualifying if you work more than 1,000 hours in a year (this hasn’t changed), you can also qualify to participate if you have worked at least 500 hours per year for at least three consecutive years (Note: in both cases, you must be 21 or older to participate). This allows part-time workers to contribute and save in a way that wasn’t possible before.
Business owners can receive a tax credit for starting a retirement plan
Although most large companies have employer sponsored retirement plans, there are many small businesses that don’t. This puts all the burden of saving for retirement directly on the individual. The SECURE Act tries to encourage small business owners to start retirement plans by raising the tax credit to cover 50% of start-up costs of a retirement plan. Before, the maximum credit for starting a plan was $500. Now, it has been raised to $5,000.
The Act also allows for a $500 additional tax credit for businesses that implement new plans which include automatic enrollment, or for existing plans that switch to automatic enrollment. The goal is that more employees will participate in their employers’ retirement plan if they are automatically enrolled. Rather than having to opt in, employees would actively have to opt out. Ideally, this credit will have more employers using plans with autoenrollment, and have more workers saving for their retirement.
Small business owners can join together to start a plan
Another way the SECURE Act is encouraging small business owners to start retirement plans for their employees is by allowing unrelated business owners to start a multiple-employer plan. This allows the employers to share the cost of starting and managing a plan while still providing benefits for their employees.
RMDs at 72
The SECURE Act delays when a retirement account holder must start taking Required Minimum Distributions (RMDs) from a retirement account. Previously, RMDs had to start by April 1st of the year after the year in which you turned 70 ½. For example, if you turned 70 ½ in July of 2018, you must start taking RMDs by April 1st of 2019. There are some exceptions to this rule.
Under the new law, that age has been raised to 72. You may now wait until April 1st of the year after you turn 72 to start taking RMDs. Note, you will still need to take your second RMD by Dec 31st of the same year, just like the old law. Despite the ability to wait, we typically recommend taking the first RMD by December 31st of the first year to avoid having to take two in one year.
Keep in mind that if you turned 70 ½ in 2019, you must start your RMDs by April 1st of 2020. This law only changes the age for those who turn 70 ½ in 2020 or later.
Contributions beyond 70 ½
The SECURE Act has removed the age limit on traditional IRA contributions. As long as you are working and have earned income, you may contribute to your IRA no matter your age.
Prohibits credit card access to 401(k) loans
Some 401(k) plan administrators allowed participants to take out a loan against their plan using a credit or debit card. Under the new act you may still take a loan against your 401(k) plan, but no longer with a credit card, debit card, or similar instrument. This is to prevent people from using loans from their 401(k)s for small or routine payments leaving them unable to pay the loan back. Retirement accounts are meant to save for retirement, not to be used as an easy line of credit.
Annuities in 401(k) plans
Although plan participants know how much is in their 401(k), they may not know how long that money is going to last. Starting in 2021, plan administrators will be required to provide disclosure statements showing the annual income participants could get each year if they were to buy an annuity. The goal of this provision may have been to give employees a better idea of how much they have saved for retirement and how much more they need to save.
In addition to the disclosure statement, the act makes it easier for employers to offer annuities as part of the 401(k) plan. However, just because an annuity is offered, doesn’t mean it’s the best choice for you, but it is always the best for the insurance company. This shows how powerful the insurance lobby is in our country. It’s a good idea to talk to a financial planner before buying an annuity.
Inherited IRA distributions must be taken over 10 years
Another big change is with Inherited IRAs. Before 2020, someone who inherited an IRA would have various options on how to take out the money. One option was taking RMDs over the beneficiary’s life expectancy. This option is no more.
Under the SECURE Act, the longest time period over which one can stretch distributions is 10 years. There is an exception for spouses, minors, and people with disabilities, but anyone else inheriting an IRA must empty the account within 10 years. This means that the funds will get taxed sooner, and possibly at a higher rate.
Penalty-free withdrawal for parents after having or adopting a child
The new law provides for a penalty-free distribution of up to $5,000 per spouse in the year after you have or adopt a child. You have one year after the date of the birth or adoption to withdraw the funds penalty-free. Keep in mind, that you will likely have to pay income taxes on the distribution.
Be aware that the penalty does still apply if you are adopting your spouse’s child.
Use 529 Plans to pay down student debt
Oddly, this retirement law includes a provision for beneficiaries of 529 plans. If a beneficiary has funds left in a 529 plan after having finished their higher education, he or she may now take a distribution of up to $10,000 tax-free to pay down student debt. A $10,000 life-time limit applies not only to the beneficiary, but also to each of his or her siblings. That means that if the beneficiary has two siblings, $30,000 may be taken to pay down $10,000 of debt for each one.
Many of the changes that the SECURE Act made are unlikely to affect you unless you are a small business owner. The greatest advantages to the act are being able to defer taxation on your retirement account until age 72 and being able to continue contributing to your account as long as you keep working. These provisions can lead to a substantial increase in earnings.
The biggest downside is the 10-year limit on distributions on Inherited IRAs. If you inherit an IRA, you will most likely end up paying more tax than you would have under the old law. If you are planning to leave an IRA to a beneficiary, it is advisable to work with a financial professional to determine the best way to leave your money to your loved ones while incurring as little tax as possible.
Overall, the SECURE Act is intended to help more Americans participate in employer-sponsored retirement plans and be more prepared for their future.