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The Secure Act – The Breakdown

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The Secure Act – The Breakdown

For time and the world do not stand still. Change is the law of life. And those who look only to the past or the present are certain to miss the future.” – John F. Kennedy 

Nothing in life stands still, including the laws that govern our country. While we understand that laws are bound to change at the societal level, it is often harder to understand how new laws will impact society at an individual level. The Secure Act (Setting Every Community Up for Retirement Enhancement Act), which started as H.R. 1994, passed in May 2019 by Congress. 

Initially, there was much speculation on whether or not this bill would move forward. However, late in 2019, the Secure Act was attached as part of the H.R. 1865: Further Consolidated Appropriations Act 2020 in the Senate and signed into law by the President. The Secure Act portion of the bill contains some of the most sweeping retirement changes, along with new pieces of legislation that haven’t been introduced in decades. These changes are so vast that they are anticipated to impact both individuals and small business owners alike for retirement planning.  

Due to the vast number of changes, we have provided a Quick Glance Resource below:

Secure Act Quick Glance

Important Tax Extensions

A major part of The Secure Act were not new changes, but rather extensions of previous tax provisions. Below are some of the key extensions:

Continuation of Mortgage Insurance Premium Deductions

One of the tax deductions extended as part of H.R. 1865  was that mortgage insurance premiums can continue to be deductible. However, in recent years with the passing of the Tax Cuts and Jobs Act (TCJA) in 2017, these deductions have less of an impact due to other major overhauls.

For example, with the Standard Deduction moving from $6,500 to $12,000 for individuals filers, $13,000 to $24,000 for joint returns, and $9,550 to $18,000 for the head of household, one must have a much higher threshold for itemizing to be worthwhile. The incentive for Itemizing has also been reduced further with the removal of the Personal Exemption, which was available to both those who itemized and for those who take the standard deduction.

Qualified Disaster Distributions

As part of H.R. 1865, the Taxpayer Certainty and Disaster Relief Act of 2019 allows for an early withdrawal penalty exemption. Normally, if one takes an early withdrawal before age 59 ½ from retirement accounts it results in a 10% penalty. Now for those that are affected by a natural disaster, they can use this exemption to make a withdrawal without the penalty. 

As part of this exemption, an individual has the option to take a distribution and pay ordinary income taxes or they can repay the distribution within 3 years of receiving the funds to avoid having to pay income taxes on that distribution. Additionally, this extension was also revised to allow 401(k) plans a larger maximum loan of $100,000 versus the previous $50,000, with additional time in paying the loan back if it is a qualifying disaster. 

Extended Tax Incentives for Economic Growth, Energy Production, and Green Initiatives

As part of the overall tax incentive to drive economic growth, there was also a variety of tax deductions and credits that are designed to help energy and green initiatives. Due to the complexity and numerous tax credit and deductions for these businesses, as well as the nature of this blog to be focused primarily on retirement and personal tax extensions I would refer readers to the text of the bill itself. 

Principal Residence Indebtedness Discharge

Another tax deduction that was extended was the ability to continue to discharge principal residence debt from being taxed as gross income. This provision allows those with discharged residential debt to retroactively discharge such debt in prior years from 2018 through 2020. Taxpayers are provided the option to go back and amend previous tax returns to reflect this. Right now, unless new legislation occurs this rule will expire and cannot be used after the end of the tax year 2020. As of writing this, the IRS has not updated its website to fully reflect these changes, however, they do provide additional information on discharged debt as well as tools to see if you may be eligible. 

Reverting Back to Previous Kiddie Tax Rules

In 2017, when the Tax Cuts and Job Act (TCJA) was passed, there was a provision that changed how children under the age of majority were taxed on their income. With this act, the first $1,100 of investable income was tax-free with the next $1,100 in investment income being taxed at the minor child’s tax rate. Once the amount or income exceeded $2,200 annually in investment income, then it became subject to the tax tables utilized trusts which can quickly supersede the tax tables for individuals. Putnam Investments has made a really handy quick guide that further explores the 2019 rates which are linked here

With the Secure Act’s passage, the Kiddie Tax rules now revert back to pre-2017 rules. It maintains the first $1,100 of investment income is tax-free. The next $1,100 gets taxed at the minor child tax rate, and anything exceeding the $2,200 will get taxed at the parent’s marginal tax rate. The Secure Act has thus eliminated the changes that the TCJA made and even retroactively allows taxpayers to amend their 2018 and 2019 tax returns as long as they filed their taxes according to the laws made by the TCJA. If you find yourself eligible for amendment, we recommend working with a qualified tax professional such as a CPA to ensure your taxes are properly corrected. 

Changes to IRA Rules

It should go without saying that the core of The Secure Act is all about “simplifying” retirement. As a result, there have been a number of changes made to the rules regarding retirement accounts. Some are rather small, while others are quite momentous. What follows are some of the major overhauls that The Secure Act brings to retirement:

Required Minimum Distribution (RMD) Age Moves to 72

There are several major changes coming towards individuals that could impact retirement planning. The first of these changes is that Required Minimum Distributions (RMDs), the compulsory requirement to take distributions from retirement accounts, has moved from age 70 and ½ to the year one turns age 72. 

RMDs from pre-tax contributions, often from Traditional IRA and regular 401(k)s require that a certain amount of funds are distributed each year using the IRS’ lifetime distribution table (see Appendix B. Uniform Lifetime Table) and that upon distribution will be taxed as ordinary income. With this requirement being pushed back two years, this will allow for a longer accumulation time period. Also, this could open up a few more years to get in Roth Conversations by tactically switching from pre-tax contributions to after-tax contributions in a tax-efficient manner. 

New Traditional IRA Contributions Age Limit 

Another welcome change to consider is that Traditional IRAs have removed the restriction that once stopped contributions at age 70 ½. Beginning in 2020, individuals of any age can contribute to Traditional IRAs as long as they have received taxable earned income, or their spouse has done so if they made a spousal contribution

As part of this new provision, The Secure Act has added language to confirm that one cannot “double-dip” by taking the tax deduction for an IRAcontribution and then distributing the contribution as a Qualified Charitable Distribution.

The “Stretch” Retirement Strategy is Gone

Estate planning continues to be among the many drivers of planning for retirement. With many of the laws that retirees have come to rely on having been steady for many years (sometimes decades), the passage of The Secure Act has rattled many of those once well thought out strategies.

Previous to The Secure Act, just about anyone with exception of non-persons (such as charities or trusts), could inherit retirement assets in a manner that allowed the received inheritance to remain sheltered outside of small RMDs that had to be taken based on the recipient own life expectancy. These provisions have been affectionately referred to as “stretch” distributions, and there were many benefits such as minimizing the tax impact to beneficiaries who could, in theory, keep those funds in their account indefinitely so long as they took out their annual RMD.    

Unfortunately, with the passage of The Secure Act, many of those strategies and estate planning tools have been removed. Currently, anyone who inherited assets of someone that passed away before the end of 2019 can maintain the “stretch” distribution strategy over their life expectancy. Or if using a qualifying trust, the trust’s oldest beneficiary’s life expectancy. With the new changes, there is now a standard 10-Year Rule. This requires that the entire inherited retirement account has to be distributed in full by the 10th year following the year the inheritance is received.

Example: Mary received an inheritance from her mother’s IRA of $750,000 in February 2020. Her mother also passed in that same year. Mary has ten years starting in 2021 to take distributions to close out the Inherited IRA balance. If Mary’s mother had been over the age of 72, she would have also had to satisfy her mother’s final RMD. Starting in 2021, Mary can take distributions in any shape or amount providing flexibility. Thus, in low-income years, she takes a larger distribution. In high-income years, she looks to take less or none at all. Ideally, timing the years with lower income during this ten year period will result in being more tax efficient.

It is worth noting that this 10-Year Rule does not apply to all beneficiaries. For example, this rule does not impact spouses, individuals less than 10 years younger than the decedent, and those that qualify as disabled. Also exempted are certain minor children who will not have to follow the 10-Year Distribution rule but this is only until they reach the age of majority (though this has yet to been clarified, particularly if a child has moved from one state with a lower age of majority to a state with a higher) and then the clock starts. 

For those that have established a Conduit or Discretionary Trust using the See-Through Trust Rules, these beneficiaries can also be affected by the Secure Act. It is highly suggested that you speak with an estate planning attorney to ensure your wishes are still aligned with your documents. Jay Knighton, one of our partnered Subject Matter Experts (SMEs), recently wrote a 4 step process to answer, “Should You Name a Trust or Individual as Beneficiary in a Post-SECURE Act World?. Jay has a Master of Law in Taxation and is Board Certified in Estate Planning and Probate in the state of Texas.

Non-Tuition Fellowship and Stipend Payments Are Treated As Income for IRA Purposes

For students that participate in a fellowship or receive a stipend payment for service rendered (often through their colleges or trade school), historically, these payments have not been considered “earned income”. As a result of fellowship and other stipend payments not being considered “earned income”, it prevented many students from contributing to an IRA. With the passage of The Secure Act, these payments are now considered “earned income”, and hence these individuals can now contribute to an IRA even if this is their only income source.  

Changes to 401(k) Rules

Just as The Secure Act provided many major changes to the IRA landscape, it has also made many new revisions to 401(k)s. Below are some of the major changes to be aware of:

Annuity Rule Changes for Retirement Accounts

In the past, many administrators that operate 401(k)s and other retirement plans have avoided allowing annuities as an investment product choice. The reason often cited for avoiding annuities is that these administrators were held out by ERISA as fiduciaries and providing an annuity as an investment option could have potential consequences if the insurance company that provides the annuity failed to meet its obligation. 

Despite the perceived risks, it is perfectly legal to have an annuity in a 401(k) plan. However, the changes in the Secure Act clarify this situation by providing a Fiduciary Safe Harbor rule for ERISA Plan Administrators. This ensures that so long as they act “with the care, skill, prudence, and diligence under the circumstance then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims when selecting an annuity provider”. This is known as the “Prudent Man rule” and must be used when engaged in an “objective, thorough, and analytical search” of potential annuity providers. 

There are several obligations that ERISA Plan Administrators will still need to complete to make sure they conduct a proper search. There is a detailed list of due diligence checks on the potential providers of insurance that must be properly documented by the Administrators. With these vast changes, many are speculating that this will result in more annuities being offered as an investment option going forward in 401(k)s and other retirement plans. 

Addition of “Distributable Events” for Annuities in Retirement Plans

Previously, for those few annuities held inside of a 401(k) or retirement plan, it became a barrier whenever employees left their job. Often an employee would go to work for a new employer, but their new retirement plan did not allow for a lifetime annuity income investment. For those employees unable to keep their assets in their previous plan, it even resulted in some being forced to liquidate the annuity since it was not transportable. 

Under the new provisions, employees now have the ability to utilize a “distributable event” which applies to annuities held in retirement accounts, where the participant no longer has access to the annuity as an investment option. With these changes, former employees can move the annuity in-kind to another vehicle. This should again positively impact employers who wish to offer annuities in their 401(k) and other retirement plans. 

Simplification of Safe Harbor 401(k) Rules

The Secure Act has eliminated notice requirements along with notice of any delayed deadlines for elections that include nonelective contributions for the safe harbor status. Previously, 401(k) plans had to notify participants before the beginning of the plan year on the 3% non-elective contribution, safe harbor provisions, and safe harbor status. Now employers can eliminate this notice. They can also amend their plans as late as 30 days before the end of the year to provide a 3% non-election to qualify as a safe harbor plan which offers more flexibility. They still have to provide notice for any matching elections before the beginning of the plan year, but this provides some leeway. Lastly, another option that has been updated is that 401(k) plans can be amended as late as the next year if they do a 4% nonelective harbor contribution.  

No More 401(k) Credit Card Loans

While the Secure Act has not removed loan provisions, one aspect of 401(k) loans that was removed, is allowing people to take a loan from their 401(k) utilizing a credit card. While a credit card at first glance might provide flexibility, the hidden downside is that these tools often have higher charges than traditional 401(k) loans, and could lead to irresponsible borrowing. Many experts have been raising the warning bells on these practices as it often hurts those in tough financial situations and so this overhaul seems to be in response to these concerns.  

Increases Auto Enrollment Cap to 15%

Many employers have embraced setting up new employees with auto-enrolment into their retirement plans. The Secure Act continues this encouragement in several aspects. One aspect is that previously the Auto Enrollment could only be set as high as 10% of one’s income. The employee can, of course, elect to do less. Now employers can set the auto-enrollment up to 15%. 

Example: Joe recently joined ABC company. With the passing of the Secure Act, ABC company has set up auto-enrollment into their 401(k) plan at 15% of one’s income. Joe can choose to put in less at any time but if Joe does not make an election it will default to putting 15% of his income into the 401(k) plan. 

Employers are also now eligible for a new $500 credit by setting up an auto-enrollment as the default setting for their employees. This rule becomes eligible in 2020 and can be claimed the year the auto-enrollment is first implemented along with two more years. 

Long Term Part-Time Workers Can Participate in 401(k) Plans

Previously, part-time workers could potentially be excluded from having access to their employer’s 401(k) plan if they worked less than 1,000 hours in a single year. This has resulted in a growing problem as it vastly decreased the amount of retirement tax-advantaged accounts available. Particularly, there are many in the workforce who work multiple part-time jobs, but lack full-time benefits, making retirement savings out-of-reach for many. In fact, there has been extensive research that has shown some industries and employers have been gradually moving to more of a part-time workforce model. 

The Secure Act looks to address this by allowing part-time workers that have worked at least 500 hours in three consecutive years to be eligible to contribute to their employer’s retirement plan. These changes are set to begin in 2021, and could very well have an impact on 401(k) plans when it comes to nondiscrimination and “top-heavy” testing.  

Misc. Important Changes

While simplifying retirement options as well as building in several tax extensions has been at the crux of the Secure Act, there are numerous miscellaneous changes that are also important to shine the spotlight on:

529 Plans Expanded for Student Loans and Apprenticeship 

Once again legislation smiles favorably on 529 plans. The Secure Act has expanded on the definition of “qualified expenses”. This allows for more options to be able to use 529 plans funds in a tax-efficient manner, as well as provides some less conventional provisions. 

With the Secure Act’s passage, there are now two new qualifying expenses:

  1. Apprenticeship Program.
    1. Includes fees, books, supplies, and required equipment.
  2. Qualified Education Loan Repayment.
    1. Allow distribution to be used to pay principal or interest on education loans.
    2. Limited to a lifetime amount of $10,000 per person.
    3. It can be used for 529 plan beneficiary siblings. 

This change is retroactive to the beginning of 2019. Individuals may want to look at various options around this if they have multiple children in college. Keep in mind, any interest that is paid via this method then removes the ability of the student or parent to claim an above-the-line deduction on their student loan interest.   

Small Business Get Larger Tax Credit For Creating Retirement Plans

The Secure Act once again incentivizes small businesses towards creating retirement accounts for their employees by providing a $500 credit for up to three years for startup cost. These retirement accounts include SEP-IRA, SIMPLE IRA, 401(k), and 403(b) plans. 

For small businesses that are classified as having 100 or fewer employees making $5,000 or more in gross income, there is potential for additional credits to start a retirement plan for employees. The breakdown of options:

  1. $500 Tax-Credit in total
  2. The lessor of either:
    1. $250 multiplied by non-highly-compensated employees that participate in the plan or $5,000.

Example: Jill is the owner of a small business with 50 of her employees eligible to participate. They are all non-highly-compensated employees. Jill can receive a credit of up to $5,000 which is the max credit one can take. 50 x $250 = $12,500 = above $5,000 credit limit.

Nondeductible IRA Contributions Can be Made with Certain Foster Care Payments:

The Secure Act now allows for “qualified foster care payments”, to be counted as “earned income” and thus used as an IRA contribution. However, one important caveat is that this contribution is not tax-deductible, and so it has to be made as either a nondeductible Traditional IRA contribution or a Roth contribution. Previously, the IRS did not recognize these tax-free “foster care payments” as income, and so these could not be utilized towards contributing to IRAs.

Increased Penalties For Failing to File Personal Returns:

Asking for tax extension just got even more important! The penalty for failing to file one’s tax return on time has increased for personal returns starting in 2020. For failing to file personal tax returns the penalty has increased as follows:

  • The lessor of:
    1. $400, or
    2. 100% of the amount of tax due.

Increased IRS Penalties for Employer Failing to File Tax Returns or Employee Benefit Plan

For employers, there are various tax return forms due, along with numerous penalties should they be filed late. Fortunately, John Carl, Founder, and President of the Retirement Learning Center, recently put together a great resource for the National Association of Plan Advisors. John breaks out new penalties for employers that fail to file proper documents on time. For further reading, here is a link to this great breakdown of forms 5500, 5310-A, 8955-SSA, 5330, 990-T, and Income Tax Withholding Notices.

Secure Act New Late Fees for Businesses

$5,000 Tax-Free Penalty for Childbirth and Adoption

The IRS has established a set of rules called 72(t) exceptions, which allow for early withdrawals from IRAs free of penalties. With the passage of the Secure Act, we can now add an additional exception (which will also apply to other retirement accounts), a change that now allows so that one can a distribution up to $5,000 for qualifying childbirth and adoptions. While this will avoid the early withdrawal penalty, the distribution is still subject to taxation. 

The Journey Ahead…

I hope that this dive into The Secure Act has been helpful. Just like the world of government, the field of financial planning is always in motion. Change is inevitable, but how we choose to respond to it is our greatest strength. It would be difficult to ask that the average person keep up with every new piece of legislation that might affect their taxes, estate, and retirement planning.  

Fortunately, with a trusted team of financial professionals working at your behest, you can always be assured that your financial plan is adaptable and is built and updated by those who make it their mission to stay on top of major changes in the financial industry. Whether you work with a professional at My Financial Coach, or with an outside advisor, it is always important to work with someone who is constantly learning and growing within their field.  

Best,

James Hargrave

Director of Financial Planning

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About the author

James Hargrave brings professional experience in financial planning from his history of working in the banking, investing, and fin-tech industries. He currently has his Master’s in Business Administration, CFP®, CLU®, Series 7 & 63, and the Life & Health License. Though proud of these accomplishments, the desire to better oneself, have integrity, and help those around him are instilled as guiding principles for life decisions.

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