In the 3 and a half years since this blog was started there have been two major tax law changes. Of course, as with any tax changes by our dysfunctional government, they come in the 11th hour of a given year. Anyway, this law came in the form of what is called the Secure Act. So let’s explore what exactly the Secure Act of 2020 changed.
The Secure Act Focuses on 529 and Retirement Accounts
The Secure Act was passed as part of the 2020 spending bill. It focuses heavily on changes to retirement accounts and 529 savings accounts. Some of these changes are positive, but some are also negative. Understanding these changes will allow you to avoid the pitfalls but perhaps also benefit.
The Negative Aspects of the Secure Act
So let’s start with the big negatives. As of 2020 employers can now offer Annuities as part of your 401k. Now I have already made it clear I am not a big fan of annuities. It is possible some people at retirement in a specific situation might benefit from an annuity. However, for most of us it is just a way for insurance companies to part us from our money.
Annuity Marketing and the Secure Act
Even worse the new law allows for some level of exemption for the Fiduciary requirement of your employer. The fiduciary requirement ensures your employer at least doesn’t take advantage of your retirement accounts by choosing funds advantageous to them. For annuities, there is now an exception to allow your employer to not to be held accountable if the agency they choose goes bankrupt or is not the best deal.
Essentially as long as the annuity company is in good stead with regulators they can be used. Cue opening of doors for annuities to be marketed in your retirement accounts to those who do not need them. Avoid these at all costs. If you did get the annuity they do allow it to be transitioned across plans and providers.
Limits of the Stretch IRA
Also on the negative side, but probably not applicable to most of my readers, is the removal of the stretch IRA. What is the stretch IRA? Essentially if you inherited an IRA before the law the tax protection lasted essentially for your lifetime. Thus you could pass assets tax-free to your non-spouse and they could spread those funds for a lifetime. They then just needed to take RMD based on their life expectancy.
Now with the tax law changes only your spouse will have a lifetime to spread IRA usage. Everyone else will simply have ten years from the death of the original plan owner. They then must use RMD across those ten years. Obviously for those using this tax method to pass funds to their heirs now will need to rethink their strategy. It is important to note those who inherited these accounts before the law was passed are grandfathered into the old laws.
The Positives of the Secure Act
So that does it for the negatives. How about the positives? Well, first there is a provision to allow part-time workers to collect a 401K. With the new laws if you work at least 500 hours for 3 consecutive years you are now eligible for a 401K. Previously you had to work 1000 hours in 1 year. I suspect few people are working part-time 500 hours a year that could afford to contribute to a 401k. But for the few who are this would be beneficial.
Age Contribution and RMD Cutoffs
More valuable to our readers are provisions around age cutoffs for your IRA contributions. Particularly RMD cutoffs have been changed from 70.5 to 72 years of age. That means you don’t have to take withdrawals from these accounts until 72. I might still recommend taking them before this point if you have ceased to work early. After all, spreading the funds out further will lower your tax bill.
But if you continue to work then delaying your withdrawals can be really advantageous. This will keep you out of the higher tax brackets by delaying the add of your withdrawals to your earnings. In fact, the new law will further give you more choices around when and how to take funds. Because effective in 2020 the age limit to adding funds to your retirement accounts is removed. So if you work late in life you can still save in retirement. It does leave an interesting question, what will happen if you are concurrently taking RMD and contributing to retirement accounts?
Incentives for Small Business 401K Creation
There is one more set of retirement benefits from the law. That is the incentive given to small businesses for creating 401Ks. The full letter of the law in this area is beyond the scope of this post. That being said the things to understand are tax credits for small employer retirement account setup have been increased. An incentive has been put in place for automatic enrollment. And finally, multiple employers can now join together to create a retirement account. All of this adds up to hopefully smaller employers being more likely to offer retirement accounts.
Provisions Allowing 401K or IRA Penalty-Free Withdrawals
In addition to changing the way you save the new law also has some provisions to help you use the money in case of specific situations. If you recall IRS ruling 72T provision also allows some exceptions to allow you to withdrawal from your 401K early without penalty. This just adds one more set of exceptions.
Particularly new parents from birth or adoption can now withdrawal 5k from a 401K or IRA to pay for delivery or adoption expenses. This withdrawal will be exempt from the 10% penalty. It will still be taxed. I honestly would not recommend most people use this provision. Once you withdrawal from your tax-deferred space that space is gone. But if you have no other source of income it provides you with one more option.
Provisions for Additional 529 Usage
Similarly the law now allows you to withdrawal from 529 plans for a few special reasons. First to repay student loans. This provision allows you to repay your student loans up to 10K per beneficiary. The real benefit here is your grandparents could, in theory, pay your student loans after the fact without impacting your FAFSA earnings. This would potentially allow the recipient to increase their financial aid. You can also now use 529s to pay towards apprenticeships.
What Counts as Income
The final change is to what counts as income for retirement purposes. For example, stipends and non-tuition fellowship now count as income for IRAs. So for those who are pursuing a graduate degree or research, you may now be able to contribute to an IRA.
Also income for foster parents with difficulty of care payments also now count. These are payments for foster care providers for caring for disabled people. This last one confuses me. Foster care requires you to have the independent income to ensure you are not turning it into a job. So fundamentally most care providers should have income for retirement anyway. I guess it just adds to the amount for those on the borderline? Note, while we do foster care we do not handle difficulty for care cases.
So that’s it. It’s a lot of changes but I suspect most moderately high-income households will not be significantly impacted by the law. Just avoid those insurance salesmen.