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New Retirement Savings Law: 6 Things You Should Know About the SECURE Act

At this point, you’ve probably heard about the SECURE Act, a law that took effect on January 1, 2020, and makes significant changes to retirement savings law (the acronym stands for “Setting Every Community Up for Retirement Enhancement”). However, you may not understand how to approach the new law from a planning standpoint.

The new law, which makes significant changes to retirement savings rules, is likely to affect people in or nearing retirement, new parents, small business owners and employees. It also will have a major impact on estate planning. Here are the six key changes you need to know about: 

1. The starting age for taking required minimum distributions (RMDs) from retirement accounts is now higher. 

The new law changed the RMD starting age to 72, up from 70½. Unfortunately, this change applies only to those who turn 70½ in 2020 or later. Those who turned 70½ in 2019 or earlier fall under the old rules, which means they still need to take RMDs this year and in all future years. The deadline for taking your first RMD is April 1st of the year following the year you turn 72 (or 70½ if you’re under the old rules).

Planning implications: Overall, this change is good news, as it gives people the option to delay RMDs if they aren’t ready to tap their retirement account funds. However, some may find that delaying RMDs will increase their tax bill later in retirement. We recommend that people with large tax-deferred retirement accounts consider withdrawing funds from these accounts earlier in retirement, in conjunction with a portion of the assets in their taxable brokerage accounts. That way, future RMDs may be reduced and investors may avoid a sharp tax-bill spike later on.

2. Traditional IRA contributions now can be made after age 70½. 

In the past, people over age 70½ couldn’t contribute to a traditional IRA, but that has now changed. As long as you have earned income (such as wages or self-employment income), you can still make traditional IRA contributions.

Planning implications: At first glance, it may seem like a good idea to continue making contributions to a traditional IRA after age 70½. However, this change creates a potentially strange situation where you could be contributing to your traditional IRA while taking RMDs from it. That’s why meeting with a tax or financial planning professional is important before deciding to use this option.

If continuing to save after age 70½ is something you’re interested in, you may want to consider doing so in a Roth account, which does not have RMD requirements. If your income is too large for a Roth contribution, you may want to consider the so-called backdoor Roth option, in which you make after-tax contributions to a traditional IRA and then do a Roth conversion. An additional option is to save money in a taxable brokerage account using tax-efficient exchange-traded funds (ETFs) and/or municipal bonds.

3. You can still make qualified charitable distributions (QCDs) at age 70½.

Fortunately for those who are charitably inclined and the organizations they support, the QCD age has not changed. You’re still allowed to give up to $100,000 per year from your IRA directly to a charity without having to include that money in your income. In addition, this donation can be used to cover your RMD.

Planning implications: There is a catch to this rule buried within the SECURE Act. Any pre-tax amount you’ve contributed to a traditional IRA after age 70½ will directly reduce your allowable QCD. This means if you contribute $7,000 to a traditional IRA and later donate $10,000 in a QCD, you will lose the deduction for $7,000 of that QCD. The remaining $3,000 of your donation will still qualify as a QCD.

The portion of the QCD that is disallowed will be treated as a distribution from your IRA and you’ll have to include that amount into your taxable income (it will also count toward your RMD). Fortunately, if you itemize your deductions, you may be able to use all (or a portion) of the disallowed QCD as a charitable donation on your tax return.

If you plan on using the QCD option during retirement, consider avoiding pre-tax contributions to a traditional IRA and look at other saving options like Roth accounts or saving in a taxable brokerage account, in order get around this issue.

4. The rules for inherited retirement accounts have changed. 

In the past, beneficiaries had the option of distributing inherited retirement account assets over their expected lifetimes, often referred to as a “stretch” IRA. However, under the new law many people who inherit a retirement account will be required to fully distribute those assets within 10 years.

Under the 10-year rule, there is no annual distribution requirement for inherited retirement accounts—which means heirs can distribute the asset any way they want, as long as all the assets have been taken out before the end of the 10th year. However, if they fail to distribute all of the assets after the 10th year, the remaining funds will be subject to a 50% penalty.

The new 10-year rule does not affect existing inherited accounts, those whose original holder died in 2019 or before. It only applies to accounts whose original owners die in 2020 and beyond. In addition, some beneficiaries—known as “eligible designated beneficiaries”—are exempt from this new rule, including the surviving spouse, minor children, disabled individuals, the chronically ill, and beneficiaries less than 10 years younger than original holder (for instance, a sibling).

Planning implications: This provision has significant estate planning implications, especially if a trust has been set up to receive retirement account assets. Those who are likely to leave a significant amount of assets to their heirs should meet with estate or financial planning advisor, to reassess their plans and ensure that their goals will be met under these new rules.

Some people may want to consider revising their estate plans. For example, rather than leaving tax-deferred retirement accounts to heirs, it may be better to do a Roth conversion, so your heirs receive tax-free assets. Another option to consider is using more of your tax-deferred assets to pay living expenses in retirement, leaving more in your taxable brokerage accounts. Leaving taxable accounts to your heirs will allow them to receive a step-up in basis at the date of your death, which could represent a significant tax savings compared with being required to take distributions from an inherited retirement account within 10 years.

5. You now can make penalty-free withdrawals from retirement accounts for birth or adoption expenses. 

New parents can now withdraw up to $5,000 from a retirement account to pay for birth and/or adoption expenses. Taxes still need to be paid on pre-tax contributions, but the 10% early-withdrawal penalty will be avoided.

Planning implications: Having the option to take out funds penalty-free to pay for a new child is a great option. However, if possible, it would be better to use assets in your bank or brokerage account to pay those expenses, so that your retirement assets can continue to have the potential to grow in tax-advantaged accounts.

6. Assets in a 529 Education Savings Plan can be used to repay student debt.

Assets in a 529 college savings accounts now can be used to repay up to $10,000 in student loans for the named beneficiary and any siblings. That means if you have three children, you could use up to $30,000 to pay down their student debt ($10,000 for each).

Planning implications: This can be a good option for people who didn’t use up all the funds in a 529 account, as this money can now be used to help out family members burdened by student debt. For people who haven’t yet taken out any student loans, it will still be better to use the 529 account assets to pay for education expenses directly before taking out any loans.

What should you consider next?

Due to how suddenly these changes became law, many people have been left wondering if they need to change their financial plans. That’s where having a good financial planner comes in. With the complexities of the modern investing environment and the constantly changing tax code, it’s important to have a trusted advisor to help you navigate the financial landscape.

What You Can Do Next

  • To hear a more in-depth discussion of the new retirement law, listen to our podcast.
  • A professional advisor can help you with complex changes. To talk to us about the services that are right for you, call us at 800-355-2162, visit a branch or find a consultant.
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Important Disclosures

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59 1/2 are subject to an early withdrawal penalty.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

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