The SECURE Act was signed in to law December 20, 2019. The Act provides for significant changes in IRA's and Qualified plans. This article focuses on the changes for IRA owners.
Required Minimum Distribution Rules
Prior to 2020, the law required traditional IRA owners to begin withdrawing from IRA accounts upon reaching age 70.5. This withdrawal is known as a required minimum distribution (RMD). A taxpayer turning age 70.5 during the year would be required to take an initial withdrawal before the end of the year, or since age 70.5 is the first year, the rules allowed a taxpayer to postpone the first withdrawal until April 1 of the following calendar year (this is a one time delay).
Example: Jean turned 70.5 in 2019, and she is required to take a withdrawal from her IRA account either by December 31, 2019 or by April 1, 2020. For this one year, Jean gets a reprieve by having the ability to postpone the withdrawal until the next year.
Taxpayers who decide to wait until April 1 of the next calendar year to take the first withdrawal will be required to take two withdrawals in the subsequent year.
So, if Jean (in our example above) decides to wait and take her 2019 initial withdrawal in 2020, she will have to take her 2020 withdrawal in 2020 as well. Remember, the reprieve to April 1, 2020 is only available for the first year, and Jean has to take a withdrawal every year until the account is depleted.
Under the SECURE Act, the age at which IRA withdrawals must begin is age 72 (Required Beginning Date). This is effective for individuals who attain age 70.5 after December 31, 2019.
Example: Henry turns age 70.5 on December 31, 2019. Henry must take a withdrawal from his IRA under the old law rules since he turned age 70.5 prior to January 1, 2020.
Example: Kevin turns age 70.5 on January 2, 2020. He will not have to take a withdrawal from his IRA for 2020 or 2021. Kevin will turn age 72 in 2022 and will need to take a required minimum distribution in 2022.
Required Minimum Distribution Rules for Beneficiaries under the Secure Act
We will not dwell on the old law here, but it is appropriate to note the new rules are not as friendly to non-spouse beneficiaries as compared to the previous rules. Prior to 2020, beneficiaries of IRA's were generally allowed to take withdrawals from inherited IRA's over the beneficiary's life expectancy (this was often referred to as the stretch IRA). Further, the beneficiary was required to take a minimum amount from the IRA every year.
The SECURE Act rules are applicable to beneficiaries who inherit an IRA from someone who dies after December 31, 2019. The SECURE Act requires distributions to most non-spouse beneficiaries to be made over no more than a ten year period beginning with the date of death of the original IRA owner. The SECURE Act does not require annual required minimum distributions (RMD).
Example: John, age 33, inherits an IRA from Robert, his father, who is 75, and died on February 2, 2020. John will required to distribute all the funds to himself by February 2, 2030. John does not have to take an annual withdrawal; however, he must liquidate the account within the required ten year window.
Exceptions to the ten year rule
- The surviving spouse of the IRA owner.
- A child of the IRA owner who has not reached the age of majority (age 18 in Texas).
- A chronically ill individual.
- An individual who is not more than ten years younger than the IRA owner (that means someone who is ten years or less younger than the owner).
Example 1: Mary is 63 years old and her husband Bob died on January 15, 2020. Mary, as the surviving spouse may elect to treat the IRA as her own and will not be subject to the ten year rule.
Example 2: Meagan, age 10, inherited an IRA from her Mother who died on February 3, 2020. Meagan will not be required to liquidate the account beginning with her mother's date of date of death as the start date for the ten year period. Once Meagan reaches the age of majority for her state, the ten year period will begin on that date, and she must distribute the account within ten years.
Example 3: Mark, age 49, is a chronically ill individual (as defined in the IRC). He inherits an IRA in 2020 from his mother. He is allowed to distribute the account under the prior law rules (Pre-SECURE Act). He may take distributions over his life expectancy and must take an annual RMD.
Example 4: Michael, age 65, inherits and IRA from his brother who passed away in 2020. Like Mark, in example 3, Michael may take distributions over his life expectancy and must take an annual RMD.
Maximum Age Repealed for IRA contributions
Prior to 2020, once an individual reached age 70.5, they could no longer make contributions to an Individual Retirement Account. This rule only applied to traditional IRA accounts as contributions to a Roth IRA were not subject to an age limit.
The SECURE Act allows anyone, regardless of age to contribute to an IRA as long as you have earned income (salaries, wages, self-employment income). This provision is effective for contributions made for tax years beginning after December 31, 2019. This is advantageous to individuals who may have gotten a late start in retirement planning or for those who may still be in a high tax bracket in retirement and maintain earned income.
Example: Robert is age 75. Under the new law, Robert may not make an IRA contribution for tax year 2019. However, he is allowed to make an IRA contribution for tax years 2020 and later.
Penalty Free Withdrawals For New Parents
The SECURE Act allows a penalty free distribution of up to $5,000 made within one year of a birth or adoption of a child (the child must be under age 18). The one year period begins on the date of birth or the finalized adoption. New parents should note that this distribution is taxable; although it may be repaid, and we will need to wait for regulations to be issued to understand how to accomplish the repayment. This provision is effective for tax years beginning after December 31, 2019.
A married couple may each take a $5,000 withdrawal if they have separate IRA accounts.
Example: Luke and Mindy are expecting a child due on June 13, 2020. The medical bills are starting to dent their budget and Luke takes a withdrawal from his IRA on March 14, 2020. This distribution will not meet the requirements of the penalty free withdrawal since the child is not yet born. This distribution will be subject to a penalty and tax and will not be eligible for repayment.
Luke and Mindy should wait until the child is born before taking the $5,000 distribution from the IRA.
We have focused on the changes in IRA's from the passage of the SECURE Act. Some of the provisions of the SECURE Act are applicable to qualified plans as well. If you have any questions, please contact us.