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The SECURE Act: Three Changes Affecting Withdrawals Are Coming

By Damian Davila

The Setting Every Community Up for Retirement Enhancement or SECURE Act of 2019 is the most significant retirement savings bill in more than a decade. The SECURE Act doesn’t just affect the rules for small business owners but also modifies several key mandates for plan holders. Let’s take a closer look at important changes on when and how you can (or now you’re obliged to!) take a distribution from your nest egg.

1. Increase in age for RMDs from 70.5 to 72

Uncle Sam gives retirement savers the option to defer taxes on eligible plans until retirement. This one of the many 401(k) tax advantages. However, how does the government eventually encourage people to bring their savings into the economy (and ultimately collect on deferred taxes)? This is achieved through the required minimum distributions (RMDs) rule, currently requiring holders of certain plans, such as a traditional 401(k) or Roth 401(k), to take distributions after they retire or reach 70 ½ years of age.

Trying to follow the current IRS distribution worksheets is complicated as it is. So, everybody is welcoming the move from the House of Representatives to round up the age for RMDs to a whole number and pushing it back for an extra 18 months (bonus!).

Since the age 70 ½ rule for was first set in the 1960s, this update was also necessary to account for changes in life expectancy. Back in 1960, the U.S. life expectancy was 69.8 years, and in 2016, it had grown to 78.7 years. Since Americans live longer, a delay in RMD age enables us to both gain more interest on our nest eggs and delay applicable income taxes for an extra 18 months.

2. $5,000 in permitted withdrawals due to the birth or adoption of a child

The U.S. birth rate keeps falling. According to the Centers for Disease Control and Prevention, the U.S. birthrate fell again in 2018 and stands at the lowest point in 32 years. One of the many reasons for this drop is that the cost of raising a child just keeps climbing up.

Current parents scrambling to make ends meet due to the birth or adoption of a child may not find help on their retirement accounts: 15% of 401(k) plans don’t offer hardship distributions. And when the plan does offer hardship distribution, birth or adoption may not be a qualifying reason to take one. The SECURE Act changes this by allowing penalty-free withdrawals from retirement plans for “qualified birth or adoption distributions.”

Keep in mind that while the 10% early distribution penalty may be waived, applicable income taxes (including capital gains taxes) still apply in these cases.

3. Withdrawal of IRA within 10-year period of the death of a plan holder

One of the changes from the SECURE Act that has gotten a lot of coverage is the elimination of the “stretch IRA.” Here’s the breakdown of what’s going down.

  • The SECURE Act is offering a lot of breaks to retirement plan holders (No penalty fees! No RMDs until age 72! 401(k) tax credits for employers!).
  • All of these breaks mean less revenue for the IRS, so the shortfall has to be covered somehow.
  • Enter Section 401 from the SECURE Act: Modifications to RMD Rules or the “death of the stretch IRA.”

Before the proposed legislation, parents could “stretch” an IRA by leaving the unused portion to their children and those children to their grandchildren. Since a younger beneficiary has a longer life expectancy than an older beneficiary, the taxable RMD can be stretched over a long period of time, providing great tax savings. Currently, the stretch IRA is a great estate planning tool for affluent and/or consistent IRA savers.

However, this could all end with the SECURE Act. The proposed legislation would require the IRA “to be distributed by the end of the tenth calendar year following the year of the employee or IRA owner’s death.” This would throw a monkey wrench to the estate planning of many families forcing large nest eggs to become taxable within a 10-year period versus over several decades.

If you’re concerned about the disappearance of the stretch IRA, a potential solution would be to convert a traditional IRA to a Roth IRA. By taking the upfront (sometimes hefty) tax hit, the full Roth IRA can continue to grow without any RMD rules and beneficiaries can inherit the Roth IRA completely tax-free.

Still got questions about the SECURE Act? For a full breakdown of the effects of the SECURE Act on small businesses, review our article on The SECURE Act – Top 9 Impacts on Small Businesses.