5 SECURE Act Changes…and How You May be Affected

In December of 2019, under the cover of darkness and impeachment hearings, some of the most significant tax legislation of the past 20 years passed in unusual bipartisan fashion: the Setting Every Community Up for Retirement Enhancement Act, or SECURE act.  The name- which undoubtedly took weeks of debate to come up with and agree upon, speaks to the purpose, though not the entirety or sweeping nature of the act; a rare legislative accomplishment for an otherwise gridlocked Washington.  While the act addresses a number of retirement chads left hanging after the Tax Cut and Jobs Act (TCJA) of 2017, it also makes changes to 529 plans, medical expense deductions, kiddie taxes and more.  The focus of the plan is clear, however, in its attempt to modernize and streamline retirement savings for Americans.  But even those decades away from retirement will find something relevant to them.  This article focuses not on the details of the act, but on the five changes most likely to impact you.

Increased Required Minimum Distribution (RMD) Age

Traditional IRAs allow for tax-deferred growth and often, given certain income limitations, a tax deduction for contributions.  This is great for the decades of deferral, but the government wants their taxes at some point, and thus requires you to begin taking distributions when you hit a certain age.  Notably, these distributions are taxed as ordinary income rather than capital gains.  Prior to the SECURE act, owner’s of Traditional IRAs were required to begin distributions no later than April 1st of the year following the year in which they turn 70.5 (at which time they would need to take two year’s worth if no prior distributions were taken).

The Act delays and simplifies this requirement to force distributions (and taxation) beginning at age 72 or specifically, delaying until April 1st of the year following their 72nd birthday).  Again, if their initial withdrawal is delayed until then, two years of distributions will be required at that time.  This rule applies to those turning 70.5 in 2020 or later.  And while this is great news for those who really don’t want or need the income from the distributions, it’s worth noting that the vast majority of retirees will need the distributions and begin taking them prior to their required mandatory distribution dates, and likely in amounts greater than those required.

Removal of “Stretch” Option for Non-Spousal IRA Beneficiaries

In addition to required distributions for those of a certain age, there are rules requiring beneficiaries of IRAs to deplete the account over a specified period of time.  There are a few options for non-spousal beneficiaries to withdraw these funds, and advisors have long recommended those who don’t need the money from these accounts should take distributions based on the beneficiary’s life expectancy, thereby deferring taxes as long as possible.  The SECURE Act removes this option and requires non-spousal beneficiaries to withdraw all funds from the account over no more than 10 years.  And while the removal of the stretch option is unwelcome, again for the few well-heeled who don’t otherwise need the money, this “10 year rule” is an improvement over the previous 5-year rule.

…And We’re back to 7.5% Hurdle

You’re forgiven if you’ve found it difficult to remember whether qualified medical expenses can be deducted, and if so, to what extent.  For some time, qualified medical expenses could be deducted to the extent the total of these expenses exceeded 10%.  Under the Tax Cut and Jobs Act of 2017, this hurdle to deduct was reduced to 7.5% for 2018, with the caveat that it would revert back to 10% in 2019 and beyond.  The SECURE Act extends the lowered 7.5% threshold for 2020 and retroactively changes the 2019 threshold from 10% to 7.5%.

The net impact of the SECURE Act, in this case, is to maintain what the TCJA did in 2018 for 2019 and 2020, reducing and maintaining that qualified medical expenses in excess of 7.5% may continue to be deducted on your 1040.

Changes to 529 Plans

As the name implies, the Setting Every Community Up for Retirement Enhancement act, is focused on, well, retirement.  Yet the Act makes significant changes to other non-retirement specific areas, probably the most significant of which is 529 Plans.  529 Plans are the tax-advantaged investment vehicles (once) used to fund college education expenses.  These plans were created as an incentive to help parents and grandparents save, in a tax-preferred vehicle, for college.  The TCJA extended the benefits and qualified use of these funds to include expenses incurred for grades K-12, up to $10K per year.  The SECURE Act extends the scope of what is qualified (read: tax-free withdrawal) for purposes of 529 withdrawals, and now allows for Apprenticeship programs qualified and registered with the Department of Labor.

Likely more relevant to readers, however, is the new “Qualified Education Loan Repayments” provision, allowing for the qualified use of 529 plans to repay student loans, up to a lifetime maximum of $10,000 per person.   Recognizing the potential for double-dipping, the act states that any interest paid with plan funds is then ineligible for student loan interest deduction, an above the line deduction on the 1040.

New Penalty-Free Distribution for Qualified Birth and Adoption under SECURE Act

Section 113 of the Act allows for a new penalty-free withdrawal/distribution from retirement plans for the qualified birth or adoption of a child under 18 or who is “physically or mentally incapable of self-support”.  The Act allows for a $5,000 withdrawal for each individual occurrence, meaning that for each child a a new $5,000 distribution can be made, without penalty.  Notably, the act states this must be made after the qualifying event within a 1-year period, though it does not explicitly state the distribution must be connected directly, i.e., trace the expense back to specific expenses related to the birth or adoption.  Additionally, the Act allows for repayment of these distributions in excess of what the standard retirement plan contribution limits are, provided the plan owner is eligible to make the contributions to said plan.

While the addition of penalty-free distribution events is welcome, it should be noted that as with additional flexibility rules with 529 plans, premature withdrawals from accounts earmarked for education or retirement will likely, depending on market performance, negatively impact these account values provided the funds are not repaid.

The SECURE Act plugged a number of holes left open from the TCJA and makes steps toward improving the ease with which Americans access and fund their retirement accounts.  It simplifies qualified retirement plan administration for employers and improves automated savings for employees.  But in the end, the changes outlined above will likely have the greatest impact as we look back on the changes in 20 years.