The SECURE Act was signed into law by President Trump at the end of 2019, and makes sweeping changes to the laws affecting retirement plans, including IRAs. The law, known as the SECURE Act, is a mixed bag of good, bad, and ugly. This article breaks down the details that IRA owners need to know moving forward.
RMD Age Raised to 72
- Required Minimum Distributions (RMDs) are no longer required until the IRA owner reaches 72. Prior to the new law, RMDs were required once the account owner reached age 70½. By extending the RMD requirement to 72, IRA owners can delay taking distributions from the IRA by an additional 1½ years. This is a good thing as you can let more money grow tax-deferred. The 70½ year rule was also confusing, as it takes a while to do the math and figure out what year you turn 70½. It used to be the only half-birthday you had to keep track of. There is still no RMD requirement on Roth IRAs. Also, if you already reached 70½ in 2019 or earlier, then you continue taking distributions as usual (even if you aren’t yet 72).
IRA Age Limit for Contributions Removed
- There is no longer an age restriction on when you can contribute to an IRA. Prior to the law, Traditional IRA contributions were restricted once you reached RMD age of 70½. Under the new law, there is no longer a restriction (even when you each 72). This means older IRA owners who are still working or have earned income can continue to contribute to a Traditional IRA.
Exception to 10% Early Withdrawal Penalty for Birth or Adoption
- A new exception to the 10% early withdrawal penalty was added in the case of the birth or adoption of a child. This is limited to $5,000, but will allow new parents to withdraw up to $5,000 from any IRA or other retirement account without having a 10% early withdrawal penalty apply. Taxes would still be due on Traditional (pre-tax) funds withdrawn, but the 10% penalty is waived.
The Stretch IRA Has Been Gutted
- The Stretch IRA, whereby a non-spouse could inherit an IRA or Roth IRA and take distributions over their lifetime, has been gutted. While a non-spouse can still inherit an IRA or Roth IRA, the account (in most instances) must be distributed in 10 years. There are no annual distributions required under this new rule over the 10-year period. Instead, the total account balance just needs to be distributed in 10 years. So, if you inherit an IRA in 2020 or later, then you will have 10 years to continue investing the account and you can take distributions whenever you want (or just at the end) with the full amount being distributed within 10 years. There are some persons who can still use the old Stretch IRA rules, but these groups are limited and include: Disabled or chronically ill persons, minor children inheriting, and beneficiaries not more than 10 years younger than the IRA owner.
The elimination of the Stretch IRA was bad and ugly. What else can I say? The only good news is that those who have already inherited one in 2019 or earlier can still operate as usual. Everyone else who looked forward to one will have to take solace in the fact that they at least have 10 years of “stretching” to continue investing the funds in a tax-free (Roth) or tax-deferred (Traditional) manner. And, under the new rule, there is no RMD rule in effect each year. Instead, the total amount must be distributed at the end of 10 years. This makes things a little easier with self-directed assets and also helps any IRA owner – 10 years is still a good amount of time – get a little bit of additional tax-deferred (Traditional) or tax-free (Roth) growth.
At Directed IRA we are a custodian of inherited Traditional IRAs and inherited Roth IRAs, we are keenly aware of the changes and are helping our clients understand the new rules. Please reach out and gives us a call if you have questions on these new rules.
I’m routinely asked questions about what taxes and rules apply when a distribution occurs from a retirement account. Here are the top ten rules you should know about distributions from retirement accounts:
The first 5 facts apply to Traditional IRA and 401(k) accounts
1. Early Withdrawal Penalty
A distribution from a traditional IRA or 401(k) before the account owner reaches 59 1/2 causes a 10% early withdrawal penalty on the amount distributed. This is in addition to taxes owed on the amount distributed. So, for example, if you take a $10,000 distribution from your traditional IRA at age 45 then you will be subject to a $1,000 penalty and you will also receive a 1099-R from your IRA custodian and will need to report $10,000 of income on your tax returns. Once you reach age 59 1/2, the 10% early withdrawal penalty does not apply.
2. Required Minimum Distributions
Whether you need the money or not, at age 70 1/2, the IRS requires a traditional IRA or 401(k) owner (unless still employed by employer 401(k)) to begin taking distributions from their retirement account. These distributions are subject to tax and the account owner will receive a 1099-R of the amount distributed that will be included on their tax return. The amount of the distribution is based on the person’s age and the account’s value. For example, someone with a $100K IRA who has turned 70 1/2 and is taking their first RMD would take $3,639 (3.79%).
3. Avoid Taking Large Distributions In One-Year
Because distributions from traditional retirement accounts are subject to tax at the time of distribution, it is wise to avoid taking too much in one year as a large distribution can push your distribution income and your other income into a higher tax bracket. For example, if you have employment and or rental/investment income of $50,000 annually then you are in a joint income tax bracket of 15% on additional income. However, if you take $100,000 as a lump-sum that year this will push your annual income to $150K and you will be in a 28% income tax bracket. If you could instead break up that $100K over two tax years then you could stay in 15% to 25% tax bracket and could reduce your overall tax liability. In short, only pull out what you need when you need it to lesson the immediate year’s tax liability.
4. Distribution Withholding
Most distributions from an employer 401(k) or pension plan (including solo K), before the age of 59 1/2, will be subject to a 20% withholding that will be sent to the IRS in anticipation of tax and penalty that will be owed. In the case of an early distribution from an IRA, a 10% withholding for the penalty amount can be made but you can also elect out of this automatic withholding provided you make an estimated tax payment or that you will otherwise be current on your tax liability.
5. If You Have Tax Losses, Consider Converting to a Roth IRA or Roth 401(k)
When you have tax losses on your tax return you may want to consider using those losses to offset income that would arise when you convert a traditional IRA or 401(k) to a Roth account. Whenever you convert a traditional account to a Roth account, you must pay tax on the amount of the conversion. In the end though, you’ll have a Roth account that grows entirely tax-free and that you don’t pay taxes on when you distribute the money. Using the losses when they are available is a good way to get your Traditional retirement funds over to Roth.
The final 5 rules are for Roth IRAs and Roth 401(k)s
6. Roth IRAs Are Exempt from RMD
hile traditional IRA owners must take required minimum distributions (“RMD”) when the account owner reaches age 70 1/2, Roth IRAs are exempt from RMD rules. That’s a great perk and allows you to keep your money invested as long as possible.
7. Roth 401(k)s Must Take RMD
Roth 401(k) designated accounts are subject to RMD. This is a confusing rule since Roth IRAs are NOT subject to RMD. Such is the tax code. How can you avoid this? Simply roll your Roth 401(k) funds over to a Roth IRA when you reach 70 1/2.
8. Distributions of Contributions Are Always Tax-Free
Distributions of contributions to a Roth IRA are always tax-free. Regardless of age, you can always take a distribution of your Roth IRA contributions without penalty or tax.
9. Distributions of Roth IRA Earnings
In order to take a tax-free distribution from a Roth IRA, you must be age 59 1/2 or older and you must have had a Roth IRA for five years or longer. As long as those two criteria are met, all amounts (contributions and earnings) may be distributed from a Roth IRA tax free. If your funds in the Roth IRA are from a conversion, then you must have converted the funds at least 5 years ago and must be 59 1/2 or older in order to take a tax-free distribution.
10. Delay Roth Distributions
Roth retirement accounts are the most tax efficient way to earn income in the U.S. As a result, it is best to distribute and use other funds and assets that are at your disposal before using the funds built up in your Roth account as those funds aren’t as tax efficient while invested.
All retirement account owners must be familiar with the required minimum distribution (“RMD”) rules applicable to their accounts. These rules require you, in most instances, to take partial distributions from your retirement account when you reach age 70 ½. And, surprise, the rules for Traditional IRAs, Roth IRAs, and 401(k)s differ. In fact, even 401(k)s where you are a 5% or greater owner have different rules than 401(k)s where you aren’t an owner. Thanks, Congress.
So what rules apply to Solo 401(k) owners? Well, generally speaking, you must begin taking distributions from your Solo K when you reach age 70 ½. Despite what you may think or presume, there are three quirks to be aware of when it comes to RMD and Solo 401(k):
Still Working Exception Does Not Work on Solo Ks
There is a general RMD 401(k) rule which states that even after age 70 ½, you are not required to take distributions from an employer 401(k) when you are still working for that employer. However, this exception does not apply to account holders or their spouses who own 5% or more of the company. In other words, business owners who use a Solo 401(k) will be forced to take RMD from their Solo 401(k) after age 70 ½ even if they are still working in the business.
Roth 401(k) Funds are Subject to RMD
RMD applies to Roth 401(k)s. I know what you’re thinking, “Wait, but why would RMDs apply to Roth 401(k)s when Roth IRAs are exempt?” Because Congress said so. I know, it doesn’t make much sense, Roth 401(k) distributions at retirement will be tax-free, like Roth IRA distributions, and the IRS will not receive any revenue from the distribution so why treat Roth 401(k)’s differently? There’s not a good answer, but you should write your Congressperson or Senator and ask. In the meantime, if you’re 70 ½ and you have funds in a Roth 401(k) which you don’t want distributed, you can roll those Roth 401(k) funds out to a Roth IRA and you can avoid the distribution requirement by letting those funds sit in your Roth IRA where no RMD is required. Checkmate, IRS.
Every 401(k) Must Have RMD Taken, No Aggregating
Every 401(k) account you have must take RMD. So, for example, if you have a Solo 401(k) and a 401(k) account with an old employer then you need to take RMD from each 401(k) account. You cannot aggregate those accounts together and take RMD out of one to satisfy both RMD requirements. This aggregating is allowed in Traditional IRAs but unfortunately does not work with different 401(k) plan accounts. If taking RMDs from multiple accounts is getting too complex, you can roll the old employer 401(k) to the Solo K or to a Traditional IRA (or Roth IRA if Roth 401(k) funds) to consolidate your accounts and your RMD requirements.
Make sure take RMD when you are required to do so. Failure to take RMD results in a 50% penalty tax on the amount you failed to take. As a result, it’s critical that you understand the RMD rules for each retirement account you hold. If you have made a mistake though, the IRS does have penalty waiver programs whereby you can correct some failed RMDs and request a waiver of the penalty due. This doesn’t work in every instance, but if you’ve failed to take RMD ask your tax lawyer or accountant on whether a penalty waiver could apply in your instance.
The IRS announced new contribution amounts for retirement accounts in 2018, and there are some winners and losers in the bunch.
The biggest win goes to 401(k) owners, including Solo K owners, who saw employee contribution amounts go from $18,000 to $18,500. Health savings account (HSA) owners won a small victory with individual contribution maximums increasing $50 to $3,450 and family contribution amounts increasing by $150 to $6,900.
However, IRA owners lost with no increase in the maximum contribution amount for Traditional or Roth IRAs. The IRA maximum contribution amount remains at $5,500 and hasn’t increased since 2013.
Here’s a quick breakdown on the changes:
- 401(k) contributions also increased for employees and employers: Employee contribution limitations increased from $18,000 to $18,500 for 2018. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $54,000 to $55,000 ($61,000 for those 50 and older).
- HSA contribution limits increased from $3,400 for individuals and $6,750 for families to $3,450 for individuals and $6,900 for families.
- IRA contribution limitations (Roth and Traditional) stayed at $5,500, as did the $1,000 catch-up amount for those 50 and older.
There were additional modest increases to defined benefit plans and to certain income phase-out rules. Please refer to the IRS announcement for more details here.
These accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualifications and phase out rules that apply, so make sure you’re getting competent advice about which accounts should be set up in your specific situation.