Tax Changes Impact Everyone

Congress recently passed—and the President signed into law—the SECURE Act, landmark legislation that may affect how you plan for your retirement. Many of the provisions go into effect in 2020, which means now is the time to consider how these new rules may affect your tax and retirement-planning situation.

Here is a look at some of the more important elements of the SECURE Act that have an impact on individuals. The changes in the law might provide you and your family with tax-savings opportunities. However, not all of the changes are favorable, and there may be steps you could take to minimize their impact.

This is all pretty confusing so we’re happy to meet with you anytime to explain your specific retirement situation.

 

Repeal of the Maximum Age for Traditional IRA Contributions

Before 2020, traditional IRA contributions were not allowed once the individual attained age 70½. Starting in 2020, the new rules allow an individual of any age to make contributions to a traditional IRA, as long as the individual has compensation, which generally means earned income from wages or self-employment.

  • Action Item – if you are over 70 ½, have earned income and want to contribute to your IRA, create a monthly contribution plan set up in January so that you can spread the cash flow over the entire year

Required Minimum Distribution Age Raised from 70½ to 72

Before 2020, retirement plan participants were generally required to begin taking “required minimum distributions,” or RMDs, from their plan by April 1st of the year following the year they reached age 70½. Starting in 2020, the age at which individuals must begin taking distributions from their retirement plan or IRA is increased from 70½ to 72.

  • Action Item – if you wish to delay taking RMDs, contact your investment advisor immediately to make the change.

 

Partial Elimination of Stretch IRAs

For deaths of plan participants or IRA owners occurring before 2020, beneficiaries (both spousal and nonspousal) were generally allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life or life expectancy (in the IRA context, this is sometimes referred to as a “stretch IRA”).

However, beginning in 2020 (later for some participants in collectively bargained plans and governmental plans), distributions to most nonspouse beneficiaries are generally required to be distributed within ten years following the plan participant’s or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed.

Exceptions to the 10-year rule are allowed for distributions to (1) the surviving spouse of the plan participant or IRA owner; (2) a child of the plan participant or IRA owner who has not reached majority; (3) a chronically ill individual; and (4) any other individual who is not more than ten years younger than the plan participant or IRA owner. Those beneficiaries who qualify under this exception may generally still take their distributions over their life expectancy (as allowed under the rules in effect for deaths occurring before 2020).

  • Action Item – review your beneficiary designations on all retirement plans and IRAs to determine if any changes are needed.

Expansion of Section 529 Savings Plans

A Section 529 education savings plan is a tax-exempt program established and maintained by a state, or one or more eligible educational institutions (public or private). Any person can make nondeductible cash contributions to a 529 plan on behalf of a designated beneficiary. The earnings on the contributions accumulate tax-free. Distributions from a 529 plan are excludable up to the amount of the designated beneficiary’s qualified higher education expenses.

Before 2019, qualified higher education expenses didn’t include the expenses of registered apprenticeships or student loan repayments.

For distributions made after Dec. 31, 2018 (the effective date is retroactive), tax-free distributions from 529 plans can be used to pay for fees, books, supplies, and equipment required for the designated beneficiary’s participation in an apprenticeship program. In addition, tax-free distributions (up to $10,000) are allowed to pay the principal or interest on a qualified education loan of the designated beneficiary, or a sibling of the designated beneficiary.

  • Action Item – review unused balances in existing 529 plans to determine if it is advantageous to use these funds to pay for student loan debt.

 

Kiddie Tax Changes for Gold Star Children and Others

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA, P.L. 115-97), which made changes to the so-called “kiddie tax,” which is a tax on the unearned income of certain children. Before enactment of the TCJA, the net unearned income of a child was taxed at the parents’ tax rates if the parents’ tax rates were higher than the tax rates of the child.

Under the TCJA, for tax years beginning after Dec. 31, 2017, the taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. Children to whom the kiddie tax rules apply and who have net unearned income also have a reduced exemption amount under the alternative minimum tax (AMT) rules.

There had been concern that the TCJA changes unfairly increased the tax on certain children, including those who were receiving government payments (i.e., unearned income) because they were survivors of deceased military personnel (“gold star children”), first responders, and emergency medical workers.

The new rules enacted on Dec. 20, 2019, repeal the kiddie tax measures that were added by the TCJA. So, starting in 2020 (with the option to start retroactively in 2018 and/or 2019), the unearned income of children is taxed under the pre-TCJA rules, and not at trust/estate rates. And starting retroactively in 2018, the new rules also eliminate the reduced AMT exemption amount for children to whom the kiddie tax rules apply and who have net unearned income.

  • Action Item – if you were negatively impacted by the kiddie tax rules in 2018, discuss this with your tax preparer to determine if it would be advantageous to amend the prior year return.

 

Penalty-Free Retirement Plan Withdrawals for Specified Expenses

Generally, a distribution from a retirement plan must be included in income. And, unless an exception applies (for example, distributions in case of financial hardship), a distribution before the age of 59 ½ is subject to a 10% early withdrawal penalty on the amount includible in income.

Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are penalty-free. That $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.

Caution – many advisors do not recommend withdrawing from tax advantaged accounts prior to retirement due to the loss of tax deferred income compounding. Make sure to seek advice from your tax and/or financial advisor before taking advantage of this opportunity.

 

Taxable Non-Tuition Payments and Stipends Qualify for IRA Contributions

Before 2020, stipends and non-tuition fellowship payments received by graduate and postdoctoral students were not treated as compensation for IRA contribution purposes, and so could not be used as the basis for making IRA contributions.

Starting in 2020, the new rules remove that obstacle by permitting taxable non-tuition fellowship and stipend payments to be treated as compensation for IRA contribution purposes. This change will enable these students to begin saving for retirement without delay.

  • Action Item – if you are receiving taxable stipends and fellowship payments, and would like to start saving for retirement now, make sure to discuss this opportunity with a financial advisor and set up monthly contributions early in the year to spread the cash flow over the entire year.

 

Tax-Exempt Difficulty-Of-Care Payments Included for Retirement Purposes

Many home healthcare workers do not have taxable income because their only compensation comes from “difficulty-of-care” payments that are exempt from taxation. Because those workers do not have taxable income, they were not able to save for retirement in a qualified retirement plan or IRA.

Starting in 2020 for contributions made to IRAs (and retroactively starting in 2016 for contributions made to certain qualified retirement plans), the new rules allow home healthcare workers to contribute to a retirement plan or IRA by providing that tax-exempt difficulty-of-care payments are treated as compensation for purposes of calculating the contribution limits to certain qualified plans and IRAs.

  • Action Item – if you are receiving difficulty of care payments and want to increase the amount of nondeductible IRA contributions, make sure to speak with your tax and/or financial advisor.

 

Please Call Our Office to Schedule a Planning Meeting

If there any questions relating to the changes and adjustments from the SECURE act, please contact our office to schedule a tax planning meeting.