Before adjourning in late December, Congress enacted a $1.4 trillion year-end spending bill that keeps the federal government running through Sept. 30, 2020. President Trump signed the legislation. Tucked away inside this spending legislation is the Setting Every Community Up for Retirement Enhancement (SECURE) Act which includes significant changes to individual retirement arrangements (IRAs) and retirement plans including the Thrift Savings Plan (TSP).
This column highlights the most important changes to IRAs and to the TSP.
Age limit eliminated for traditional IRA contributions
Effective Jan. 1, 2020, the SECURE Act eliminated the age limit for making traditional IRA contributions. With this change, those individuals who have earned income or whose spouses have earned income can continue to contribute to a traditional IRA regardless of their age.
Until this change in the law, starting in the year an individual reached age 70.5, the individual could not contribute to a traditional IRA, even if the individual had earned income (wages/salary or self-employment income) or if the individual is married and whose spouse has earned income. Note that this change takes effect on Jan. 1, 2020, meaning that federal employees over age 70.5 or who have working spouses with earned income cannot make traditional IRA contributions for the year 2019 even though the deadline to make 2019 IRA contributions is the 2019 income tax filing deadline of April 15, 2020.
Changes the age of initiation for required minimum distributions (RMDs) from 70.5 to age 72 for all retirement accounts subject to RMDs, including the TSP
Note that this change for taking one’s first RMD from age 70.5 to age 72 (new required beginning date or RBD) affects only traditional IRA owners and retirement plan owners (including traditional TSP and Roth TSP participants) who become age 70.5 after Dec. 31, 2019 (that is, only individuals born after June 30, 1949).
This change is a tremendous benefit for employees and annuitants born after June 30, 1949, and will allow additional time for the traditional and Roth TSP accounts, as well as traditional IRAs owned by federal employees or annuitants, to grow untouched for an additional year and a half. The fact is that many federal employees are remaining in the workforce longer, which in turn means that these employees can further delay withdrawing their traditional IRAs and their traditional TSP and Roth TSP accounts.
Also, the new proposed changes in the RMD life expectancy tables in 2021, combined with the new higher RBD, will allow those individuals who do not need to withdraw these accounts to keep these accounts growing, tax-deferred or tax-free (Roth TSP), somewhat longer.
The law has not changed for individuals over 70.5 owning traditional IRAs who use qualified charitable distributions (QCDs) to fulfill their traditional IRA RMDs. QCD’s can still be performed at age 70.5, even though traditional IRA RMDs can be delayed until age 72 for traditional IRA owners born after June 30, 1949.
With the elimination of the age limit for making traditional IRA contributions comes expanded “backdoor” Roth IRA opportunities
As explained above, effective Jan. 1, 2020 as a result of the SECURE Act passage, there is no age limit for making traditional IRA contributions. Those individuals age 70.5 or older with wages or self-employment earnings (earned income), or who are married to spouses with earned income, can contribute to a traditional IRA regardless of their age. Note that Roth IRAs do not have age limitations with respect to contributions.
But there are individuals over age 70.5 with earned income who cannot contribute to a Roth IRA because their income is too large. With the SECURE Act passage, such an individual can now contribute to a nondeductible traditional IRA and immediately convert the traditional IRA to a Roth IRA, called a “backdoor” Roth IRA.
SECURE Act allows parents to take penalty-free withdrawals from defined contributory retirement accounts (such as the TSP) upon the birth or adoption of a child
After Dec. 31, 2019, parents can withdraw up to $5,000 (per spouse) from a retirement account within a year of a child’s birth or adoption. The law waives the 10 percent early withdrawal penalty that retirement plan owners younger than age 59.5 would be normally subject to.
But they must pay federal income tax on the amount of the withdrawal. The birth or legal adoption distribution amount can be repaid at any future time, to any retirement account.
IRA contributions for fellowships and stipend payments
Effective Jan. 1, 2020, taxable non-tuition fellowships and stipend payments can be treated as compensation for the purpose of qualifying to make a traditional IRA and/or Roth IRA contribution.
Limits the ability of traditional IRA and Roth IRA owners to extend the life of their traditional and Roth IRAs by leaving the accounts to much younger heirs such as grandchildren
Congress has in fact severely stopped the use of the “stretch” IRA. Beginning for deaths after Dec. 31, 2019, the “stretch” IRA will be replaced with a 10-year rule for the vast majority of beneficiaries. Until the change, the heirs of traditional or Roth IRAs had the option of taking required withdrawals over their lifetime and perhaps receive decades of income – tax-free or tax-deferred – after the original IRA owner’s death.
For example, a 24-year-old heir of his or her grandfather’s IRA could take payouts over about 60 years – thus the name “stretch” IRA. Under the new rules, there will be no annual RMDs for inherited IRAs. Instead, the only RMD for either an inherited traditional IRA or Roth IRA will be a lump sum payment of the balance of the IRA at the end of the 10-year period after the death of the IRA owner. For a sizeable traditional IRA composed of before-taxed earnings in which the distribution is mostly taxable to the heir, the lump sum payment could result in a huge federal and state tax liability for the heir.
Under the legislation, there are five classes of eligible designated beneficiaries who are exempt from the 10-year post-death payout. They are:
- Heirs of IRAs whose original owners died before Jan. 1, 2020;
- surviving spouses;
- chronically ill or disabled heirs;
- heirs within 10 years of age of the original owner; and
- minor children up to the age of majority or age 26, if the child is still in school. Once the minor child reaches the age of majority, or if still if school at age 26, the 10-year payout period begins.
For federal employees and retirees, the new rules for IRAs and the TSP resulting from passage of the SECURE Act mean s a new landscape with respect to retirement and estate planning. Future columns will discuss what employees and annuitants should discuss with their financial advisors in order to make the most of the new retirement and estate planning opportunities resulting from the passage of the SECURE Act.