December 20, 2019 the Consolidated Appropriations Act, 2020 (the Act) became law. The Act included numerous tax provisions updating or reinstating items that expired after 2017, 2018 or were set to expire after 2019. Most notably though, the Act incorporates the Setting Every Community Up For Retirement Enhancement Act or SECURE Act, which is considered the most significant legislation affecting retirement accounts since the Pension Protection Act of 2006. The SECURE Act changes the age at which Required Minimum Distributions begin and eliminates the popular "stretch IRA" provisions for most non-spouse beneficiaries which is sure to impact financial planning for years to come.
Required Minimum Distributions
A Required Minimum Distribution (RMD) is the amount that must be distributed from the taxpayer's IRA each year after reaching the required beginning date (RBD) or inheriting an IRA. Under the old law, the required beginning date was April 1st of the year following the year the taxpayer reached age 70 ½. The SECURE Act pushes the trigger age out to 72, which means the required beginning date is April 1st following the year the taxpayer turns age 72.
1 Ultimately, the delay resulting from a later required distribution age is only impactful for taxpayers who do not need their RMD to support cash flow and can afford to delay distributions. This delay affords taxpayers a longer time horizon for their IRA investments to grow tax-deferred. Additionally, the law specifically states that the new delayed start date does not apply to taxpayers who attained age 70 ½ during 2019. Apologies to those born before July 1, 1949.
For example: John and Sally are married. John was born on January 5, 1949 while Sally was born July 5, 1949. John turned 70½ during 2019 and therefore must begin RMDs in 2019. Sally turns 70½ during 2020 and is covered under the new rules of the SECURE act and can delay her first RMD until age 72.
For tax years beginning after 2019 the Secure Act allows taxpayers over age 70½ to continue making Traditional or Roth IRA contributions as long as the other requirements for contributions are met, namely having earned income.
One popular provision that remains unchanged is a taxpayer's ability to begin Qualifying Charitable Distributions (QCDs). Interestingly, taxpayers can still begin QCDs after reaching age 70½ and do not need to delay until age 72. For an in-depth look at QCDs, see my colleague Julie's newsletter from November 2019:
Turbo Charge Your Giving with Tax-Efficient Strategies
Future developments: While the new law shifts the age at which taxpayers must begin RMDs, it does not address the underlying life expectancy used in the calculation. The IRS received a separate proposal during 2019 which if passed would increase life expectancy, thereby reducing annual RMDs, so stay tuned.
The two biggest factors in determining required distributions from inherited IRAs are:
- Who is the beneficiary? Not all IRA beneficiaries are created equal, and naming multiple beneficiaries could have unintended consequences...here's looking at you trusts and charities.
- Did the IRA owner die prior to the required beginning date, or on or after the required beginning date?
The old law divided beneficiaries into three categories, surviving spouse, designated individual beneficiaries (including some trust beneficiaries) and non-designated beneficiaries (estates, charities and some trusts). Under the old rules the surviving spouse and designated individual beneficiaries were able to stretch distributions from an inherited IRA over their remaining life expectancy in most circumstances.
The SECURE Act removes this popular stretch provision by requiring designated beneficiaries to distribute the full account balance by December 31st of the 10th year following the account owner's death.
2 Note that
beneficiaries are not required to take distributions annually during the 10 year period which creates significant cash and tax planning opportunities.
The law provides an exception to the 10-year rule for "Eligible Designated Beneficiaries" which includes the surviving spouse, a child of the decedent who has not reached age of majority, a disabled individual, a chronically ill individual or an individual who is not more than 10 years younger than the decedent. Therefore, eligible designated beneficiaries can still stretch distribution over their remaining life expectancy.
The SECURE Act also enriches two benefits for surviving spouses who choose to remain the beneficiary of an inherited IRA:
- Spousal beneficiaries can delay taking RMDs from the inherited account until the decedent would have been required to begin RMDs of their own, and
- If the surviving spouse dies prior to when RMDs would have been required for the original account owner, the surviving spouse is treated as the original account owner, which means their beneficiaries would be treated as the first beneficiaries of the account and potentially classified as eligible designated beneficiaries.
Notably, the provisions above primarily impact individual beneficiaries. The act does not change the 5-year rule that applies to non-designated beneficiaries which requires distribution of the full account by December 31st of the 5th year following the account owner's death if the account owner died prior to beginning RMDs.
In summary, IRAs and the distribution rules are tricky for those approaching RMD age and it is definitely time to start reviewing your IRA beneficiaries. The summary above only hits the highlights of the new laws, so a thorough review of each taxpayer's circumstances is necessary. At Providence Capital Advisors, we are keeping up-to-date on the latest legislative changes and are prepared to help with your IRA questions.
Under both the old and new law, taxpayers have the option to delay the first distribution until April 1st of the year following the trigger age. Subsequent distributions must be made annually prior to December 31st. Therefore, if a taxpayer delays the first distribution, they will need to take two distributions in year 1 - the 1st distribution by April 1st and the second by December 31st.
The 10-year rule is effective for individuals dying after 2019.
Minor children qualifying as designated beneficiaries are required to distribute the remaining balance within 10 years of reaching the age of majority.