As part of the year-end budget bill, the President signed into a law a package of tax provisions including the Further Consolidated Appropriations Act of 2020 and the SECURE Act (Setting Every Community Up for Retirement Enhancement). Several of the tax law changes take effect not only for 2020 but also for 2019. Let’s take a look at some of those tax law changes.
1. Stretch IRA provisions
- Probably the most remarkable change resulting from the SECURE Act is the elimination of the so-called “stretch” provision for most (but not all) non-spouse beneficiaries of inherited IRAs and other retirement accounts. Under previously issued regulations, non-spouse designated beneficiaries could take distributions over their life expectancy, but for many retirement account owners who pass away in 2020 and beyond, beneficiaries will have only 10 years to empty the account.
- Under this rule, the entire inherited retirement account must be emptied by the end of the 10th year following the year of inheritance. Within this period, there are no distribution requirements. Thus, designated beneficiaries will have some flexibility when it comes to timing distributions from the inherited account(s) for potential maximum tax efficiency, as long as the entire account balance has been taken by the end of the 10th year after death. Timing of distributions will be critical and doing tax projections is recommended so you can manage the tax brackets, aka “thread the needle.”
- You can see the exceptions to the “10-year rule” at the end of the blog post.
- We need to remind ourselves of the importance of IRA distribution planning: which is to try and minimize income tax on distributions and thereby maximize deferral
2. Required Minimum Distribution (RMD) age
- Another important retirement planning change is the age increase for the onset of RMDs from age 70 ½ to age 72. The change is welcome, as many taxpayers were perplexed with turning age 70 ½ and the implications, and age 72 is just plain easier to understand.
- One question received from an advisor was, “My client turned 70 ½ in 2019 and is required to take their first required distribution by April 1, 2020. Can my client take advantage of the law’s increase in the age for starting required minimum distributions to 72?”
- The answer is no. Only account owners who turn 70 ½ after December 31, 2019, can start mandatory distribution at 72 years of age.
- Another question we received from advisors was about the Qualified Charitable Distribution (QCD), “Did anything change?”
- The answer is no. Currently taxpayers who are 70 ½ or older can give money from a traditional IRA to one or more charities and exclude the amount donated (up to $100k per person) from their taxable income. There was nothing within the SECURE Act that changed that.
- One point to keep in mind is if a taxpayer is 70 ½ or older prior to 2020, has a mandatory distribution and wants to do a QCD for 2020, it may be best to do so early in the year, as the first money to come out of an IRA is the RMD. Keep in mind that the taxpayer does not pick up the RMD as income, but also does not take the charitable contribution deduction. If a taxpayer is not planning to itemize, a QCD can be a tax-smart idea.
3. Traditional IRA contributions
- The age limit for making IRA contributions is gone. Some taxpayers continue to work in retirement, but were not permitted to fund a traditional IRA after age 70 ½. Under the SECURE Act, the restriction on making contributions to a traditional IRA after age 70 ½ has been lifted, though earned income is still required.
- Taxpayers could always fund a Roth IRA with their earned income as long as they are under the income limits for their filing status.
4. It will be easier to get a medical expense deduction in 2019 and 2020.
For 2019, under the Tax Cuts and Jobs Act (TCJA), you could deduct only the part of your medical and dental expenses that is more than 10% of your adjusted gross income (AGI). This floor makes it difficult to claim a write-off unless you have very high medical bills or a low income (or both). Under the new law, the lower 7.5% floor returns for both the 2019 and 2020 tax years.
5. The Kidde Tax Changes Back!
- It was just two years ago when Congress changed the way unearned income of certain children was taxed using trust tax rates, which are very compressed. Well, that did not last long. The SECURE Act makes any income subject to the Kidde Tax taxable at the child’s parent’s (or parents’) marginal tax rate. The change is in effect for 2020.
- Also, taxpayers can elect to have the current Kidde Tax rules apply for the 2019 tax year and 2018. For 2019, the tax preparer could calculate under the two tax regimes and the taxpayer could choose to file with the lowest tax cost.
- For 2018, a tax recalculation would need to be done, and if the tax bill is lower using the parent’s marginal tax bracket, an amended return could be filed to retrieve the tax overpayment.
- It’s going to take some time for advisors and clients to digest the SECURE Act and the other recently passed tax provisions. Advisors will need to know both pre-SECURE and post-SECURE Act law for many years.
We will have more on the SECURE Act in the near future, so stay tuned.
SECURE Act Stretch IRA 10 Year Rule – There are exceptions for certain beneficiaries (“eligible designated beneficiaries”). IRC 401(a)(9)(E)(ii)
- Surviving spouse.
- The employee’s children under the age of majority (not grandchildren or any other children), but only until they reach the age of majority.
- Disabled (as defined by IRC 72(m)(7)).
- Chronically ill (as defined by IRC Section 7702B(c)(2)).
- Individual no more than 10 years younger than decedent.
Neither SEI nor its subsidiaries provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.
Information provided by Independent Advisor Solutions by SEI, a strategic business unit of SEI Investments Company. The content is for educational purposes only and is not meant to provide investment advice or as a guarantee of any specific outcome. While SEI welcomes comments, SEI is not responsible for, and does not endorse, the opinions, advice, or recommendations posted by third parties. The opinions expressed in comments are the view(s) of the commenter(s), and do not represent the views of SEI or its affiliates. SEI reserves the right to remove any content posted by users of this site in its sole discretion.