In January 2020, the government launched the Setting Every Community Up for Retirement Enhancement (SECURE) Act. This bill updated and changed many of the rules for retirement plans, with the goal of improving retirement security for Americans. Now that these changes are kicking in, here's how the SECURE Act could impact your planning efforts.
Pushes Back the Age for Mandatory Retirement Plan Withdrawals
If you saved money through a 401k or a Traditional IRA, you got a tax deduction for your contributions. This delayed taxes both on the income you put into the account and your investment earnings. The government wants to collect those taxes eventually, which is why they set an age where you have to start taking money out of these accounts through Required Minimum Distributions (RMDs).
You need to take out enough to meet the RMDs (as determined by the IRS calculations based on your life expectancy) and pay taxes on the withdrawal. If you don't make the minimum withdrawal, you'll owe a steep penalty worth 50% of the amount you should have taken out. While a 401k might allow you to delay withdrawals as long as you're working, depending on the plan rules, with IRAs you need to take the RMDs at the age limit no matter what.
Before the SECURE Act, the IRA required you to take your first RMD by April 1 of the year after you turned 70 ½. The new law pushed the age back until you turn 72. This can improve retirement security because if you don't need the money when you turn 70 ½, you get another year and a half to delay taxes and keep growing your savings.
Removes the Age Limit for Traditional IRA Contributions
People are working and saving for retirement at later ages than in the past. However, before the SECURE Act, you could only contribute to a Traditional IRA if you were younger than 70 ½, even if you were still employed.
The law removed this age limit, so you can contribute to a Traditional IRA at any age. You need earned income from a job to qualify, as the contributions can't come from investment earnings. So long as you do, you can contribute up to $7,000 per year to this plan ($6,000 if you're younger than 50), receive a tax deduction for your contributions and see your investments grow tax-deferred, as long as they're in the IRA.
Supports the Use of Annuities in 401ks
Running out of money is understandably one of the top fears for retirees. Pensions used to mitigate this problem because they would pay retired workers income for the rest of their lives. Since pensions are now less common, chances are you need to manage your own savings to cover your bills, which means there's a risk you could run out.
Annuities can be a way to make your savings last. With these contracts, one of the payout options is to turn your savings into future income that's guaranteed for life. In other words, they work like your own personal pension.
With the SECURE act, the government aimed to expand access to annuities by making it easier for employers to offer them directly through their 401ks. Prior to this law, employers faced too much legal risk and were reluctant to include these investments. For example, they could have been held liable for missed payments if the annuity company went bankrupt. As a result, fewer than 10% of 401k plans offered annuities as an option in 2019, the last year before the SECURE Act passed, according to the Plan Sponsor Council of America.
The new law reduced employer liability for 401k annuities, as long as they pick companies that are in good standing with the state insurance department. As a result, they could become a more common investment option. If you have a 401k, check to see if your plan now offers annuities. If they don't, you could still buy one on your own by using your other savings or transferring money from your 401k.
Requires Faster Withdrawals for Inherited IRAs
One downside of the new legislation is that it reduced the withdrawal flexibility for an inherited retirement plan. When someone inherits a pretax Traditional IRA, they need to take the money out over time and pay taxes on the withdrawals.
Before the SECURE Act, they were able to split these withdrawals over their entire life expectancy (as calculated by the IRS). Under the new rules, people must take everything out within 10 years. However, this doesn't apply to spouses, who are allowed to delay the withdrawals as long as they want.
This could impact your planning if you expect to inherit a retirement plan. If you want to leave your retirement plan behind as an inheritance for your children or a partner who isn't your spouse, they should also know that they will have a limited 10-year window to make the withdrawals and pay the taxes.
Improves 401k Access for Part-time Workers
If you're working part-time heading into retirement, the SECURE Act made it easier to access your workplace 401k. Before, part-time workers could only use a company's 401k if they worked at least 1,000 hours in a year, roughly 20 hours per week.
Now, you can also qualify by working at least 500 hours a week for three years straight, with contributions starting in 2024. This opens up another retirement plan option for people who scaled back their hours but still want to save for the future.
Provides Incentives for Small Business Retirement Plans
Small business owners may be reluctant to set up a workplace retirement plan for their employees because of the costs and the extra work involved in running the plan. The SECURE Act created a few new incentives to help them out.
First, it created a $500 tax credit for small business owners who set up a 401k or Simple IRA with automatic enrollment for employees. The law also simplified the rules for 401ks to make it easier for small business owners to manage them. If you're working at a small business, this could make it more likely that you'll receive a small business retirement plan in the future.
Allows 529 Plans to Pay Off Student Loans
A 529 plan helps you save money to pay for college costs. If you spend the money on eligible expenses, your withdrawals are tax-free, so you never owe taxes on the investment gains. Before, you were supposed to spend the money on costs related to attending school, like college tuition, room and board, and textbooks.
The SECURE Act opened up another option. Now, you can use up to $10,000 to pay off the student loans of the account beneficiary (the person you set the account up for). If they don't end up needing all of the money, you can also use the 529 plan to pay off up to $10,000 of loans for each of the beneficiary's siblings. This can give you more spending flexibility when you open a 529 plan for another family member.
The SECURE Act wasn't an overhaul of the retirement system, but it did make gradual improvements across many areas, such as increasing access to retirement plans at work and giving retirees more options to manage their savings later in life.
Navigating all of the changes from this law can be tricky because it touched on so many areas. For more information, meet with a financial advisor or tax expert to figure out exactly how this law impacts your retirement planning.