Retirement rules for savers change significantly under SECURE Act
The SECURE Act modifies the rules for retirement plan participants and employer-sponsors starting in tax year 2020. Learn how these changes impact certain taxpayers.
Congress passed both the Further Consolidated Appropriations Act, 2020 (HR 1865) and the Consolidated Appropriations Act, 2020 (HR 1158). Together, the Acts provide for funding of the federal government through the end of fiscal year 2020 (September 30, 2020). HR 1165 includes the Taxpayer Certainty and Disaster Tax Relief Act of 2019 and the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.
The Taxpayer Certainty and Disaster Tax Relief Act extends certain expired and expiring tax provisions through 2020, provides additional disaster relief, and makes other tax law changes.
The SECURE Act modifies rules for retirement plan participants as well as plans themselves and employers that sponsor plans. Most changes are effective beginning in tax year 2020 (TS21).
Finally, HR 1865 repeals certain Affordable Care Act (ACA) provisions.
The SECURE Act
Taxable non-tuition fellowship and stipend payments treated as compensation for IRA purposes
The SECURE Act amends the definition of “compensation” for IRA purposes to include any amount included in an individual’s gross income and paid to the individual to aid them in their pursuit of graduate or postdoctoral study. This change allows more students to contribute to IRAs. The change is effective for tax years beginning after December 31, 2019.
Age limit for traditional IRA contributions repealed
The SECURE Act repeals the age rule for traditional IRA contributions. This change aligns traditional IRAs with other plans such as the 401(k) and Roth IRA, which do not have maximum age limits for contributions. This change is first effective for contributions made for the 2020 tax year. This means that the age limit for contributions remains at 70½ and continues to apply for tax year 2019, even if contributions are made in 2020 for tax year 2019.
The Act also includes rules to coordinate deductible IRA contributions with qualified charitable distributions (QCDs) made in the same year.
New penalty-free withdrawal for birth or adoption of child
The SECURE act adds a new exception to the 10% penalty for early distributions. The exception applies to qualified birth or adoption distributions up to $5,000. A qualified birth or adoption distribution is a withdrawal from an eligible retirement plan to an individual during the 1-year period beginning on the date the individual’s child is born or on which a legal adoption of an eligible adoptee is finalized by the individual.
An eligible adoptee is an individual (other than a child of the taxpayer’s spouse) who has not attained age 18 or is physically or mentally incapable of self-support. In order to qualify for the special treatment, the taxpayer must include the name, age, and taxpayer identification number of the child or eligible adoptee on the taxpayer’s tax return for the year of the distribution. The Act includes provisions for recontributing qualified birth or adoption distributions to eligible retirement plans.
This change applies to distributions made after December 31, 2019.
Required beginning date for required minimum distributions increased
The SECURE Act increases the required beginning date from the year the taxpayer turns 70½ to the year the taxpayer turns age 72. This applies for distributions required to be made after December 31, 2019 with respect to individuals who reach age 70½ after December 31, 2019.
Excludable difficulty-of-care payments treated as compensation for determining retirement contribution limits
For IRA contributions, a new rule provides that if an individual excludes a difficulty-of-care payment (a type of qualified foster care payment for certain individuals with special needs), and the maximum IRA deduction for the year exceeds the individual’s gross income, the individual may elect to increase their nondeductible limit to their IRA by the difference between the maximum nondeductible IRA contribution for the year and their gross income. For example, if the individual’s maximum nondeductible IRA contribution is $6,000 and their compensation included in gross income is $0, they can increase their nondeductible IRA contribution limit to $6,000.
The rules for IRA contributions take effect for contributions made after December 20, 2019.
For contributions to a defined contribution plan such as a 401(k), a plan participant’s compensation can be increased by excludable qualified foster care payments that are difficulty of care payments. Any contributions made that are allocable to this increase will be treated as investment in the plan and will not cause the plan to be treated as failing to meet any requirements.
The rules for defined contribution plans take effect for plan years beginning after December 31, 2015.
Long-term part-time workers may participate in 401(k) plans
The Act allows certain part-time employees to participate in 401(k) plans. To qualify, the employee must work for the employer at least 500 hours per year for at least three consecutive years and be at least age 21 by the end of the three-year period. Once the long-term part-time employee meets the service and age requirements, the employee may participate in the plan the earlier of:
- The first day of the plan year beginning after the date both requirements are met, or
- Six months after the date both requirements are met.
The three-year testing period may not include years beginning before January 1, 2021. Thus. the earliest date a long-term part-time employee may participate in the plan is January 21, 2024.
Section 529 plan expansion
Distributions from 529 plans may be used tax-free to pay for up to $10,000 of qualified student loan repayments, including principal and interest. Any deduction for qualified student loan interest is disallowed to the extent tax-free distributions were used to pay the interest. Tax-free distributions may also be used to cover costs associated with certain registered apprenticeships. The changes apply to distributions made after December 31, 2018.
Benefits for volunteer firefighters and emergency responders
For one year only, the Act reinstates exclusions for qualified state and local tax benefits and qualified reimbursement payments made to members of qualified volunteer response organizations. Also, the qualified reimbursement payment exclusion is increased to $50 a month. This temporary reinstatement applies only to tax year 2020.
The following provisions are revenue raising measures included in the Act:
Kiddie tax change
The Act repeals the TCJA measure that taxes the unearned income of children at trust and estate rates. The change is generally effective for years after December 31, 2019. However, taxpayers may elect to apply the change to tax years beginning in 2018, 2019, or both. Although the kiddie tax is meant to increase revenue, taxes for many affected taxpayers may decrease because of the change.
Distribution rules modified for inherited plans
The SECURE Act changes the rules for the treatment of inherited retirement assets. Previously, taxpayers who inherited traditional IRA assets could stretch distributions out over the lifetime (often referred to as “stretch” IRAs). Under the SECURE Act, spouses can continue to stretch retirement plan assets out over their lifetimes.
However, if a taxpayer leaves a traditional IRA or retirement plan to a designated beneficiary other than their spouse, the designated beneficiary can only defer withdrawal for up to 10 years. The same rule applies to Roth IRAs and other defined contribution plans.
The rules are slightly different for a few types of designated beneficiaries, including a child of the employee who has not reached the age of majority (generally, age 18), a disabled individual, a chronically ill individual, and an individual who is not more than 10 years younger than the employee.
These rules apply to the retirement accounts of individuals who die after December 31, 2019. Taxpayers who inherited retirement accounts from taxpayers who died before January 1, 2020 will apply the prior rules to their distributions.
Increased failure-to-file penalty
For returns due after December 31, 2019, the Act increases the failure to file penalty the lesser of $435 (up from $2330 prior to the Act) or 100% of the amount of tax due.
Originally published in the 12/26/19 special edition of TAX in the News