How Does the SECURE Act Affect Retirement Assets?

It’s been just over a year since Congress passed the SECURE Act. The law is designed to make it easier for individuals to save for their retirement. However, it also includes changes that affect retirement assets already in place, and those inherited after the contributor passes away. If you don’t know about these changes, doing nothing could be expensive for you and your loved ones.

What is the SECURE Act?

In January 2020, Congress enacted the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The retirement law made several changes to the way the federal government (including the IRS) treats retirement accounts. For example, under the new act:

• Employers must include part-time employees in their 401(k) plans after they work 500 hours per year for three years
• Retirement accounts can include annuity payouts providing fixed income during retirement similar to a pension
• Small businesses can cooperate to offer multi-employer 401(k) plans to their employers
• Individuals have more access to 529 education savings accounts
• 401(k) statements will include income stream disclosures to give individuals more information about their retirement savings needs

Many of the changes were designed to increase individuals’ access to 401(k), IRA, and other retirement accounts. The law was created in response to concerns over how few employees had access to 401(k) accounts. However, for those that do, the SECURE Act behaves a bit differently.

How the Act Affects Retirement Assets, Generally

In addition to opening up retirement account access to part-time and small business employees, the SECURE Act also changes the way those accounts operate.

Understanding Different Retirement Asset Types

Before getting into the details, there are a few baseline rules you should know. Retirement accounts fall into two categories: pre-tax and post-tax contributions.

Pre-tax accounts, like 401(k)s, 403(b)s, and IRAs put off the payment of income tax until the funds are withdrawn from the retirement account. These accounts also have age restrictions:  you must either be of retirement age (59 ½ years old) or have a qualifying disability to withdraw funds without penalties. However, until 2020, the latest you could start taking distributions from a pre-tax account was age 70 ½, called Required Minimum Distributions (RMDs).

Post-tax accounts, including ROTH IRAs, are funded with money on which the investor has already paid taxes. Withdrawals from post-tax accounts do not trigger new tax obligations or penalties, and the ROTH accounts do not have the same limits on when and how you can withdraw the money.

Retirement Asset Changes under the SECURE Act

The SECURE Act made two significant changes to the way pre-tax retirement accounts work:

• Older workers can put off taking their RMDs until age 72 (previously 70.5)
• Parents can withdraw up to $5,000 each penalty-free for child birth and adoption expenses

These changes acknowledge that workers are staying healthy and employed longer. They also recognize that for many families, choosing to invest for retirement means having less savings available for family needs, such as childbirth expenses.

What the SECURE Act Means for Beneficiaries Who Inherit Retirement Assets

As with most laws, the SECURE Act has both pros and cons. The down side of the new retirement law comes in the changes to what happens to inherited retirement assets.

Many families use retirement assets as part of their estate plan. They plan for the possibility that they may have retirement assets remaining when they pass away, thus providing them the opportunity to pass on any remaining assets to their heirs and beneficiaries. Prior to the SECURE Act, an account owner could leave their retirement assets to individuals, and those beneficiaries could take just the RMD based on their remaining life expectancy, and thus “stretch” out the payments over their lifetime. These were commonly called “stretch IRAs” because the beneficiaries could receive small distributions every year for their lifetime. This allowed them to spread the tax obligations out over time while also providing supplemental income year after year.

However, the SECURE Act (mostly) eliminates the “stretch” for all but a few select beneficiaries. Under the new law, most beneficiaries must take all their distributions from an inherited retirement account within 10 years of the original account holder’s death. For those who inherit large pre-tax retirement accounts, this could result in higher taxes on the distributions and less time to allow the inherited retirement account to continue to grow.

Exceptions for Eligible Designated Beneficiaries

There are only a few, limited beneficiaries who may still be entitled to spread their distributions out over time, thus taking advantage of the “stretch” distributions. The SECURE Act includes exceptions to the 10 year distribution rule for “eligible designated beneficiaries”, which includes:

• Surviving spouses
• The contributor’s child or children up to age 18 (or age 26 if in “a specified course of education.”) Note, this exception does not apply to all minors; rather, it only applies to the account owner’s own minor children, but not step children, grandchildren, or other minors.
• People with disabilities or chronic illnesses (as specifically defined)
• People within 10 years of age of the IRA contributor (i.e. domestic partners or siblings)
• Designated beneficiaries who inherited pre-2020 stretch IRAs

The SECURE Act means big changes for retirement accounts and estate plans that use retirement savings as an asset-protection strategy. If you are planning to leave your 401(k) or IRA to your loved ones after your death, it is a good time to review those plans with an experienced estate planning attorney. At NSSSB, we will help you understand how the new law works so you can make estate planning decisions that will protect your friends, family, and loved ones, and keep them from paying more taxes than they need to. Click here to schedule a consultation with an attorney and start making your estate plan today.