Bipartisan legislation that would change IRA rules on contributions and distributions, known as the SECURE Act and RESA, has cleared both the Senate Finance and the House Ways and Means Committees. The House bill is called Setting Every Community Up for Retirement Enhancement (SECURE) Bill of 2019 (HR 1994), and the identical Senate bill is called the Retirement Enhancement and Savings Act (RESA).
This post discusses significant changes in this retirement saving legislation that are important for IRA planning.
Changes in the legislation for 401(k)s will be discussed in a later post.
Most Significant IRA Changes under New Retirement Savings Bills
Three changes in these bills stand out for IRA financial planning purposes:
- Moving the start date for Requirement Minimum Distributions (RMDs) to the year the owner turns 72;
- Ending the 70 ½ age limit for contributing to an IRA; and
- Shortening the distribution period for nonspouse inherited IRAs to a 10 year maximum.
Required Minimum Distribution (RMD) Beginning Date Would be Age 72
If the legislation is passed, the RMD beginning date for employer plans and for IRAs is moved from year owner reaches age 71 ½ to the year the owner reaches age 72.
Example. Jerry and Joyce are married with IRAs. Jerry’s date of birth is May 11, 1950, and Joyce’s is July 19, 1949. They both turn 70 ½ in 2020, and under the existing rule they must both begin to take RMDs for that year. Under the SECURE Act and RESA, however, they each begin the year they reach age 72. Jerry would have to begin RMDs in 2022, and Joyce would have to start in 2021.
Benefits of Later Start Date
Retirement distributions, including RMDs, are generally taxed at ordinary rates. Individuals with income opportunities from more lightly taxed sources, such as long-term capital gains, might prefer to postpone taking retirement distributions as long as they can and extending the RMD beginning date a year or two into the future will help.
The delay would also help individuals who have no trouble living on their social security or monthly pension income and who would prefer to delay taxation as long as possible. Or perhaps they are concerned about “living too long” and outlasting their money. The delay would help preserve their balance.
IRA Contribution Age Limit Would End
Another positive change is the age 70 ½ age limit for contributing to a traditional IRA is eliminated. Many retirees do not earn compensation in those years, but some do. Even in years when the owner must take RMDs, contributing to the IRA in the same year would cushion the effect.
Example. Shelley’s birth date is March 1, 1950. She has been working for an accounting firm during tax season, and annually makes a traditional IRA contribution based on that compensation. Under the existing rule, she cannot make her IRA contribution for 2020 because she turns age 70 ½ in that year. Under the new rule, she could continue to make IRA contributions for any year in which she has compensation.
Later-in-Life IRA Contributions Can Still Make Sense
One might wonder why someone what to continue making retirement contributions deep into retirement. One perhaps obvious reason is that if the individual is still earning compensation, the individual may not actually be retired. But even for someone who is mostly retired, there’s no reason the same considerations that spur us on to make contributions at age 30 or 60 don’t apply at 80. We avoid current tax, and save for our future (or at least somebody’s future).
Another reason to contribute later in life is to blunt the effect of RMDs. Unlike 401(k)s which postpone RMDs until retirement, the beginning date for IRAs is same age for all – whether it’s the current rule — the year the individual turns age 70 1/2, or the new rule — the year the individual turns age 72.
Example. Karen is age 72 and works part-time. She has funds in her IRA, which she prefers not to touch for as long as she can. Under the new rule, she would be able to make an IRA contribution that would effectively offset any RMD up to the IRA contribution limit.
Maximum Stretch for Non-Spouse Inherited IRAs Shortened to 10 Years
Under the new legislation, the distribution period for nonspouse designated beneficiaries would be limited to 10 year rather than the beneficiary’s lifetime. This limit does not apply to designated beneficiaries who are disabled or chronically ill. For any child of the owner who has yet to reach the age of majority as of the date of the owner’s death, the 10 year clock does not start running until the child reaches the age of majority.
This change provides the government with a revenue offset to help pay for the delay in beginning RMDs. Looked at in that light, the change would provide flexibility to almost every retiree at the cost of eliminating a planning technique for those lucky enough to have clever advisors. In any case, it would provide a reason to review a client’s financial and estate plans.
By James Solheim, J.D.