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2020 Year End Review of Recent Retirement Plan Changes

Over the last year, both before and after the current pandemic, there have been multiple law changes that have impacted retirement plans and retirement benefits. There have been many articles and constant commentary on these changes, but as we reach the end of 2020, it is a good time to review all of the changes.

On December 20, 2019, Congress signed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act is designed to increase access to retirement plans, encourage more people to invest in retirement plans, and account for Americans’ longevity including increased time spent actively working. The SECURE Act contains provisions that affect owners of retirement plans during their lives and potentially impacts their estate plans.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by Congress on March 27, 2020. The CARES Act provided economic assistance for small businesses and individuals, which included provisions related to retirement accounts.

Here is an overview of some of the important provisions:

COVID-19 Specific Provisions

  1. Penalty Free Withdrawal in 2020: Under the CARES Act, a plan sponsor may choose to allow participants to take early withdrawals totaling up to $100,000 before December 31, 2020 without incurring the normal 10% penalty, if one of the following conditions are met:
    1. The plan participant or the participant’s spouse or dependent is diagnosed with COVID-19 by a CDC-approved test; or
    2. The plan participant “experiences adverse financial consequences” as a result of being quarantined, furloughed, laid off or having work hours reduced due to COVID-19; or
    3. The plan participant is unable to work due to child care issues; or
    4. The plan participant is a business owner and operator who has had to close or reduce business hours; or
    5. The plan participant has experienced other factors as determined by the Secretary of the Treasury.

These penalty free distributions may be re-contributed to the retirement plan, or to another retirement plan within three years from the date of the distribution and such re-contribution will not count towards annual contribution limits without consequence. If the distributions are not re-contributed within the three year time period, the distribution will be taxable (though not subject to penalties) and the participant may spread the income tax over a three year period.

  1. Increase in Potential Loan Amounts and Payback Time: If the plan sponsor chooses and if the plan document permits loans, the CARES Act allows participants to borrow the lesser of 1) 100% of his or her vested account balance, or 2) $100,000. It also allows borrowers an extra year (from 5 to 6 years) to pay back loans and no payments are due in 2020.
  2. Required Distributions: For 2020, Required Minimum Distributions (“RMDs”) that would otherwise be required are no longer required and do not need to be made in 2020. The waiver of RMDs applies to all defined contribution plans (i.e. 401(a) plans, 401(k) plans, 403(a) plans, 403(b) plans, etc.).
  3. Charitable Distributions: Although RMDs are not required to be taken in 2020, a participant may still take a qualified charitable distribution (“QCD”) up to $100,000. The QCD made directly to a charity will not be includable as taxable income.

The CARES Act increases the deductible limit of cash gifts to public charities to 100%, up from 60% for 2020.

There is also a new above-the-line deduction up to $300 for charitable deductions, which allows those taxpayers who do not itemize to gain some benefit from charitable contributions.

Additional Provisions

The SECURE Act impacts on retirement account holders extend beyond 2020. Some important provisions are as follows:

  1. RMDs will start at Age 72: For participants who have not yet begun taking their RMDs, they will now be able to let their retirement funds grow an extra 1.5 years before starting to take their RMD. The SECURE Act pushes back the age that triggers RMDs from 70 ½ to age 72. Unfortunately, clients who have already begun taking their RMDs, but have not yet attained age 72 must continue to take their RMDs, though not in 2020, as discussed above.
  2. Extended Time to Make IRA Contributions: The SECURE Act repealed the rule that prohibited taxpayers who were age 70 ½ and older from making contributions to traditional IRAs. For clients who continue to work into their 70s and older they may continue to contribute to their IRAs as long as they are working.
  3. Ability to Use Retirement Account for Birth or Adoption of Child Without Penalties. Following the birth or adoption of a child, a new parent or parents may now withdraw up to $5,000 each from his or her account without incurring the usual 10% penalty on early withdrawals. Additionally, parents may make this withdrawal up to one year after the birth of the child and may put the money back into the retirement fund at a later date. When adopting a child, the penalty-free withdrawal is available as long as the adoptee is under 18 years of age, a spouse’s child, or is physically or mentally incapable of self-support.
  4. Expansion of Annuity Information and Options. The SECURE Act now requires 401(k) plan administrators to provide annual “lifetime income disclosure statements” to plan participants. The lifetime income disclosure statements will show plan participants how much money they could get each month if their total 401(k) account balance was used to purchase an annuity. Additionally, the SECURE Act makes it easier for 401(k) plan sponsors to offer annuities and other lifetime income options to plan participants.

Considerations for Post-Mortem Planning

One of the biggest changes caused by the SECURE Act for plan holders dying after December 31, 2019 is the end of the “stretch” IRA as we know it.

Prior to the enactment of the SECURE Act, qualified beneficiaries of inherited IRAs were able to use their lifetime, rather than the deceased owner’s, lifetime as the basis for making the RMDs. The SECURE Act still allows spouses, minor children, disabled beneficiaries (within the definition of IRC §72(m)(7)), chronically ill beneficiaries (within the definition of IRC §7702B(c)(2)), and beneficiaries less than ten years younger than the plan holder to stretch the RMDs over their lifetimes.

For all other beneficiaries, such as non-minor children or a trust, the entire retirement plan must be distributed out to the beneficiary by the end of the tenth year after the plan holder’s death. It should be noted that the plan does not have to be distributed pro rata over the ten years and may instead be taken out as lump sums as the inherited beneficiary needs so long as it is entirely withdrawn within ten years. Distributions are taxed as ordinary income in any year(s) that the beneficiary withdraws from the plan.

Given these changes, there are pros and cons to naming a trust or individual(s) as a beneficiary, especially when considering income tax ramifications and family dynamics. For example, a plan holder may want to delay a beneficiary from receiving retirement plan funds for as long as possible, but if a beneficiary receives the entire retirement fund in one lump sum at the end of ten years he or she may be stuck with a hefty income tax bill or even be pushed into a higher tax bracket. On the other hand, if a retirement plan is distributed out over ten years to mitigate the income tax responsibility it may result in a beneficiary having access to funds much sooner than the plan holder anticipated or wanted.

If you have any questions about what strategy might be best for your family and tax situation, such as leaving your retirement plans to a trust, please reach out to us and make an appointment to go over your current plan.

Posted In: COVID-19, News