The $1.4 trillion spending package enacted on December 20, 2019 and recently signed by the President, included the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which overwhelmingly passed the House of Representatives in the spring of 2019, but then subsequently stalled in the Senate. The SECURE Act represents the most sweeping set of changes to retirement legislation in more than a decade. While many of the provisions offer enhanced opportunities for individuals and small business owners, there is one notable drawback for investors with significant assets in traditional IRAs and retirement plans. These individuals will likely want to revisit their estate-planning strategies to prevent their heirs from potentially facing unexpectedly high tax bills. Read more on this below. All provisions take effect on or after January 1, 2020, unless otherwise noted.
Elimination of the “Stretch IRA”
Perhaps the change requiring the most urgent attention is the elimination of longstanding provisions allowing non-spouse beneficiaries (usually one’s children) who inherit traditional IRA and retirement plan assets to spread distributions — and therefore the tax obligations associated with them — over their lifetimes. This ability to spread out taxable distributions after the death of an IRA owner or retirement plan participant, over what was potentially such a long period of time, was often referred to as the “stretch IRA” rule. The new law, however, generally requires any beneficiary who is more than 10 years younger than the account owner to liquidate the account within 10 years of the account owner’s death unless the beneficiary is a spouse, a disabled or chronically ill individual, or a minor child until they reach the age of majority. This shorter maximum distribution period could result in unanticipated tax bills for beneficiaries who stand to inherit high-value traditional IRAs. This is also true for IRA trust beneficiaries, which may affect estate plans that intended to use trusts to manage inherited IRA assets. If an individual currently has a trust named as a beneficiary, it is recommended to review and possibly update your estate plan. In addition to possibly reevaluating beneficiary choices, traditional IRA owners may want to revisit how IRA dollars fit into their overall estate planning strategy. For example, it may make sense to consider the possible implications of converting traditional IRA funds to Roth IRAs, which can be inherited income tax-free. Although Roth IRA conversions are taxable events, investors who spread out a series of conversions over the next several years may benefit from the lower income tax rates that are set to expire in 2026 .
Benefits to Individuals
On the plus side, the SECURE Act includes several provisions designed to benefit American workers and retirees.
• People who choose to work beyond traditional retirement age will be able to contribute to traditional IRAs beyond age 70½. Previous laws prevented such contributions.
• Retirees will no longer have to take required minimum distributions (RMDs) from traditional IRAs and retirement plans by April 1 following the year in which they turn 70½. The new law generally requires RMDs to begin by April 1 following the year in which they turn age 72. The RMD change to 72 only applies to those that turn 70½ in 2020 and beyond. Those that turned 70½ in 2019 are still under the old rules.
• The age for Qualified Charitable Contributions is still 70½, so individuals can make charitable contributions up to $100,000 directly from their IRA before RMDs begin at age 72, creating a unique opportunity for charitably included individuals.
• Part-time workers age 21 and older who log at least 500 hours in three consecutive years generally must be allowed to participate in company retirement plans offering a qualified cash or deferred arrangements. The previous requirement was 1,000 hours and one year of service. (The new rule applies to plan years beginning on or after January 1, 2021.)
• Workers will begin to receive annual statements from their employers estimating how much their retirement plan assets are worth, expressed as monthly income received over a lifetime. This should help workers better gauge progress toward meeting their retirement-income goals.
• New laws make it easier for employers to offer lifetime income annuities within retirement plans. Such products can help workers plan for a predictable stream of income in retirement. In addition, lifetime income investments or annuities held within a plan that discontinues such investments can be directly transferred to another retirement plan, avoiding potential surrender charges and fees that may otherwise apply.
• Individuals can now take penalty-free early withdrawals of up to $5,000 from their qualified plans and IRAs due to the birth or adoption of a child. The $5,000 amount is a per child limit and can be used for each subsequent child. Regular income taxes will still apply, so new parents may want to proceed with caution.
• Taxpayers with high medical bills may be able to deduct unreimbursed expenses that exceed 7.5% (in 2019 and 2020) of their adjusted gross income. In addition, individuals may withdraw money from their qualified retirement plans and IRAs penalty-free to cover expenses that exceed this threshold (although regular income taxes will apply). The threshold returns to 10% in 2021.
• 529 account assets can now be used to pay for student loan repayments ($10,000 lifetime maximum) and costs associated with registered apprenticeships.
Benefits to Employers
The SECURE Act also provides assistance to employers striving to provide quality retirement savings opportunities to their workers. Among the changes are the following:
• The tax credit that small businesses can take for starting a new retirement plan has increased. The new rule allows employers to take a credit equal to the greater of (1) $500 or (2) the lesser of (a) $250 times the number of non-highly compensated eligible employees or (b) $5,000. The credit applies for up to three years. The previous maximum credit amount allowed was 50% of startup costs up to a maximum of $1,000 (i.e., a maximum credit of $500). • A new tax credit of up to $500 is available for employers that establish an auto enroll feature on a SIMPLE IRA or 401(k) plan. This applies to any plan and not just new ones. The credit applies for three years.
• With regards to the new mandate to permit certain part-timers to participate in retirement plans, employers may exclude such employees for nondiscrimination testing purposes.
• Employers now have easier access to join multiple employer plans (MEPs) regardless of industry, geographic location, or affiliation. “Open MEPs,” as they have become known, offer economies of scale, allowing small employers access to the types of pricing models and other benefits typically reserved for large organizations. (Previously, groups of small businesses had to be affiliated somehow in order to join an MEP.) The legislation also provides that the failure of one employer in an MEP to meet plan requirements will not cause others to fail, and that plan assets in the failed plan will be transferred to another. (This rule is effective for plan years beginning on or after January 1, 2021.)
• Auto-enrollment safe harbor plans may automatically increase participant contributions until they reach 15% of salary. The previous ceiling was 10%.
IRA contribution limits
The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2020 is $6,000 (or 100% of your earned income, if less), unchanged from 2019. The maximum catch-up contribution for those age 50 or older remains at $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2020, but your total contributions can’t exceed these annual limits.
Traditional IRA income limits
If you are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. For those who are covered by an employer plan, the income limits for determining the deductibility of traditional IRA contributions in 2020 have increased. If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2020 if your modified adjusted gross income (MAGI) is $65,000 or less (up from $64,000 in 2019). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) in 2020 if your MAGI is $104,000 or less (up from $103,000 in 2019).
If you’re not covered by an employer plan but your spouse is, and you file a joint return, your deduction is limited if your MAGI is $196,000 to $206,000 (up from $193,000 to $203,000 in 2019), and eliminated if your MAGI exceeds $206,000 (up from $203,000 in 2019).
Roth IRA income limits
The income limits for determining how much you can contribute to a Roth IRA have also increased for 2020. If your filing status is single or head of household, you can contribute the full $6,000 ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $124,000 or less (up from $122,000 in 2019). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $196,000 or less (up from $193,000 in 2019). (Again, contributions can’t exceed 100% of your earned income.)
Employer retirement plans
Most of the significant employer retirement plan limits for 2020 have also increased. The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan is $19,500 in 2020 (up from $19,000 in 2019). This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2020 (up from $6,000 in 2019). (Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.) If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2020 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2020 (plus any catch-up contributions). The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) is $13,500 in 2020 (up from $13,000 in 2019), and the catch-up limit for those age 50 or older remains at $3,000.
The maximum amount that can be allocated to your account in a defined contribution plan (for example, a 401(k) plan or profit-sharing plan) in 2020 is $57,000 (up from $56,000 in 2019) plus age 50 catch-up contributions. (This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.)
Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2020 is $285,000 (up from $280,000 in 2019), and the dollar threshold for determining highly compensated employees (when 2020 is the look-back year) is $130,000 (up from $125,000 when 2019 is the look-back year).
Being the bearer of bad news isn’t fun.
When the third-party administration firm relays that aspects of the annual compliance testing have failed causing many of the company’s executives to receive taxable distributions from the plan, it isn’t a great day for the HR manager. The administrator explains that the regulations require testing to prevent highly paid employees from receiving disproportionately greater benefits than other employees. At a much-needed lunch that day, the HR manager learns from a colleague that they once had the same issue but adopted a “safe harbor” design to solve the problem.
In their 61st Annual Survey of Profit Sharing and 401(k) Plans, the Plan Sponsor Council of America reports that, of the 605 plan sponsor respondents to the survey, 42% reported using a safe harbor design. Since December 1st, 2019 marks the last day to make a safe harbor election for 2020 calendar year plans, understanding the pros and cons of these elections will help you decide if a safe harbor design is the right choice for your plan.
Each year in a non-safe harbor plan, a series of nondiscrimination tests are performed to demonstrate that the contribution rates for highly compensated employees (HCEs) are not disproportionately larger than those for non-HCEs (NHCEs). HCEs are generally owners of more than 5% of the company and any employee with compensation in the prior plan year over a specified level ($125,000 for 2019). If a plan elects to be “safe harbor” for any given year, the compliance testing can be avoided by meeting the safe harbor standards. One of the main reasons for adopting a safe harbor design is to allow HCEs to defer up to the maximum dollar limit ($19,000 for 2019) without the potential limitation of the participation rate of the NHCE group.
So, what’s the trade off? In order to satisfy a safe harbor election, the employer is required to comply with safe harbor standards which include the following:
Does your plan include an automatic enrollment feature? If so, a modified version of the safe harbor plan is available for you. The rules for so-called Qualified Automatic Contribution Arrangements (QACA) are similar to the regular safe harbor rules, except that the QACA matching requirement is 100% of the first 1% of compensation deferred, plus 50% of the next 5% of compensation deferred (maximum match of 3.5%). In addition, safe harbor contributions under the QACA must be 100% vested after two years of service rather than the immediate vesting required of traditional safe harbor plans. The participant notice must contain additional information describing the automatic enrollment features.
A safe harbor design is an excellent way for many employers to get the most out of their 401(k) plans. By eliminating nondiscrimination testing, all employees can contribute up to the annual deferral limit and not be concerned about the possibility of refunds after year-end. If you think a safe harbor option is right for your plan, contact us.
On Sept. 23rd, the IRS published a final rule that relaxes several existing restrictions on participant hardship distributions from defined contribution plans.
Some of these changes are mandatory, requiring employers to make the changes by Jan. 1st, 2020, while others are optional. Though the IRS had issued the proposed regulations in 2018, the final regulations clarify a few key provisions:
For plan sponsors who use “pre-approved” plan documents for their 401(k) plans, the due date to amend your plan for the new regulations is the same as the tax filing deadline (including extensions) for the year in which the provisions become effective. For example, if the new rule is effective on January 1st, 2020 for a plan sponsor with a calendar fiscal year, the due date for amending the plan is the due date of the plan sponsor’s 2020 return including extensions. Regardless of the amendment date, compliance must begin on January 1st, 2020. For those who maintain individually designed plans, the deadline will be December 31st, 2021 regardless of plan year.
Plan Sponsors that took action on the proposed regulations should review their plan and operational processes to ensure compliance with the new rules and can contact us with any questions.
1st: Participant Notices – Annual notices due for Safe Harbor elections, Qualified Default Contributions (QDIA), and Automatic Contribution Arrangements (EACA or QACA).
31st: Participant Notices – Annual notices due for ERISA 404(c) and Fee Disclosure.
31st: Discretionary Amendments – Deadline to adopt discretionary plan amendments for calendar-year plans. If changes have been made to your retirement plan this year, the amendment documenting this change must be signed by the last day of the plan year in which it became effective.
31st: Required Minimum Distributions – Participants who have attained age 70 1/2, and have begun receiving distributions from their account, are required to receive a distribution each year prior to December 31st.
31st: IRS Form 945 – Deadline to file IRS Form 945 to report income tax withheld from qualified plan distributions made during the prior plan year. The deadline may be extended to February 10th if taxes were deposited on time during the prior plan year.
31st: IRS Form 1099-R – Deadline to distribute Form 1099-R to participants and beneficiaries who received a distribution or a deemed distribution during prior plan year. A deemed distribution can occur if a participant fails to make timely loan repayments.
31st: IRS Form W-2 – Deadline to distribute Form W-2, which must reflect aggregate value of employer-provided employee benefits.