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Big Tax Changes to Retirement Plans

One of the highlights of the $426 billion bill signed by the President in late 2019 was the SECURE Act, “Setting Every Community Up for Retirement Enhancement Act of 2019.” This bill was years in the making and includes comprehensive changes that lift some of the long-standing restrictions on retirement plans. One of the biggest changes is the opportunity for small businesses to join with other businesses to offer a retirement plan to their employees, but there are many updates that benefit Americans planning for retirement.

Required Minimum Distributions (RMDs)

Starting in 2020, the age at which taxpayers will be required to take minimum distributions from their retirement plans is changed from 70 ½ to age 72. This change is especially helpful for taxpayers who continue to work past age 70 and do not need retirement plan distributions.

IRA Contributions After Age 70 & Inherited IRAs

The IRA changes are a mixed bag, but mostly taxpayer-friendly. While the legislation repeals the 70½ maximum age for traditional IRA contributions, the bill also disallows “stretch IRAs”, an estate planning strategy that extends the tax-deferred status of an inherited IRA when it is passed to a non-spouse beneficiary. Previously, taxpayers were allowed to recognize income from an inherited IRA over their life expectancy. Now, they must withdraw the funds and recognize the income within 10 years. Exceptions are included for some beneficiaries, including surviving spouses and the chronically ill or disabled.

More Annuity Options

Under the bill, employer-sponsored 401(k) plans will be better able to offer annuities as investment options. Annuities can convert a 401(k) plan into a guaranteed stream of lifetime income. Previously, companies did not offer many annuity options in their 401(k) plans because of possible legal exposure if something went wrong.

Retirement plans will now have a “safe harbor” protecting them from lawsuits if the annuity stops making payments. More annuity options are likely to be offered by employer plans, meaning taxpayers could face a greater risk of losing retirement funds. It is important to get independent advice from your financial planner when choosing any new annuities offered.

More Small Employer Plans

The new law makes it easier for small employers to join together to sponsor a single retirement plan for their workers. In the past businesses had to join up with other businesses that shared a common economic or representational interest (common industry etc. or professional association) to form a multiple employer plan. The new legislation increases the ability of unrelated employers to band together to offer plans to their employees. The new law also eliminates the “One Bad Apple” rule where a regulatory violation by a single employer in the multiple employer plan could potentially disqualify the entire multiple employer plan. These changes should decrease costs and encourage more small business to create plans for their employees.

The law also increases the credit limitation for small employer pension plan start-up costs by changing the calculation of the flat dollar amount limit to the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of non-highly compensated employees who are eligible to participate in the plan or (b) $5,000. The credit applies for up to three years.

Mandated Plans for Part-Time Workers Starting in 2021

Under current law employers may generally exclude part time employees from plan eligibility based on a 1000 hour per year plan rule. The new law, effective in 2021, requires employers maintaining a 401(k) plan to use a dual eligibility requirement when excluding part time employees. Under the dual eligibility requirement an employee must complete a one year of service requirement (with the 1000 hour rule) or 3 consecutive years of service where the employee completes more than 500 hours of service. With regards to those employees that become eligible under the 500 hour rule, the employer may elect to exclude such employees from testing under the nondiscrimination and coverage rules.

Other Retirement Changes

The budget bill also:

  • Enhances the ability of employees to transfer their retirement plan assets when they change jobs.
  • Increases the cap on automatic escalation of employee deferrals under automatic enrollment safe harbor plans from 10% of compensation to 15%.
  • Encourages employees to increase their retirement savings annually through automatic increases in contributions to 401(k) plans. The bill also requires that benefit statements provided to Defined Contribution plan participants must include a lifetime income disclosure at least once during any 12 month period. The disclosure would illustrate the monthly payments the participant would receive if the total account balance was used to provide a lifetime income stream.
  • Prohibits the distribution of plan loans through credit cards or similar arrangements.
    Allows parents to withdraw up to $5,000 from a retirement account within a year of a child’s birth or adoption without incurring the 10% penalty for early withdrawals.

There is a lot of good news in the SECURE Act for American taxpayers. These retirement provisions have the potential to change important decisions made by taxpayers, so this year it is especially important to consult your Frazier & Deeter tax advisor to discuss what the changes mean for you. If you have questions about your benefit plan, please contact Jeff.James@frazierdeeter.com.

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