There’s a new law in town, and it wants to help you improve your retirement savings outlook.
The Setting Every Community Up for Retirement Enhancement Act, known as the Secure Act, has many moving parts. Some of its provisions are aimed at individual savers; others are focused on employers.
Big picture, the act brings major changes to IRAs and 401(k)s, including the ability to delay distributions, reduced flexibility for inherited IRAs and penalty-free withdrawals for new parents.
Here are some money moves to consider as a result of the new law:
1. Plan ahead for inherited IRAs
Before the Secure Act, if you inherited an IRA from someone other than your spouse, you were required to take distributions from that account, but you could stretch out those payments over your entire life.
Under the new law, if an IRA owner dies in 2020 or after, the account’s beneficiaries must take all of the money out of the inherited IRA within 10 years after the year of the death. (Some beneficiaries, including spouses and minor children, are exempt from this rule.)
If you inherit a Roth IRA, this isn’t that big of a deal — everything comes out of a Roth tax-free. But with a traditional IRA, you must pay income tax on any distributions in the year you take the money out. (Learn more about the differences between Roth and traditional IRAs.) That could add up to a big tax hit, especially given a typical scenario, where, for example, an account owner in their 80s leaves a hefty IRA to an adult child in their 50s.
“That child is getting that money at a point in time when he or she is probably in their highest earning years,” says Ed Slott, founder of IRAHelp.com, based in Rockville Centre, New York.
That means they’re paying a higher tax rate, and that tax rate will apply to distributions from the inherited IRA, which are taxed as income. On top of that, the distributions may push the taxpayer into an even higher tax bracket.
Money move: If you inherit a traditional IRA, have a plan in place for withdrawals to avoid a big tax bill. You can choose the tempo of your distributions — a little bit every year for 10 years, all at once or some other pace. That gives you flexibility in managing your tax bill each year.
2. Rethink IRAs for estate planning
People who have hefty IRAs that they want to leave to their heirs need to consider the same provision described above: Non-spouse beneficiaries must empty inherited IRAs within 10 years. There’s no way to let that money continue to sit and grow, and the tax bill on distributions may be big.
“IRAs have received a major downgrade as an estate-planning vehicle,” Slott says. “They’re still good for accumulating money but they’re not good for leaving to beneficiaries.”
Money move: If you’re planning to leave a big IRA to your heirs, consult an estate plan expert to assess your best options under the new law. Some alternatives to look into, Slott says, include converting traditional IRA money to a Roth, so your heirs won’t owe tax on the distributions (this may mean a tax bill for you, so consult with a tax expert); investing in a cash-value life insurance policy, which can offer tax benefits; or contributing to charities from the IRA starting when you’re 70 1/2 (which can be done without incurring income taxes) and leaving other accounts to your beneficiaries instead.
3. Do more Roth conversions
The new law eliminates the age limit — previously 70 1/2 — on contributions to a traditional IRA. That means people who earn too much to be eligible to contribute directly to a Roth IRA can employ the strategy known as the backdoor Roth IRA — where you convert a traditional IRA into a Roth and sidestep the Roth IRA’s income limits — for longer.
Before the new law, “That strategy was not workable once you turned 70 1/2 because the process starts by being eligible to make a contribution to a traditional IRA,” Slott says. “Now, they can do the backdoor Roth even after 70 1/2.”
Money move: If you like the idea of avoiding required minimum distributions (which are required for traditional IRAs but not Roth IRAs) and of embracing the tax-free investment growth offered by a Roth, consider a strategy for systematic Roth IRA conversions past 70 1/2.
4. Max out IRA contributions for longer
As noted above, before the new law, contributions to a traditional IRA had to stop once you hit 70 1/2 (Roth IRAs have never had age limits). Now, there’s no age limit, so you can keep contributing.
But don’t forget: You need income from work to contribute to an IRA. (If you’re married and file your taxes jointly, a nonworking spouse can contribute to an IRA as long as each spouse’s IRA contributions combined don’t add up to more than the couple’s taxable compensation and don’t exceed annual contribution limits.)
Money move: Keep contributing to your IRA beyond 70 1/2 — for as long as you’re working.
5. Get the lowdown on annuities
The Secure Act makes it easier for employers to offer annuities in 401(k)s and similar workplace retirement plans.
Annuities make sense for some people, and can offer a helpful source of guaranteed income in retirement, but they’re not for everyone.
Money move: If you’re considering an annuity in your plan, work with a fee-only financial advisor to ensure it’s the right choice. Here’s more on how to decide if a retirement annuity is right for you.
6. Delay 401(k) and IRA withdrawals
Before the new law, you generally had to start taking required minimum distributions, or RMDs, from 401(k)s and IRAs when you turned 70 1/2.
Under the Secure Act, the age that RMDs must start has been pushed out to 72. This only matters for folks who don’t need to tap their savings earlier — many people can’t afford to wait.
That means the biggest benefit for most people may be this: No one has to wrap their heads around that half year anymore. “It confused people,” Slott says. “People would ask me, ‘When am I 70 1/2?'”
Money move: Plan your retirement income strategy before you retire. If you have enough savings in other accounts, or earn enough from Social Security or a job and you don’t need to tap your retirement accounts, you can take advantage of this new opportunity to delay retirement plan distributions until 72 — and let your retirement savings sit and grow longer, tax-deferred.
7. Students, save more
To contribute to a traditional or Roth IRA, you must have what the IRS calls “taxable compensation.” The annual IRA contribution limit is the smaller of your taxable compensation or the $6,000 ($7,000 if 50 or older) IRS limit.
Eligible types of income include wages, salaries, bonuses, tips and net income from self-employment. The new law adds a category of compensation that qualifies as eligible for IRA contributions: certain nontuition fellowships and stipends. That’s good news for graduate students, who are often paid that way.
Money move: If you receive qualified fellowships and stipends, try to stash at least some money in an IRA each year. Thanks to the power of compounding, even a small amount invested now can grow to power your retirement decades down the road.
8. New parents, breathe easier
IRAs, 401(k)s and other retirement plans offer sweet tax benefits and in return for those tax breaks, you need to abide by the fairly strict withdrawal rules or risk getting hit by a hefty 10% early withdrawal penalty.
But there are some exceptions to the early-withdrawal rules, and the new law adds one more: In the year you become a parent — through birth or adoption — you can withdraw up to $5,000 from your IRA or other retirement plans without getting hit by the penalty. You’ll still face income taxes. The $5,000 limit is per individual, so a couple could withdraw $10,000.
Money move: If you’re a new parent who is struggling financially, know that there’s a new avenue for finding financial relief, if necessary. That said, try to seek alternative sources of money if possible. Once you pull money out of a retirement account, you can never recover the lost investment growth on those dollars — although the new law allows you to repay the distribution back to a retirement account at any time.