In a rare bipartisan display, the House passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act by a vote of 417-3. The Act now goes to the Senate for reconciliation with similar bills and hopefully quick passage. The Act contains a broad array of non-controversial retirement-related provisions and some technical fixes to the 2017 tax bill. In this Alert we focus on the changes coming as early as 2020 that are most likely to be of interest to participants in existing retirement plans, including changes to required minimum distributions (RMDs) and new penalty-free withdrawals upon birth or adoption of a child.
RMDs at Age 72
The change that is probably generating the most headlines is the delay in beginning RMDs from the year in which a participant turns 70-1/2 until the calendar year in which he or she turns 72. The “age 70-1/2” rule has been around so long that this seems like a major change, but mostly it recognizes that employees are working longer and have longer life expectancies. It applies to all types of retirement plans and IRAs, and is effective for participants who turn 70-1/2 after 2019—if you turn 70-1/2 this year the existing rules still apply. Surviving spouses can likewise defer commencement until the participant would have turned age 72.
RMDs after Death
To pay for the delay in starting RMDs and other tax breaks, the law greatly accelerates RMDs to beneficiaries after death. Rather than beneficiaries being able to stretch out distributions over their lifetime, most beneficiaries other than surviving spouses will have to take distributions of the entire account by the end of the 10th year after death. That limit will apply whether the participant had begun taking distributions or not. This rule likewise applies to all plans and IRAs except defined benefit plans, and is generally effective for participants who die after 2019. (There is a delayed effective date for governmental and collectively bargained plans, and payments already being made under an annuity contract.) This will drastically affect some common tax and estate planning techniques. For example, it has been common to name the spouse as beneficiary, and then have the spouse name a much younger successor beneficiary to stretch out payments potentially over decades. Now the spouse will be able to take RMDs over the spouse’s life, but any successor beneficiary will have to take whatever is left within 10 years. There are some limited exceptions for disabled and “chronically ill” beneficiaries, children up to age 18, and non-spouse beneficiaries close to the participant’s age. Still, estate planners are already scheduling seminars to deal with this prospective change in the rules.
Penalty-Free Withdrawals for Children
Another provision that many participants will be interested in is the ability to take withdrawals of up to $5,000 within one year of the birth or adoption of a child, without the usual 10% penalty and without any showing of hardship. The bill specifies that such distributions will be treated as not violating the normal distribution restrictions for a retirement plan (other than a defined benefit plan) or IRA, but it isn’t clear whether plans need to be amended or whether a plan must add this feature. Each parent would be able to withdraw up to $5,000 total from their plans or IRAs, effective for distributions made after 2019—so participants could start to take distributions early in 2020 for children born in 2019. While the tax writers were concerned about “leakage” of retirement plan assets, they decided this limited exception would encourage young participants, who might also be thinking about starting a family, to start saving earlier. Another change under the Act does combat leakage—it would prohibit plan loans from being offered in the form of a credit card or debit card to discourage borrowing money from the plan to meet everyday expenses.
Lifetime Income Disclosures
The Act also incorporates a version of a rule that has long been under consideration by the Department of Labor (DOL), to require plan statements to show the estimated lifetime benefits that can be purchased with the participant’s account balance, even if the plan does not offer an annuity feature. This estimate would not have to appear on every quarterly statement, but only once every 12 months. These statements would not start to appear until a year after the DOL issues interim rules, a model disclosure form, and assumptions that plans should use to convert account balances to estimated annuity payments. DOL must act within one year after enactment, but may be prepared to issue those items fairly quickly, since it has essentially had them “on the shelf” since 2013.
Savings Opportunities for Part-Time Employees
Many 401(k) plans allow immediate eligibility for salary deferrals, but some plans still limit participation to employees who have a year of service (1,000 hours in a year). Concerned that this left part-time employees with only IRAs as savings vehicles, the Act requires 401(k) plans to allow long-term part-time employees to participate. Employees would become eligible after working three consecutive 12-month periods of 500 hours or more each. This requirement applies only to 401(k) plans, not 403(b) or 457(b) plans. It also expressly does not require any employer match or profit sharing contribution for part-time employees, and allows employers to exclude these employees when performing coverage and nondiscrimination testing. But it provides a foot in the door for salary deferral savings at a higher level than IRAs.