Signed into law on December 20, the SECURE Act introduced several changes that may have important implications for today’s younger investors, including student loan repayment and assistance with starting a family. Retirement Director Ben Rizzuto outlines the key provisions to be aware of.
When a significant piece of legislation like the SECURE Act passes, millennials or younger investors tend to assume it will only affect older people or those with substantial wealth. But some of the legislation’s key provisions have important implications for today’s younger generations.
The End of the Stretch IRA
One of the most significant changes introduced with the SECURE Act is the elimination of the “stretch IRA.” In the past, the recipients of an inherited IRA could distribute assets from the account based on their own life expectancy. Since a child or grandchild would typically receive these assets at a relatively young age, this strategy allowed those young recipients to potentially “stretch” the life of the IRA over several years, if not decades. It also allowed them to limit the income tax hit of distributions by stretching the period during which assets grew tax-deferred.
With the passage of the SECURE Act, IRAs inherited by non-spouse beneficiaries now must be depleted within 10 years of receipt, which will lead to significant increases in income and taxes for younger investors. While there’s no getting around the 10-year rule, IRA owners and their beneficiaries may want to consider exploring one of the following other options:
Convert the Traditional IRA to a Roth Prior to Inheritance. While converting to a Roth means the IRA owner will need to pay taxes up front, the recipient is then protected from having to pay taxes. When converting, it makes sense to pay the taxes with liquid assets outside the IRA to keep the IRA “whole” and allow assets to continue growing.
Establish a Charitable Remainder Trust. Another option is to move IRA assets into a trust and name a beneficiary. The beneficiary would receive a taxable payment for up to 20 years, but the assets can continue to grow tax-free within the trust. Whatever is left in the trust at the end of a predetermined term or at the end of the beneficiary’s life will then be passed on to one or more charities.
Additionally, based on the tax implications this type of inheritance could present for recipients, it may make sense to gift beneficiaries not only IRA assets, but also cash based on their respective tax brackets. This strategy can also help make things more equitable, which is something many parents and grandparents aim to do when leaving assets to more than one child or grandchild.
529 Plans May Now Be Used to Repay Student Loans
Millennials are the best-educated generation in U.S. history. However, the rising costs of higher education – combined with a spotty job market over the past 25 years – have left this group saddled with unprecedented student loan debt that they are struggling to pay off.
The SECURE Act offers a few options to consider for managing student loan debt. With the passage of the Tax Cuts and Jobs Act of 2017, 529 account assets became usable not only for university tuition but for K-12 expenses as well. Under the SECURE Act, these assets can now be used for student loan repayments and apprenticeship programs.
Families may use up to $10,000 from their 529 savings plan to repay student loan debt. These “Qualified Education Loan Repayments” will now be viewed as a qualified educational expense. The $10,000 is a lifetime limit; however, note that an additional $10,000 distribution may be taken to help pay for student loans for each of the 529 plan’s beneficiary’s siblings. (For example, a parent with three children may take a $10,000 distribution to pay student loans for each child – a total of $30,000.)
Additionally, for those who may not wish to pursue a university degree, 529 plan assets may be used to help develop skills through a qualified apprentice program. Just as with college-related expenses, these assets can be used to cover fees, books, supplies and required equipment, provided the program is registered and certified with the Department of Labor. (For more information on apprenticeship programs available in your area, visit www.apprenticeship.gov.)
Finally, the SECURE Act now allows individuals who are in graduate or post-doctorate programs to count taxable non-tuition fellowship and stipend payments as compensation for IRA contribution purposes, starting in 2020.
Assistance with Starting a Family
In 2018, the U.S. birthrate decreased to 1.72 births per American woman – the lowest point in 32 years. Part of this stems from the fact that fewer and fewer millennials are having children based largely on the cost. However, for those younger couples who do want to start a family soon, the SECURE Act provides some assistance.
To help with the costs associated with childbirth or adoption, a new exception to the 10% early distribution penalty was introduced, allowing up to $5,000 to be distributed penalty-free from an IRA or retirement plan as a “Qualified Birth or Adoption Distribution.”
Of note is the fact that the distribution may be taken from the IRA or plan one year from the date of birth or the date on which the adoption is finalized. In other words, these distributions must be used to “reimburse” oneself for expenses incurred during the adoption process or after the date of birth or adoption. Additionally, this $5,000 exception is available for “any birth or adoption,” which means it may be used for more than one birth/adoption.
Of course, while these distributions are helpful for short-term expenses, the goal should be to eventually replenish the amount taken from the IRA or plan. Based on language in the SECURE Act, those who take these distributions may repay the amounts taken, which could mean that an additional contribution would be possible over and above standard contribution limits. (Future guidance from the U.S. Treasury Department should provide more clarity on the rules surrounding re-contributions.)
As we’ve noted previously, the SECURE Act offers a number of different options for many types of investors. And even though retirement is a long way off for millennials, the legislation provides several ways to help younger investors plan for the future.
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