The Secure Act, part 1

Erik (00:06):

You're listening to uncommon sense, a podcast by Bowman Financial Strategies. I'm your host, Erik Bowman and thank you for joining me today. Hi everyone. This is Erik Bowman, your host and it's January 22nd, 2020.

Erik (00:27):

One of the highest priorities we have is providing our clients accurate information to allow them to make informed decisions relating to their retirement income. Taxation is probably the biggest expense retirees will face in retirement and bringing actionable information to make confident decisions is a core philosophy of the Bowman Financial Strategies LiveWell Formula. The LiveWell Formula is our process of analyzing our client's current situation, managing their financial investments, coordinating their distributions from various accounts with the goal to minimize taxes and increase net income. It also includes detailed social security, filing, timing and pension planning. Recommendations for some estate planning and legacy planning are a part of the plan. In this episode, I am going to cover some of the highlights of the Secure Act approved by the Senate on December 19th, 2019. The Secure Act addresses many issues relating to retirement savings and distribution. Like everything in this world though there is some good news and some bad news in this new legislation. My goal is to provide you an education of the main components of the law and understand how it may impact you personally and additionally, we want to address how this new law may require changes to our retirement plan to both take advantage of the new provisions and to minimize the pain associated with others.

Erik (01:57):

The setting every community up for retirement enhancement act of 2019, better known as the Secure Act, which originally passed the house in May of 2019, was approved by the Senate on December 19th, 2019 and signed into law by the president on December 20th of 2019. The bill includes significant provisions aimed at increasing access to tax advantaged accounts and preventing older Americans from outliving their assets. There are a few key provisions regarding required minimum distributions and inherited IRAs that should be considered.

Erik (02:39):

In addition to the inherited IRA and required minimum distribution provisions, there are other aspects of the Secure Act. First, IRA contributions can now be made after the age of 70 and a half as long as you're still working. Employees can contribute to their own or their spouse's IRA after they've reached the age of 70 and a half. Long term part time workers are now able to join their company's 401k plan. Employees that work over a thousand hours in one year or over 500 hours in three consecutive years are now able to participate in their employer's 401k. Small business employers, of a hundred employees or less, will receive a maximum tax credit of $5,000. That's $250 per non highly compensated employee. When they establish a retirement plan, account owners are able to withdraw up to $5,000 penalty free from their retirement plan upon the birth or adoption of a child. This will be free from the 10% early withdrawal penalty, but will still be subject to ordinary income tax. Further, 529 Plans can be used to pay down student loan debt and small business owners can now more easily establish Multiple Employer Plans, or MEPs, by allowing unrelated employers to join together in the creation of a plan. The employers no longer have to be related by common ownership or by being in the same industry among other options.

Erik (04:05):

But for today we're going to really focus in on the required minimum distribution aspect and then our next podcast we are going to focus in on the inherited IRA changes. Today I'm going to focus on the required minimum distribution changes. They are pretty exciting and I think that most retirees would look at this as a benefit. I am going to talk about the pros and cons of this change, however. So the age for required minimum distributions has increased the age at which a retirement plan participant needs to take required minimum distributions has been pushed back from 70 and a half to age 72. What that means is in the previous setup, when you reach 70 and a half, you had to begin taking required minimum distributions by April of the following year based on a calculation by the federal government. Now they've pushed off the required minimum distributions until age 72, allowing a retiree to allow their IRA to continue to grow tax deferred until age 72. Individuals who are tr who turned 70 and a half on 1-1-2020 or later will not have to begin taking RMDs until April of the year following the year in which they turned 72. Individuals who have turned 70 and a half prior to the end of 2019 are not affected and must take out RMDs based on that 70 and a half mile stone.

Erik (05:37):

So let's dig into this a little bit. First, the old 70 and a half methodology was simply confusing. Why use a midyear data point to increase the odds of someone making a mistake and having to pay a 50% penalty to the government? Sounds a little bit like one of those questions that already has the answer pretty well known so I'll let you mull that over on your own. Don't forget that that penalty for noncompliance, again with the required minimum distributions, is 50% on the amount you were supposed to take out payable to the treasury. Now that the RMD start date is age 72 the first question is why? The second is how can we leverage this to the advantage of our clients? The primary published reason for increasing the RMD age is because people live longer. By previously forcing distributions and taxation at 70 and a half, the government was potentially forcing distributions from a person that might not necessarily need them and therefore forcing them to incur a tax bill that they otherwise would not create and potentially forcing them to liquidate their IRA earlier than hoped during the course of retirement. For more information on the general RMD provisions and how they functioned, by the way, I do have a dedicated podcast to all things RMDs that I did earlier in 2019 you might want to check that out.

Erik (07:04):

The benefit of the later age requirement of age 72, is that a client may continue to defer taxes in their IRA until age 72 which would result in a larger tax deferred account balance at age 72. And this sounds good at first glance. However, to get good use out of that, you would have to consider not taking distributions from your IRA until age 72. That can be a pretty big challenge for people who aren't generating income through wages and who may only have a social security income coming in. This could force you to actually take social security earlier than hoped for if you decided you wanted to bridge that gap and delay until age 72. For our clients, we're going to be running revised 30 year projections considering expenses, various social security filing strategies, and various IRA distribution strategies along with Roth conversions to determine the optimal combination of tactics to provide efficient net income after taxes.

Erik (08:07):

To clarify the new age 72 rule. Here are two examples to highlight the basic provisions. Example one John's birthday is April 20th and he turned 70 and a half in 2020. Will he need to take RMDs in 2020? The answer is no because John turned 70 and a half after the start of 2020 so he will not need to take RMDs until April of the year after he turned 72. John will turn 72 on April 20th, 2021. He will need to begin taking his first RMDs by April of 2022. Example two Sue's birthday is June 20th, and she turned 70 and a half in 2019. Will she need to take RMDs in 2020? The answer is yes because Sue turned 70 and a half before the end of 2019 she will need to take her first RMD by April of 2020, the year after the one in which she turned 70 and a half.

Erik (09:16):

Suffice to say, most people would say this is a win for retirees and I agree on many levels. However, it may not be as powerful for those that need to already take IRA distributions to meet the expense needs from mid sixties to age 72. In addition, not to be cynical, but let's walk through this from the government's perspective. First, by allowing you to delay until age 72, theory goes, your account balance should be larger. That means the formula used to calculate your RMDs at age 72 will result in a larger distribution than you would have taken at age 70 and a half so this can lead to a scenario. Will you be unknowingly pushed into a higher tax bracket than you otherwise would have been if you had taken strategic action in the decade leading up to age 72. The government actually likes this because they will get larger tax proceeds starting in 2021 and potentially larger account balances and IRAs may be passed on to children, or what we call non spousal beneficiaries. And the issue here is that with the new inherited IRA changes in the secure act, it can result in tremendous taxation at very high tax brackets for your non spouse beneficiaries.

Erik (10:33):

Usually a child. More on that. The inherited IRA changes in my next podcast.

Erik (10:43):

However, one strategy that may become more advantageous because of this and other secure act provisions is the Roth conversion opportunity. Roth IRAs are not subject to required minimum distributions and are tax free at distribution. The taxes are paid at contribution or the year of conversion. This strategy can lower your taxable IRA balance, therefore allowing you to control your tax bracket more efficiently and effectively in retirement. Make sure you evaluate the pros and cons of the strategy with your current advisor and make sure it fits into your long-term tax strategy. Certainly everyone should at least explore this option. If you're not a client and you want to hear more about Roth conversions and other tax mitigation strategies for those approaching or in retirement, how it may impact your plan, please feel free to reach out to my office and schedule some time to chat. If you are a client you can expect in your next financial review, there's going to be a detailed review of Roth conversion strategies and other strategies appropriate for your situation.

Erik (11:51):

In my next podcast, I am going to review another provision of the secure act, the change to inherited IRAs. This specifically applies when passed onto a non spouse, a child for example. This has a distinctly negative impact on your family from a tax perspective and must be addressed with proper planning beyond the lookout for that podcast soon. In closing, the takeaway from this new legislation is that retirement planning is not a once and done project. It is never ending requiring detailed knowledge of the tax system, current law and the tools and strategies to address these challenges as they come. The government can and does change very meaningful laws on a regular basis. The Secure Act is simply one recent example. Your plan should be flexible enough to adjust as the world around you changes and you should have access to a professional that understands not only your family's needs and goals, but also the external world that will impact those needs and goals.

Erik (12:53):

Thanks for listening today and as always you can hear my podcasts on Apple, Stitcher, Google Play and others. And you can also go to the Bowman Financial Strategies podcast web page and listen to them right there. Have a great day. Tell a friend about us if you think this information is helpful and I look forward to hearing from you soon. Thank you for joining me for Uncommon Sense, the Bowman Financial Strategies financial education series. I'd love to hear your feedback on financial topics you would like to learn more about. Just drop me an email at Erik, that's E R I K @ bowmanfinancialstrategies.com or go to the Bowman Financial Strategies website and send me a note on our contact page. In addition, you can always search for topics of interest in my archive on our podcast page at www.bowmanfinancialstrategies.com/podcasts. Have a great day.

Speaker 3 (13:53):

This communication does not constitute federal tax advice and may not be used as such. Please consult a qualified tax professional for tax advisor assistance. In addition, investment advisory services offered by ChangePath LLC, a registered investment advisor, change path and Bowman Financial Strategies are unaffiliated entities.