The New and “Improved” IRA

Subtopic: The Rise of Rosé Air Date: July 15th, 2020

Individual Retirement Accounts (IRA) were introduced in 1974 and continue to be one of the most popular vehicles for retirement savings. They are relatively straightforward and almost anyone can benefit from IRA’s, though they are quite simple. However, these seemingly ubiquitous retirement accounts have experienced some major modifications in recent months.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act and the Coronavirus Aid, Relief, and Economic Security (CARES) Act, both recently signed into law by President Trump, are intended to help Americans save more for retirement and provide relief for individuals affected by the coronavirus (COVID-19) pandemic. So, if you have an IRA or other retirement plan, you will be glad you tuned in.

Today we want to highlight 5 changes brought about by these Acts.

Change #1: The maximum age for making traditional IRA contributions is repealed.

Before 2020, traditional IRA contributions were not allowed beyond age 70½. Starting in 2020, however, as long as you have earned income from wages or self-employment, IRA’s can be included in your savings program.

This SECURE Act provision is effective for 2020 and later tax years, and is not retroactive. This means IRA owners age 70½ or older in 2019 cannot make prior-year contributions for 2019 in 2020, as they fall under the old eligibility rule.

This change brings the rules for traditional IRAs more in line with Roth IRAs, which have never had an age restriction for making contributions.

Change #2: The required minimum distribution (RMD) age changed from 70½ to 72.

Before 2020, retirement plan participants and IRA owners were required to take annual distributions known as RMDs. These “Required Minimum Distributions”, first applied in the early ’60s, begin by April 1 of the year following the year the account owner reaches age 70½. The impetus to this recent change is increased life expectancies.

To be clear, persons 70 ½ in 2020 will be able to delay their RMD to 72.

Change #3: “Stretch IRAs” were partially eliminated.

If a plan participant or IRA owner died before 2020, their beneficiaries (spouses and non-spouses) were generally allowed to stretch out the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life or life expectancy. This is sometimes called a “stretch IRA.”

Starting with IRA owner deaths in 2020, most non-spouse beneficiaries who are more than 10 years younger than the IRA owner must distribute their inherited IRA assets within 10 years of the IRA owner’s death.

There are exceptions to the 10-year payout rule for beneficiaries who, at the time of the IRA owner’s death, are:

  • Married to the IRA owner
  • Disabled
  • Chronically ill
  • No more than 10 years younger than the IRA owner
  • Minor children of the IRA owner
  • Recipients of certain annuitized payments begun before the enactment of the SECURE Act

There are some exceptions to the 10-year rule. For example, it’s still allowed for: the surviving spouse of a plan participant or IRA owner; a child of a plan participant or IRA owner who hasn’t reached the age of majority; a chronically ill individual; and any other individual who isn’t more than 10 years younger than a plan participant or IRA owner. Those beneficiaries who qualify under this exception may generally still take their distributions over their life expectancies.

Change #4: Penalty-free withdrawals are now allowed for birth or adoption expenses.

A distribution from a retirement plan must generally be included in income. A “qualified birth or adoption” distribution is exempt from the 10% early distribution penalty tax (if applicable) for distributions of up to $5,000 in aggregate from IRAs and defined contribution retirement plans, 403(b) plans, and governmental 457(b) plans, per individual.

The $5,000 limit applies separately to each birth or adoption. A qualified adoptee is anyone (other than a child of the taxpayer’s spouse) under age 18 or an individual who is incapable of self-support.

The $5,000 amount applies on an individual basis. Therefore, each spouse in a married couple may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption.

Change #5: IRA contributions by graduate students.

Based on the SECURE Act, Effective for 2020 and later years, certain stipends, fellowships, and similar payments to graduate and postdoctoral students will be treated as eligible compensation for IRA contribution purposes.

Previously, because some of these types of payments were not considered eligible compensation, graduate students were not able to make IRA contributions unless they had compensation from other sources.