Final SECURE 2.0 regulations

 The IRS has finally issued its long-awaited Final Rule implementing the “SECURE 2.0” legislation governing distributions to non-spouse designated beneficiaries of IRAs, 401(k) plans, and similar retirement vehicles. Although this release affects a number of finalized regulations, one of the most important for IRA owners and their families involves the long-uncertain question of whether required minimum distributions (RMDs) will be needed during the 10-year period that applies to “non-eligible designated beneficiaries.” The IRS’s final answer is: If the owner of the account had reached his Required Beginning Date (which usually means he has started taking required distributions), then those distributions must continue during the 10-year period. If he had not, then no RMDs are needed. 

These RMDs will be based on the owner’s life expectancy, not that of the beneficary(ies), under the statutory rule that the distributions must continue “as least as rapidly” as they had been before the death of the owner. 

Recall our earlier posting advising that many non-eligible designated beneficiaries can benefit from a shortened period (six years or so) rather than trying to plan distributions over the entire 10-year period. 

Dancing with IRMAA and MAGI

Jane is a widow. Her 76-year-old husband died in late 2019. She has assets and income for 2020 that look like this: 

• Widow’s social security benefits, based on 100% of her husband’s benefit - $2,700 per month, $32,400 per year  
• An IRA with a balance that generates RMDs of $35,000 this year
• Investments that generate income of $27,000 

Jane is 72. She has been on Medicare for seven years. This year, she is paying $144 per month as the premium for Part B coverage, and another $20 per month for Part D (prescription drugs), subject to a $435 per year deductible. 

Jane and her husband never had to worry about possible increases to their Part B and Part D premiums in past years. The threshold for those increases for a married couple is about $176,000, and their annual income was well within those limits. But now Jane has to dance with IRMAA. 

IRMAA is the awkward acronym that stands for “Income-Related Monthly Adjustment Amount.” The Social Security Administration, which manages Medicare payments and premiums, will increase the Part B and Part D premiums for beneficiaries who have more than a threshold income. Jane is now a single woman, and her income threshold is now $88,000. Jane now has to be concerned about that threshold. She has to dance with IRMAA. 

Trying to figure out how to know where the line is can be pretty complicated. The total of all of her sources of income is $92,400 per year. Her Adjusted Gross Income (AGI) is $4,860 less than that because only 85% of her social security income is taxed. But the technical rule requires that the income that is considered be calculated based on Modified Adjusted Gross Income, or MAGI. Without getting into too much detail, we can note that, for most people, MAGI will be the same as or pretty close to AGI. The untaxed portion of social security benefits is not included in MAGI for this purpose, either, but there are other items that, after being removed to calculate AGI, are put back in to calculate MAGI. 

The important thing for Jane and those in her situation to know is: If her MAGI gets into the mid-$80,000s or higher, she should keep IRMAA and MAGI in mind, and seek advice to avoid running over the line if possible, or be prepared to accept the higher Medicare premiums. Interestingly, her 2020 income will affect the calculation of her Medicare premiums for 2022. 

In truth, IRMAA will be a problem for Jane only if her total MAGI for 2020 is right at the $88,000 level. If it is less than that figure, there will no increase in premiums. If it is higher than $89,000, she will have enough money from the additional income to pay the increased premiums, which are described at this IRS site. If her 2020 income is $95,000, for example, she will have more than enough to pay that additional premium. If she happens to hit just over $88,000, she can always take out additional distributions from the IRA to bump up both AGI and MAGI for that year. 

Jane does have options, then, and at any rate having to pay a little more because she has more income is not a bad tradeoff. 

Notice from IRS on reversing RMDs from retirement accounts

IRS notice 2020-51 has been released as additional "fine-tuning" of the provision in the CARES Act that excuses required minimum distributions (RMDs) from IRAs and other retirement accounts this year. The notice advises that anyone who had already taken an RMD for 2020 before the law was passed in March will have until August 31, 2020 to restore the funds to the account, and the distribution will be regarded as rescinded. Under the statute and regulations, the "standard" time is limited to 60 days.

Recall that the other important provision of the CARES Act was that anyone, regardless of age, can withdraw up to $100,000 from an IRA if the money is needed due to a Covid-related hardship, and some or all of the money can be restored within three years without the recognition of income. If the owner finds that he is unable to restore all of the money, he will be given three years to pay the income tax due on the distribution.

Incidentally, our experience this year leads to a new recommendation. If you calculate your RMD in January based on the value of the account as of the preceding December 31, you should sell the assets you need to liquidate rather than waiting until later in the year. Most retirement accounts saw values drop by 20-25% in March and April of this year, and if such a drop happens the owner of an IRA can be hard pressed to take the RMD from the remaining funds.

IRS Guidance on the new rules

The IRS has released Notice 2020-6, which provides some early comments on a couple of details on the change in retirement plan distribution rules.

The first provides some relief to custodians who may include erroneous information about the Required Beginning Date when sending a required form to owners.

The other is directed to advisors of those individual IRA and 401-k owners who are right at the age 70-71 boundary. In its typical fashion, this IRS notice tells them:

The SECURE Act did not change the required beginning date for IRA owners who attained age 70-1⁄2 prior to January 1, 2020. In order to reduce misunderstanding among IRA owners, the IRS encourages all financial institutions, in communicating these RMD changes, to remind IRA owners who attained age 70-1⁄2 in 2019, and have not yet taken their 2019 RMDs, that they are still required to take those distributions by April 1, 2020. 

Enter the IRS Translator. What this means in English is: If you were born after June 1948 but before July 1949, your Required Beginning Date is still April 1, 2020 and this will not change.

Your first required distribution, which must be taken by that date, will be for 2019, based on the account value as of December 31, 2018. The 2020 distribution will need to be taken this year as well.

(h/t Kitces)

New distribution rules for inherited retirement accounts

You may have read reports of the SECURE Act passed in December and signed by the President. Most of the changes made in this new legislation relate to creating new employer-sponsored retirement accounts - allowing employers to combine to offer new plans to their employees.

Three of the new provisions are very important for the owners of existing IRAs and other retirement accounts:

• The “required beginning date” on which the owner of the account must begin taking required distributions from the account is now April 1 after the year he or she reaches age 72, an extension of one to two years. 
• The prohibition on contributing to an IRA after the owner must begin taking required distributions has now been removed. 
• The money that is left in the account after the death of the owner or (in many cases) the owner's spouse must now be distributed to the designated non-spouse beneficiary within ten years of the death. Those distributions are taxable income. The previous preferred option of taking those funds out over that beneficiary’s life expectancy has been removed. 

For the owners of sizable retirement accounts (more than $100,000-200,000 or so per designated beneficiary) there are some trust-based options that we can discuss, particularly for those beneficiaries who would have trouble managing money for themselves. These would not avoid the tax but they would assist in the preservation and management of the funds that remain.

Using retirement funds pre-retirement

It is common wisdom among estate planners and commenters on financial matters that people between the age of 60 and 70 should not touch their retirement accounts until they are required to do so, and that those who have reached the point at which they must take required distributions (around age 71) should take only the required minimum distributions (RMDs). While this is good thinking for many people, it will not work for everyone. 

The common recommendation no doubt arises from the assumption that most clients have a sizable retirement account and a sizable investment account comprised of non-retirement assets. The recommendation is based on the fact that non-retirement funds consist of money on which tax has already been paid, and thus using that money will not result in the recognition of income and the imposition of additional tax based on that income. 

But a client who has a very large retirement account and whose other assets are modest may benefit from a bit more liberal thinking about the use of the retirement funds. 

Let us do a bit of calculating for a moment. Let’s begin by assuming a client who 60 and who has exactly $100,000 in retirement funds. We know that 

• His RMDs will begin in about 10 years. 
• His accounts are likely to grow to about $138,000 in that time, assuming no additional contributions are made. 
• His RMD for the first year, often his age 71 year, will be $5,223. 

A $5,000 annual distribution is of course not much. 

These calculations do “scale” perfectly, though. If we change one assumption, considering a retirement account with a current value of $1 million, it will change the following parameters. 

• His accounts are likely to grow to about $1,380,000 in that time, assuming no additional contributions are made. 
• His RMD for the first year, his age 71 year, will be $52,230. 

Now we are talking about a significant required minimum distribution. 

Let’s say that our client decides that he wishes to use the money to enhance his quality of life during the next ten years. Each year, he wants to use $7,500 of his accounts (probably netting about $6,000 after taxes) to do some traveling with his wife. What is the result? 

When he reaches age 71, he finds that 

• His total retirement account is $1.3 million, or about $80,000 less than it would have been if he had not touched the money. 
• His initial RMD is $49,000, or about $3,200 less than it would have otherwise been. Each successive RMD is also moderately smaller than it otherwise would have been. 

The differences, in all honesty, are not that great. And there is a real-life factor that seems to elude many who comment in this field. In general, our client is likely to be much better able to travel and get around in his 60s than he will in his 70s. The ability to use his money to travel and in general to enhance the lives of both spouses is likely to be greater in their 60s. In general, the money will be more useful to them in those years than it will be when they are 75, 80 or 85 years old. 

Update 12-7-18 - A user at Quora posted this in response to a question: 

I took my pension at 60 and get less than I would have if I had waited until I was 65. However, I got to enjoy retirement between 60 and 65 when my health was good and I could do pretty much anything I wanted to.
Retirement is much less enjoyable when your health is failing. Your eyesight goes so you can’t read or drive any more. Your joints start to ache so sports are less enjoyable. Out of country health insurance costs a lot more so travel is more expensive.
I personally recommend retiring as soon as you can and do as much as you can while you have your health. Living in retirement is a lot less expensive than most people think. I’m very glad I retired when I did.

IRS discontinues MyRA

The MyRA program that we described in our November 2015 post has now been cancelled by the IRS, citing "extremely low" participation by taxpayers.

Expected changes to inherited IRAs

Included in the Retirement Enhancement and Savings Act introduced last year is a proposal to modify the ability of a non-spouse designated beneficiary of an IRA or other retirement account to take mandatory distributions, after the death of the participant (the worker whose earnings originally funded the account), over a "stretch" period based on the life expectancy of that beneficiary.

This idea has been raised, in one form or another, several times in the past few years, by Federal officials eager to accelerate the release of these funds as distributions of ordinary income that will generate tax revenue. Most of the proposals made by the outgoing Obama administration had called for the outright elimination of the "stretch" distribution for all funds payable to a non-spouse beneficiary.

This more recent proposal offers more of a compromise. It would provide:

• The current right of the spouse of the participant to treat the account as his or her own after the participant's death to remain unchanged.   
• The current ability of a non-spouse beneficiary to take distributions from the account based on his or her own life expectancy to remain in effect for the first $450,000 in all accounts owned by him. 
• For amounts over $450,000, they are to be subject to a much faster distribution schedule. All such funds must be distributed, as ordinary income, within five years after the participant has died. 

On request, we can provide a model payout schedule that will demonstrate, for a given set of retirement accounts, how this proposal would affect distributions.

Knowledgeable observers expect that this proposal or something close to it has a good chance of passing in 2017. At this point, the bill has been approved by the Senate Finance Committee. There are still several steps needed before it is passed and enacted.

How much additional revenue this proposal would generate is uncertain. Commentators familiar with the issue have pointed out that most non-spouse beneficiaries do not leave the funds in place to continue to grow over the "stretch" period. Most, they say, take the money out, pay the tax on it, and spend it.

The new MyRA

The U.S. Treasury Department has announced a new type of retirement savings program to encourage people to start retirement savings. The "MyRA" program is essentially an entry-level Roth IRA program. Money can be contributed or can be deducted from paychecks and maintained in an account with the Federal government, and the money will earn interest at the rate used for the Government Securities Program, reportedly 2.34% in 2014.

These are the differences between a standard IRA and the new MyRA vehicle:

	IRA	MyRA
Source	Before-tax money	After-tax money
Tax deduction	Yes	No
Limits	$5,500 per year	$5,500 per year
Withdrawals	Subject to income tax	Not subject to income tax – tax has already been paid
Early withdrawal	10% penalty before age 59.5 (as to earnings only)	No penalty
Invested	Any vehicle – CDs, stocks, bonds, mutual funds	Governmental account paying interest
Can lose money	Yes	No

According to the regulation, issued by Treasury in December 2014, the custodian of the accounts will invest the proceeds in a new investment vehicle called "Retirement Savings Bonds" which will not be held by individual savers. Rather, they will be held by custodian. Interestingly, there has been no announcement of who that custodian will be.

When the amount in the account reaches $15,000, or after the individual has participated for 30 years, whichever comes first, eligibility is at an end, and the individual will then be required to move the funds to a Roth IRA sponsored by a bank, credit union, or financial adviser.

Recheck your beneficiary designations

Most people who have money in tax-deferred retirement accounts such as IRAs or 401-k plans know that it is important to name a designated beneficiary (DB) and a contingent beneficiary (CB) for those plans. The Federal statutes that govern these plans provide:

• The account will be payable to the DB and can be paid out over the DB's life expectancy.
• The account will be payable to the CB in the same fashion if the DB dies before the owner of the account.
• If there is no DB or CB, the account is payable as the plan documents direct, and that may be to the estate of the owner.
• If there is no proper DB/CB, the entire amount in the account must be distributed, as taxable income, within five years of the owner's death.
• The owner's spouse must be the DB for "qualified" retirement plans, including 401-k plans, unless that right is specifically waived in writing.

We always recommend that the designations be reviewed in the event of any major life change, such as marriage, divorce, death, or retirement.

It is also a good idea to check the designations every year or two, even if no life change has occurred, to ensure that what was previously designated remains in place. We frequently hear about accounts for which a DB and CB were properly designated but for which the custodian has, for whatever reason, lost track of the designation. The owner of the account can correct such errors while he is alive. The family members who are disappointed after he dies cannot do so.

The timing of social security benefits

Bob is 61, working as a physical therapist, and is the owner of a clinic with two other therapists. He earns an average of $170,000 per year. His wife Carol, also 61, is a homemaker. She had worked as a medical secretary, full-time for 14 years before their first child was born, and part-time for the next ten years before her position was eliminated. She has not worked since. She made $30,000 per year in her last year of full-time work.

Both of them have earned enough credits to be eligible for social security benefits. They could begin as early as next year, when they reach age 62.

These are among the considerations:

• If Bob retires at age 62 and begins collecting social security benefits, he will only receive 80% of what the benefit would be if he waited until 66, his "full retirement age." 
• If he waits until age 70, the benefit he will receive will be 32% higher than the NRA figure, and 64% higher than the age 62 figure. 
• The percentages of each will change each year. No one has to choose between age 66 and age 70. If Bob wants, he can decide to retire at age 68. 
• When Bob begins collecting his benefits, Carol will be paid a spousal benefit that is 50% of Bob's benefit. That calculation, which uses his earning record, will be much higher than her own benefit, using her earning record. Essentially, the household will receive payments equal to 150% of his benefit. This is all the more reason to wait until he is age 70. 
• If Bob dies, Carol will begin collecting benefits equal to those he was receiving, based on his earning record, in her own name. 

Carol cannot start receiving that 50% spousal benefit now. She has to wait until Bob starts collecting. But there is one step that she could take now. She could apply for a benefit based solely on her earning record now, and collect that (lower) monthly benefit until Bob decides to retire at age 66 or later. When he does so, she can then apply for the 50% spousal benefit.

Most people in her position should take that step. When Bob does retire, the total combined 150% figure will take effect, and it will not be affected by her decision to start taking her own benefits early. The cost-benefit analysis that goes into the personal decision on the question of when to retire does not enter into this question. If she does not begin collecting benefits on her own record now, that money will be forever lost.

As always, consultation with a qualified adviser is recommended.

To roll over or not

Most advisors recommend that an employee who departs from a company roll her 401(k) funds into a self-directed IRA. This article from Smart Money provides a few reasons not to follow that standard advice. The conclusion, probably accurate but not very helpful: "There's no universal right answer."

A New Trick: Don't Roll Over Your 401(k)