Some of the biggest retirement plan and IRA changes in more than a decade went into effect on January 1, 2020. Most of these changes are designed to increase retirement savings, but if you’re not prudent, some may lead to higher taxes and/or costly lawsuits.
President Donald Trump signed a $1.4 trillion spending bill into law on December 20, 2019, that involves massive changes to retirement plan and IRA rules, some of which became effective January 1, 2020. The retirement portion of the bill (SECURE Act) contains 29 new provisions or major changes in its 124 pages. Here are eight provisions that will affect most doctors.
Has more part-time employee coverage for 401(k) plans—Previously, your retirement plan could exclude part-timers who work fewer than 1,000 hours per year, which is roughly 20 hours a week. Under the new law, your plan must now cover employees if they either complete one year of service by working at least 1,000 hours during the plan year or have three consecutive years during which they work at least 500 hours. Therefore, a two-day-a-week hygienist (16 hours a week) who has worked for at least three consecutive years was not eligible under the old rules but must now be covered effective January 1, 2021. Twelve-month periods beginning before January 1, 2021, will not be taken into account.
Increases maximum age to 72 for taking required minimum distributions (RMDs) from retirement plans and IRAs—If you’re not yet age 70½ as of December 31, 2019, you can now defer taking RMDs from IRAs and retirement plans until age 72. If you have sufficient funds elsewhere to cover personal living expenses, this offers a huge tax saving opportunity to defer distributions and convert additional amounts from your regular IRA into your Roth IRA for up to two more years, while you’re in a lower tax bracket.
Allows contributions to traditional IRAs after age 70½—If you work later in life, (a current trend since the average retirement age has risen to 69), you can now continue making contributions up to $7,000 per spouse annually to a traditional or Roth IRA if you or your spouse has at least that much earned income.
Changes rules related to 529 plans—The new law allows lifetime aggregate penalty-free distributions of up to $10,000 per child from Section 529 college savings plans to repay student loans.
Allows penalty-free withdrawals of up to $5,000 from retirement plans or IRAs to cover the cost of birth or adoption of a child—Distributions before age 59½ are normally subject to a 10% penalty, but in this case the penalty is waived. However, the withdrawal is still subject to federal and state income taxes.
Expands retirement plan tax credits—Are you setting up a new retirement plan? If so, the new law provides tax credits of up to $5,000 (or $250 per non-highly compensated employee if less) a year for three years, or $15,000 total, to offset the costs incurred to set up, administer, and educate employees about the new retirement plan, using IRS Form 8881. In addition, the new law creates a tax credit of up to $500 a year for three years, or $1,500 total, if you add an automatic enrollment feature to your 401(k) plan.
Promotes annuities as a retirement plan investment option—Bowing to intense insurance industry lobbying, Congress eased the rules for adding annuities as acceptable investments in retirement plans. In their simplest form, annuities are an insurance product that allows participants to convert their account balances into a guaranteed income stream in retirement.
The new law reduces the fiduciary requirement to vet the insurance companies and products before their issue. However, I recommend not investing retirement plan funds in annuities due to the potential for being sued because of their high expenses, surrender fees if the policy is cancelled within the first seven to 10 years, low returns, and potential for default.
According to Morningstar, the average variable annuity costs between 2.18%-3.63% annually, depending on the product type and features selected, but costs are about 10 times the average fees on other 401(k) plan investments. So, stay away from offering annuities inside your retirement plan or IRAs. Rather, another mix of stock and bond investments can provide the steady stream of income you need in retirement without these drawbacks.
Eliminates “stretch” options by requiring most inherited IRA distributions to be paid out in 10 years or less—Under current law, if your children inherit your IRA they can stretch the distributions (and related income taxes) over their lifetimes, which provides longer tax-deferred growth to build family wealth. The resulting distributions are normally smaller, which keeps your children from vaulting into a higher tax bracket during their peak earning years.
The new law requires all inherited IRAs to be distributed, and related income taxes paid, within 10 years of the account owner’s death. Fortunately, there’s an exception for those inherited by surviving spouses, minors, the disabled, and those who are fewer than 10 years younger than the account owner. This provision is expected to raise taxes by $15 billion over the next 10 years.
JOHN K. McGILL, JD, MBA, CPA, provides tax and business planning for dentists and specialists and publishes The McGill Advisory newsletter through John K. McGill & Company Inc., a member of The McGill & Hill Group LLC, your one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit mcgillhillgroup.com.
