The SECURE Act changed a variety of retirement account rules, including who is eligible to contribute to retirement accounts and when withdrawals are required. The new legislation also adds a new exception to the early withdrawal penalty.
Important retirement account changes from the SECURE Act include:
- The required minimum distribution age increases to 72, up from 70 1/2.
- The age limit for IRA contributions has been removed.
- Inherited retirement account distributions must be taken within 10 years.
- New parents can take penalty-free withdrawals.
- Long-term part-time employees may now be eligible for 401(k) plans.
Here's an in-depth look at the SECURE Act and how it may affect you.
An Older Required Minimum Distribution Age
Previously, you were required to start taking withdrawals from a traditional IRA by April 1 of the year after you turned age 70 1/2. These withdrawals are known as required minimum distributions. “One benefit of the law is the extension of required minimum distributions from the age of 70 1/2 to 72,” says David Mann, a wealth management advisor in Las Vegas, Nevada. “This allows IRA owners to defer withdrawals longer in hopes of additional growth of their IRA assets.”
If you turn 70 1/2 in 2021, you don't have to start withdrawing from your traditional IRA. You have the option of waiting until you turn 72 to begin taking RMDs.
No More Age Limit for IRA Contributions
Workers with an individual retirement account used to only be able to contribute up until age 70 1/2, but that age limit has now been removed. “Anyone who is working and has earned income may contribute to a traditional IRA regardless of age,” says Ryan Brown, a partner and attorney at financial planning firm CR Myers & Associates headquartered in Southfield, Michigan. “This will benefit older retirees who may wish to keep contributing to their IRAs.”
In 2021, the contribution limit for an IRA is $6,000, or $7,000 if you are 50 or older. If you and your spouse are both over 50 and at least one of you is still working, you can contribute up to $7,000 to an IRA in each of your names, or $14,000 total.
Inherited Retirement Account Distributions Must Be Taken Within 10 Years
Before the new law was in place, those who inherited IRAs could stretch out the withdrawals and required tax payments on each distribution over their life expectancy. Now, for retirement account owners who pass away after Jan. 1, 2020, beneficiaries may be required to withdraw assets in an inherited IRA or 401(k) within 10 years. However, there are a variety of exceptions to the new 10-year rule, including a surviving spouse, minor children, disabled and chronically ill beneficiaries and beneficiaries who are up to 10 years younger than the IRA owner.
“Prior to the SECURE Act, a 40-year-old IRA beneficiary could take relatively small withdrawals for 20-plus years while allowing the IRA to potentially continue to grow, net of the withdrawals,” Mann says. “In theory, after those 20 years, that beneficiary would now be retired with a reduced income, thereby able to pay lower taxes on the withdrawals.”
With the SECURE Act, a 40-year-old beneficiary will need to withdraw the entire IRA balance by age 50. The withdrawals will be subject to taxes. Taking out everything within a decade “could result in a significant increase in taxes on the withdrawals due to the likelihood that a 40-year-old is in their peak earning years,” Mann says.
Prior to the law, if you took a withdrawal from your IRA or 401(k) before age 59 1/2, the amount would usually be subject to income tax and a 10% penalty. However, the IRS allows penalty-free early distributions from some types of retirement accounts for specific circumstances, such as an expensive medical emergency or to purchase health insurance after a job loss. The SECURE Act adds an additional exception to this list. Your plan may allow a $5,000 withdrawal from an IRA or 401(k) after the birth or adoption of a child. You won't have to pay a penalty for withdrawing the funds, and you can repay the funds as a rollover contribution. Income tax will be due on the distribution if it is not repaid to the account.
Long-Term Part-Time Employees Are Now Eligible for 401(k) Plans
The law provides a way for more part-time workers to be eligible for a 401(k) plan. In the past, part-time employees needed to work at least 1,000 hours during a 12-month period to be able to contribute to a 401(k) plan. Under the SECURE Act, employees who log at least 500 hours in a 12-month period for three consecutive years can contribute to a 401(k)-plan starting in 2024. “This means the clock starts ticking now on accruing hours, so it's important for part-time employees to start thinking about how they can take advantage of their company retirement plan,” says Allison Brecher, general counsel and chief privacy officer at Vestwell in New York.
Tax Credits to Start a Small Business Retirement Plan
Many small businesses find it too costly to provide a 401(k) option for their employees. “The SECURE Act helps to offset costs for business owners with the hope that more employees of small businesses will have access to a 401(k) plan to save for retirement,” Mann says. The SECURE Act provides a tax credit to small employers with up to 100 workers that start a workplace retirement plan, with an additional credit available if the plan includes automatic enrollment.