On Dec. 20, President Donald Trump signed into law the imaginatively acronym-ed Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The new law is mainly intended to expand opportunities for individuals to increase their retirement savings. It also includes some other important tax changes that have nothing to do with retirement.
In an earlier column, I covered the three most important changes that can affect individuals. See here. But there’s more. In this column, I’ll cover the rest of the important changes for individuals. Here goes.
Penalty-free early retirement plan and IRA distributions allowed for births and adoptions
If you receive a distribution from a qualified retirement plan, a Section 403(b) tax-sheltered annuity plan, an eligible Section 457(b) deferred compensation plan, or an IRA, you must report the taxable portion as income on your return. Fair enough. But if you receive a distribution before age 59½ (an early distribution) you’ll also get hit with the dreaded 10% early distribution penalty tax on the taxable portion — unless a tax-law exception grants you relief.
New law: For 2020 and beyond, the SECURE Act allows penalty-free treatment for a qualified birth or adoption distribution. That means a distribution made during the one-year period beginning on the date when an eligible child of the account owner is born or the date when the legal adoption of an eligible adoptee of the account owner is finalized. An eligible adoptee means any individual (other than a child of the account owner’s spouse) who has not attained age 18 or is physically or mentally incapable of self-support.
Key point: The maximum penalty-free qualified birth or adoption distribution is $5,000, and this limit is apparently applied on an individual-by-individual basis. So, if both you and your spouse have an eligible retirement plan account or IRA, you can each apparently receive a $5,000 penalty-free qualified birth or adoption distribution.
Graduate fellowship and stipend payments can count as compensation for IRS contribution purposes
IRA contributions for the year generally cannot exceed your compensation (as defined) plus any net self-employment income for that year. However, if you’re married you can count your spouse’s compensation and/or self-employment income.
New law: For 2020 and beyond, the Secure Act stipulates that taxable amounts paid to aid you in the pursuit of graduate or postdoctoral study (such as a fellowship, stipend, or similar payment) count as compensation for IRA contribution purposes.
No more retirement plan loan borrowings through credit cards
Subject to tax-law limitations, employer-sponsored qualified retirement plans can make loans to plan participants. Some plans have allowed employees to access their plan loans using a credit card or similar mechanism.
New law: For plan loans taken out after 12/20/19, the Secure Act stipulates that borrowings cannot be distributed through credit cards or similar arrangements without causing the distributed amounts to be treated as deemed taxable distributions rather than tax-free loan amounts.
Unfavorable TCJA kiddie tax rates retroactively repealed
Before the Tax Cuts and Jobs Act (TCJA), the Kiddie Tax rules taxed a portion of an affected child or young adult’s unearned income (typically from investments) at the parent’s marginal federal income tax rate if that rate was higher than the rate the child or young adult would otherwise pay. The Kiddie Tax rules can potentially apply until the year an affected young adult reaches age 24.
For tax years beginning after 2017, the TCJA changed the deal to tax a portion of an affected child or young adult’s unearned income at the rates paid by trusts and estates. That change could cause the Kiddie Tax to be much more expensive when an affected child or young adult had substantial unearned income.
New law: Belatedly, our beloved Congress became concerned that the TCJA change unfairly increased the federal income tax bills of certain children and young adults, including those who are survivors of deceased military personnel, first responders and emergency medical workers. In effect, the Secure Act retroactively repeals the TCJA Kiddie Tax rate change for all affected children and young adults and reinstates the pre-TCJA Kiddie Tax calculation. So, the calculation is once again based on the parent’s marginal tax rate like before the TCJA was hatched. This development will be a meaningful tax-saver for kids and young adults with substantial investment income. Good!
Effective date: While the Secure Act’s repeal provision is generally effective for 2020 and beyond, you can choose to apply the repeal to 2018 and/or 2019 returns of Kiddie Tax victims. So, if you have a Kiddie Tax victim in your family, an amended 2018 return may be in order. You’ll probably want to follow the Secure Act change for the victim’s 2019 return as well.
Liberalized rules for tax-free Section 529 plan distributions
Section 529 plans are state-sponsored programs that allow you to make contributions to an account established to cover the designated account beneficiary’s qualified college expenses or to prepay qualified college tuition for the account beneficiary. Distributions to cover the beneficiary’s qualified college expenses are federal-income-tax-free. Tax-free 529 account distributions can also be used to cover up to $10,000 of annual qualified expenses to attend public, private, or religious elementary or secondary schools.
New law: The Secure Act sweetens the already-sweet 529 plan deal by allowing federal-income-tax-free 529 distributions to cover eligible apprenticeship costs. This change applies to distributions made after 12/31/18. The Secure Act also allows federal-income-tax-free 529 distributions to cover up to $10,000 of qualified student loan principal and/or interest payments. This change also applies to distributions made after 12/31/18.
Key point: The limited deduction for student loan interest is disallowed to the extent the interest is paid with a tax-free 529 distribution.
Increased penalty for failure to file federal returns
The Secure Act increases the penalty for failure to file affected federal tax returns to the lesser of: (1) $400 or (2) 100% of the amount of tax due. This change applies to returns that are due in 2020 and beyond, including any extensions. Previously, the dollar limit for returns due in 2020 was $330.
The bottom line
The SECURE Act includes important tax changes, including some that have nothing to do with retirement. Now you know. You’re welcome.