If you have an IRA, a 401(k) and/or a 529 education savings plan, Congress is looking to make it easier for many of you to save and spend money in these accounts.
A far-reaching bill, which was approved overwhelmingly by the House of Representatives—and as of our press time in mid-July was awaiting Senate action—contains nearly 30 provisions affecting retirement and education savings plans in big ways.*
To prepare for the potential changes, Bottom Line Personal asked retirement and education savings experts to explain various ways the legislation would affect people who have these accounts…
If you want to delay distributions from your retirement accounts (as well as delay facing taxes on some distributions) as long as possible….
Under the new legislation, the age when you typically must start taking required minimum distributions (RMDs) from your IRAs and 401(k)s would be pushed back to the year you turn 72 (up to 75 in the Senate version) instead of 70½ under the current rule. Like the current rule, the new one typically requires RMDs from traditional IRAs, 401(k)s and from Roth 401(k)s but not from Roth IRAs, which never force the original owner to take RMDs.
Bottom line: The new rule allows extra time for your traditional IRAs and 401(k)s to grow tax-free. (Roth accounts never face taxes on distributions.)
If you work past 70½…
You would no longer have to stop contributing to traditional IRAs at age 70½. (There has never been an age limit for contributing to a Roth IRA.)
Bottom line: As long as you continue working, even part-time, you could keep making annual traditional IRA contributions within the allowable limits, up to the amount that you earn in taxable employment income.
If you are planning to leave an IRA to heirs or to inherit an IRA…
The current so-called “stretch” provision for inherited IRAs would be eliminated under the legislation. That provision allows beneficiaries who inherit a traditional or Roth IRA to stretch the RMDs—and any taxes owed on money from the traditional IRAs—over a lifetime. (Roth distributions typically are never taxed because they are funded with post-tax contributions.) Under the new legislation, there would be no annual RMDs for any inherited IRA. Instead, all the assets in an inherited IRA would have to be distributed by the end of the 10th calendar year following the year of the original owner’s death, with some exceptions such as if the beneficiary is a surviving spouse.
Bottom line if you are bequeathing an IRA: As an alternative to the no longer available stretch IRAs, consider other estate-planning strategies to maximize inheritances and help reduce taxes for your heirs. Example: As long as you are at least 59½, you could start taking annual distributions from your traditional IRA—even if you haven’t turned 72 (which is when you must start taking RMDs under the new legislation). You would pay annual taxes on the sped-up withdrawals at today’s relatively low income tax rates. Then use some or all of the withdrawn assets to buy a life insurance policy naming your heirs as beneficiaries. Although life insurance premiums can be costly, the policy’s payout to the beneficiaries when you die could be much larger than the IRA itself and typically is free of income taxes.
Bottom line if you inherit a traditional IRA: Rather than wait until the 10th year and end up taking a big distribution in a single year, you could choose to spread out withdrawals over the 10 years. That way you could avoid facing a big tax bite all at once at a possibly heightened tax rate. Caution: Under this strategy, you would need to avoid taking out so much in any year along the way that it would push you into a higher income tax bracket for that year. If you inherit a Roth IRA, whose distributions are never taxed, you would not use this strategy because you could maximize the potential for tax-free gains by delaying distributions until the end of year 10.
Ed Slott, CPA, is president of Ed Slott & Company, a financial consulting firm specializing in IRAs and retirement planning, Rockville Centre, New York. IRAHelp.com
401(k) and Similar Plans
For those of you with an employer who does not have a defined contribution plan such as a 401(k)…
Small employers with or without retirement plans—no matter what industry they are in—would have the option to band together to offer a pooled plan such as a 401(k) plan (or a 403(b) for certain public schools and tax-exempt organizations). Before, employers had to be in the same type of business to do this. By adopting a broader pooled plan, multiple employers—and their employees—could benefit from economies of scale and reduced administrative hassles. Also, under the new rules, small businesses would be allowed an annual tax credit of up to $500 for three years to help pay for the cost of establishing the retirement plans.
Bottom line: Lobby your employer to join a pooled plan and to offer a program to match your contributions.
If you work part-time…
Employers with defined contribution retirement plans would have to make them available to part-time workers with at least three consecutive years of 500 hours of work annually. In the past, part-time workers had to complete 1,000 hours of work per year to be eligible.
Bottom line: You could open and contribute to a 401(k) even if you work as little as 10 hours a week each year.
If you need regular and dependable monthly income once you retire…
Two provisions would make it easier for employers to offer annuities in a 401(k) and for participants to use them. Annuities are a type of insurance contract that, in exchange for a lump-sum payment up front, guarantee you a monthly income stream as long as you live. Less than 10% of retirement plans offer annuity products, partly because plan employers are concerned that they might be held liable if they select an annuity provider that later goes out of business.
Safe harbor for selection of an annuity provider. The employer would be protected from legal liability as long as the chosen provider is licensed by the state in which the company is headquartered.
Portability of annuities. Under the old rule, if a worker with an annuity in his/her 401(k) plan left his job and his account was terminated (which happens in some cases if the account is small or the employer goes out of business), he was forced to cash it out and pay surrender charges unless a 401(k) plan at a new employer accepted the annuity. Under the new rule, the worker could transfer the annuity to an IRA with no penalties.
Bottom line: If you are interested in an annuity and your employer already offers one in a 401(k)—or starts offering one—consider that option. You generally get a better deal buying an annuity within your 401(k) than on your own because plan sponsors can negotiate institutional discounts from insurers. Careful: Annuities have a checkered reputation because many have high fees, questionable returns and mind-numbing complexity. You should review any potential annuity purchase with an independent financial planner.
Ric Lager is president of Lager & Company, which advises retirement-plan participants around the country about options, Golden Valley, Minnesota. LagerCo.com
529 Education Savings Plans
For a family with a 529 education savings plan and education debt…
Under the new legislation, as the owner of one or more 529 plans, you could withdraw a total of $10,000 to be used by the plan’s beneficiary to repay his qualified education loans. Plan beneficiaries that could qualify include family members ranging from spouses, children and grandkids, to nieces and nephews. Federal loans and most private student loans could qualify for repayment. Some families who take out education loans wind up with leftover funds in their 529 plans when a child finishes college—for instance, if the child won a scholarship or received unexpected gifts or inheritances from relatives. In the past, you weren’t allowed to use leftover 529 money to pay off student loans. Under the new rule, you have added flexibility in how to use leftover 529 money.
Bottom line: Although a beneficiary can use no more than $10,000 in 529 money to pay off loans, the owner of the 529 account could change the designated beneficiary to any qualified family member who has education loans. So let’s say you have $20,000 left over in a 529 plan you own for which the beneficiary is your child. He could use the $10,000 to pay down a Stafford loan. Then you could change the beneficiary to yourself and withdraw another $10,000 to pay down your Parent PLUS loan, which, unlike the Stafford loan, is a loan taken out by the parent.
Mark Kantrowitz has been a financial-aid expert on college savings for 25 years and is publisher of SavingForCollege.com.
*As of July 15, Congress had not specified various details about the bill including the dates its provisions would go into effect if it is signed into law. The Senate would likely require changes to some provisions. Also, the IRS would need to create timetables and fill in other details.