The SECURE Act – Non-retirement changes

The Setting Every Community Up for Retirement Enhancement Act (more commonly referred to as the SECURE Act) has received a lot of buzz in the estate and retirement planning communities lately thanks to the significant changes it has made to laws related to retirement.

How will the SECURE Act impact my life?

Although the buzz is justified given the many changes to the law related to retirement, the SECURE Act has impacted the law in areas other than retirement.

Here are a few areas that have little to do with retirement, but have been impacted significantly by the SECURE Act:

Qualified Birth or Adoption Distributions–

If you receive an early distribution (before age 59 ½) from an IRA, 401(k), 403(b), or eligible 457(b) deferred compensation plan, then not only will the distribution be subject to an income tax liability, but also a 10% early distribution penalty tax. There are some exceptions to the 10% penalty tax.

The SECURE Act now provides for an additional exception by allowing penalty-free treatment for a qualified birth or adoption distribution of an amount not to exceed $5,000 per parent. This means that parents could take distributions up to $10,000 if both parents qualify and have available assets in their qualified retirement accounts without a penalty. The distributions will still be subject to income tax.

The early distribution must be made within one year from either the birth of the eligible child or the date the adoption of the eligible adoptee is finalized. Under the SECURE Act, an eligible adoptee is any individual, except the child of the account owner’s spouse, who is under 18 years old or is physically or mentally incapable of self-support.

Although it is not specifically referenced in the section of the statute (IRC 72(t)(2)) revised by the SECURE Act, new law indicates that the qualified birth or adoption distribution can be taken with each new birth or adoption.

The rules also allow for the repayment of the qualified birth or adoption distribution at a later time regardless of the plan/IRA contribution limit. This repayment can be made incrementally or at once from either the plan the distribution was made or an IRA. Since the law is silent on the repayment deadline, the IRS may issue regulations clarifying the timing of the repayment.

This could be a very helpful option for parents who have incurred significant costs related to the birth or adoption of a child.

Section 529 Plan distribution–

A Section 529 plan is a college savings plan that offers tax (federal and state) and financial aid benefits. If the 529 plan satisfies the basic requirements, the federal and state tax law provides tax benefits. These tax benefits may include tax-free qualified distributions and state income tax deductions or credits, depending on the state. New York is one of 33 states and the District of Columbia that offer residents a tax deduction or tax credit for 529 plan contributions.

The SECURE Act now allows federal-income-tax-free 529 distributions to cover apprenticeship costs, some homeschooling expenses, and up to $10,000 of qualified student loan principal and/or interest payments.

The distribution of $10,000 for payment of qualified student loan principal and/or interest payments is a lifetime limit that applies to the 529 plan beneficiary and each of their siblings. For example, a parent who has 2 children may take a $10,000 distribution to pay student loans for each child for a total of $20,000.

Although these changes will likely provide more options for families and students, it is important to note that this is a federal law that may not apply to your state law, and you may suffer a tax detriment if you make a non-qualified withdrawal.

This means that if you are a New York resident and you use funds from the NY 529 Plan to pay for your child/grandchild’s student loans (or any other non-qualified distribution), you may be subject to recapture of the state income tax deduction for the 529 contribution.

The last time the federal law changed to expand the qualifying education expenses to include K-12 tuition under the TCJA, New York and some other states did not comply with the federal law. So, it is very possible that New Yorkers may not get the benefit of the 529 plan changes brought on by the SECURE Act.

It is important to confirm your state’s 529 Plan rules with a qualified professional to ensure that you will receive the maximum tax benefits offered and not inadvertently cause any tax detriments.

The increased minimum penalty for failure to file federal returns–

If you file a federal income tax return more than 60 days late (absent reasonable cause), you will be subject to a failure-to-file penalty. The failure-to-file penalty is normally 5% of the unpaid taxes for each month or part of a month that a tax return is late. However, a minimum penalty is assessed in certain cases.

The SECURE Act increases the minimum penalty for failure-to-file federal tax returns to the lesser of $400 or 100% of the amount of tax due. This change applies to returns that are due in 2020 and beyond, including any extensions.

Kiddie tax rates retroactively repealed–

The SECURE Act retroactively repeals the portion of the Tax Cuts and Jobs Act of 2017 (TCJA) that imposed a higher tax rate on certain children and/or young adults who received unearned income, such as interest, dividends, and long-term and short-term capital gains. These taxes are commonly referred to as the Kiddie Tax. Generally speaking, the TCJA effectively changed the Kiddie Tax rates from the parent’s marginal federal income tax rate to the same rates paid by trusts and estates, which typically results in much higher tax liability for the child.

The new law reinstates the Kiddie Tax rates to the tax rates in effect prior to the TCJA, which means the calculation to determine the Kiddie Tax is once again based on the parent’s marginal tax rate. This is a huge benefit to children and young adults with substantial investment income.