Edward A. Zurndorfer
Before adjourning in late December, Congress enacted a $1.4 trillion year-end spending bill that keeps the federal government running through Sept. 30, 2020. President Trump signed the legislation. Tucked away inside this spending legislation is the Setting Every Community Up for Retirement Enhancement (SECURE) Act which includes significant changes to individual retirement arrangements (IRAs) and retirement plans, including the Thrift Savings Plan (TSP). In the first of two FEDZONE columns discussing the SECURE Act, this column discusses the most important retirement planning changes to IRAs and to the TSP resulting from the SECURE Act passage, including the advantages and disadvantages of each change affecting federal employees and annuitants.
- Age limit eliminated for traditional IRA contributions. Effective Jan. 1, 2020, the SECURE Act eliminated the age limit for making traditional IRA contributions. With this change, those individuals who have earned income (salary or self-employment income) or whose spouses have earned income can continue to contribute to a traditional IRA regardless of their age. Until this change, starting in the year an individual reached age 70.5, the individual could not contribute to a traditional IRA, even if the individual had earned income or whose spouse had earned income. Note that this change takes effect on Jan. 1, 2020 meaning that federal employees over age 70.5, and/or who have working spouses with earned income, cannot make traditional IRA contributions for the year 2019 even though the deadline to make 2019 IRA contributions is the 2019 income tax filing deadline of April 15, 2020. But they can make IRA contributions for tax year 2020.
Advantages: For federal employees who work past age 70.5, or who are retired and over age 70.5 but who have spouses who continue to work, the SECURE Act now allows these individuals to continue contributing to some type of an IRA. Note that previously before the SECURE Act passage, such individuals over age 70.5 were prohibited from contributing to a traditional IRA but could contribute to a Roth IRA (assuming these individuals’ modified adjusted gross income (MAGI) did not exceed specified limits depending on one’s tax filing status). Of course, any employee can contribute to a “nondeductible” traditional IRA (there are no MAGI restrictions) and immediately convert that traditional IRA to a Roth IRA (this is called a “backdoor” Roth IRA). If the conversion is performed almost immediately after the contributions are made to the traditional IRA, then no tax will be due as a result of the Roth IRA conversion. Note that Congress did not change the rules with regard to the establishment of “backdoor” Roth IRAs. With the SECURE Act passage, individuals over 70.5 with earned income who cannot contribute to a Roth IRA (because their MAGI exceeds the limit) can perform a “backdoor” Roth IRA conversion because they can now contribute to a nondeductible traditional IRA.
Disadvantages: Another change resulting from the SECURE Act passage is the fact that the age that a retired individual must start taking required minimum distributions (RMDs) from his or her traditional IRAs, qualified retirement plans like 401(k) plans and 403(b) plans (as well as the Thrift Savings Plan (TSP)) is raised from age 70.5 to age 72 (see below). What this means is that a federal employee who is over 70.5 can still contribute to a traditional IRA but the year that employee reaches age 72 that employee will still have to start traditional IRA RMD and every year thereafter. Such an employee after reaching age 72 every year could, in fact, be contributing to a traditional IRA and in the same year having to withdraw from that traditional IRA via an RMD. In that sense, it is better for that employee to contribute to a Roth IRA in which there are no RMDs.
If the employee is not eligible to contribute to a Roth IRA because of too large of MAGI, then the employee is best off contributing to a nondeductible traditional IRA and then performing a Roth IRA “backdoor” conversion. It should be emphasized that a Roth IRA “backdoor” conversion can be challenging from the standpoint of tax reporting and should only be performed under the guidance of a tax professional who has experience in and fully understands the tax consequences of Roth IRA conversions.
- Changes the age of initiation for required minimum distributions (RMDs) from 70.5 to age 72 for all retirement accounts subject to RMDs, including the TSP. Note that this change for taking one’s first RMD from age 70.5 to age 72 affects traditional IRA owners and qualified retirement plan owners, including traditional TSP and Roth TSP participants, who become age 70.5 after Dec. 31, 2019 (individuals born after June 30, 1949). This change is a tremendous benefit for employees and annuitants born after June 30, 1949, and will allow additional time for the traditional and Roth TSPs and traditional IRAs that are owned by federal employees and annuitants, to grow tax-deferred or tax-free. The fact that many federal employees are remaining in the workforce longer which in turn means that these employees can wait somewhat longer before being subject to the RMD of their traditional IRAs and their traditional TSP and Roth TSP accounts. This should prove to be beneficial to these employees and to their beneficiaries. The new proposed changes in the RMD life expectancy tables in 2021, combined with the new RMD age, will allow those who do not need the funds to keep them growing, tax-deferred or tax-free (Roth TSP), a little longer. The law has not changed for individuals over 70.5 owning traditional IRAs who use qualified charitable distributions (QCDs) to fulfill their traditional RMDs. QCDs can still be performed at age 70.5, even though no RMDs will be required until age 72 for traditional IRA owners born after June 30, 1949.
Advantages: While this is not a huge change, it is nonetheless RMD relief for those individuals who own traditional IRAs and/or TSP participants who have retired from federal service and who don’t need or want their RMDs and will only take their RMDs because they are forced to do so. As an added benefit, people understand the concept of turning 72 a lot more than they do turning 70.5 (and figuring out their first RMD age factor, which in turn varied depending on whether their birthday was in the first or last 6 months of the year, due to the ½ year age trigger). Therefore, explaining when RMDs need to begin, and the calculation of the first RMD, should become at least a little bit easier in the future. As is true with current RMD rules, individuals reaching the requisite age of 72 (instead of 70.5) will still be able to delay their first RMD until April 1 of the year following the year for which they must take their first RMD (the required beginning date or RBD). This means, for example, an individual becoming 72 on January 17, 2023, can delay his or her first RMD until as late as April 1, 2024. That first age-72 RMD will be calculated using the age-72 life expectancy factor (25.6 or 3.91%). Pre-SECURE act, that individual would have had to take his or her first RMD no later than April 1, 2022, using an age-70 life expectancy factor of 27.4 or 3.65%. This is particularly helpful for individuals born in any year after 1949, during the first six months of a calendar year.
Disadvantages: Only individuals born after June 30, 1949 can take advantage of the new law. Raising the RBD to age 72 means a larger percentage of the IRA and/or TSP balance must be taken (3.91 percent versus 3.65 percent of the account balance) in the first year.
- Taxable Non-Tuition Fellowship and Stipend Payments Treated As Compensation for IRA Contribution Purposes. Beginning in 2020, individuals who have taxable stipends or other amounts paid to them to aid in the pursuit of a graduate or postdoctoral study can use those amounts as compensation for IRA/Roth IRA contribution purposes.
Advantages: Many federal employees and uniformed service members have children or other family members who are working on graduate degrees (Masters, Ph.D.) or are pursuing postdoctoral opportunities. They are receiving fellowship and/or stipend payments that while considered taxable compensation, until the passage of the SECURE Act this income did not count as far as allowing these individuals to contribute to some type of IRA (traditional or Roth). These individuals also may not be married or if they are married, their spouses do not have earned income which will allow them to contribute to an IRA. Now these individuals (and their spouses if married) can contribute to some type of IRA which, for many of them, means starting to save for their retirement in their 20’s which they are highly encouraged to do. Starting for the calendar year of 2020, they can contribute as much as $6,000 ($7,000 if they are age 50 or older) to an IRA.
Disadvantages: There are no disadvantages to this provision of the SECURE Act.
- New Exception to the 10 Percent Penalty for Childbirth or Adoption. The SECURE Act adds a new 10 percent penalty exception for birth or adoption, but the distribution is still subject to federal and state income taxes. The exception allows up to $5,000 to be distributed penalty-free from an IRA or from a defined contribution plan (such as the TSP) as a “qualified birth or adoption distribution”. To meet the requirements of a qualified or adoption distribution, an individual must take a distribution from his or her retirement account at any point during the one-year beginning on either the date of birth or the date on which the adoption of an individual under the age of 18 is finalized. Also, the $5,000 limit is a limit “with respect to any birth or adoption”. This means that the $5,000 withdrawal applies to each subsequent birth or legal adoption. Furthermore, the exception applies on an individual basis, meaning that if both a child’s parents have available retirement assets, then each parent can make a qualified birth or adoption distribution of up to $5,000 for each child born or adopted. Finally, in the event a parent took a qualified distribution and is able to “repay” such amount, the parent may do so back to the qualified retirement plan or IRA from which the distribution was made.
Advantages: Young parents will have additional money available to them to pay for the cost of having or adopting a child. This could be particularly helpful for a single parent with no spouse or partner. The distribution from the qualified retirement account or IRA could be used to pay any expenses, provided the distribution is made after the qualifying event. In reality, because there are no restrictions as to how the distributed funds are to be spent (need not be for birth/medical expenses or adoption/legal expenses), the $5,000 could be withdrawn from a qualified retirement account or IRA to go on a vacation to celebrate the birth or adoption. This assumes the $5,000 distribution occurs within one year following the birth or adoption. If a parent has to take time off (and must take a leave of absence with no compensation) in order to have a child or to adopt a child, then the $5,000 may be very helpful for reimbursing expenses associated with the birth or adoption of the child. Once the parent returns to work, the retirement account or IRA can be reimbursed.
Disadvantages: When the amount is withdrawn from a retirement account or a traditional IRA to pay for qualified birth or adoption expenses, although there is no IRS early withdrawal penalty, federal and state income taxes will still have to be paid on the amount withdrawn from a qualified retirement account or a traditional IRA. If the amount withdrawn is paid back, then after-taxed funds will be used to pay back the amount withdrawn. And once the funds used to repay the amount withdrawn are themselves withdrawn, then federal and state income taxes will have to be paid – again on those same funds. This means double taxation on the amounts original withdrawn. This situation is no different than a TSP loan (emanating from a traditional TSP account) in which after-taxed funds are used to pay back a TSP loan and these same after-taxed funds will be taxed again when they are withdrawn from the TSP account. Worse of all, funds withdrawn from an IRA or qualified retirement account will lose earnings while they are no longer held within the IRA or retirement account. Consider the example of a federal employee who is 26 years and withdraws $5,000 from his or her TSP after either having a child or adopting a child. The employee is 27 years old and has no intention of paying back the $5,000. Assume the $5,000 is invested in the TSP “C” fund which, according to, Morningstar ratings, has an annualized portfolio average return over 60 years of 10 percent*. Assume the individual has no intention of paying back the $5,000. When the individual becomes age 67, the $5,000 withdrawn at age 67 would have lost at least 40 years’ worth of earnings at an average return of 10 percent*. Had the $5,000 stayed in the TSP “C’ fund, the $5,000 would have grown to $226,300. With two parents each drawing $5,000, the combined $10,000 would have grown (assuming an annualized return averaging 10 percent*) to $452,000. With more children and subsequent $5,000 childbirth or adoption distributions, a married couple could stand to lose over $1 million in potential income for their retirement. In short, the $5,000 distribution is in many ways similar to a TSP loan in that: (1) It should be used as a last resort; (2) even if it is paid back, the lost earnings on the amount distributed in most cases cannot be “made up” and are lost forever; and (3) if the distribution is paid back, taxes will have to be paid twice on the amounts distributed – the first time when the amounts are distributed and the second time after the amounts are paid back the same funds and subsequently distributed taxes will again be paid.
*Past investment performance is not indicative and no guarantee of future investment return.
Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While the employees of Serving Those Who Serve are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
Secure Act Passage