How did the SECURE Act change regulations around IRAs (Individual Retirement Accounts)? In this article we will give you a broad look at IRAs, as well as an explanation of some of the changes made by the SECURE Act. Read on for more!
Traditional Individual Retirement Accounts
The defining feature of a traditional IRA is pre-tax contributions into the account. This means that distributions are subject to regular taxes. Remember, Traditional = regular Taxes. You can begin to take penalty-free distributions when you are as young as 59.5 years of age.
What if you need to make an early withdrawal? Is there a way to avoid the penalty? In truth, there are a few exceptions to the general rule around early withdrawals. For example, you can take out as much as $10,000 to help finance a home purchase as a first-time buyer. If you are unemployed, you can withdraw money to pay for health insurance premiums when certain circumstances exist.
Another exception gives you the ability to take distributions to cover unpaid medical bills. If you are permanently disabled, the age requirement is waived, and there is no penalty if you take distributions to cover higher education expenses.
Okay, so we covered early withdrawals. What about later withdrawals? When do you have to start taking money out of the account? This is one of the alterations under the SECURE Act. You are now required to take mandatory minimum distributions when you are 72 years of age; prior to the enactment of the SECURE Act, this age was 70.5.
A further change permits a traditional account holder to contribute to their account for an open-ended period of time. Prior to this alteration account holders who were older than 70.5 could not make contributions into their accounts.
Now that we’ve covered traditional individual retirement accounts, let’s look at Roth IRAs. Contributions into Roth IRAs are made after taxes have been paid on the income. This means that your distributions will not be taxed and account holders are never required to take mandatory minimum distributions. Why is this? The IRS received their tax money up front.
Roth IRAs are otherwise the same as their traditional counterparts with regard to the penalty-free withdrawal age and exceptions. Holders of Roth IRAs have always been able to contribute to their accounts indefinitely, and that has not changed.
Elimination of the Stretch IRA
What about the “stretch IRA?” What was it, and what happened to it?
Bear with me, as this can be a bit complicated. The taxation rules for non-spouse beneficiaries of individual retirement accounts mirror the arrangement for traditional account holders. Traditional account beneficiaries have to report this income. Distributions to Roth IRA beneficiaries are not subject to taxation; remember, the IRS got their taxes up-front there.
Beneficiaries of both types of accounts are required to take mandatory minimum distributions on an annual basis. The age of the beneficiary will determine the amount that must be taken each year. Younger beneficiaries can take less than their older counterparts.
What does that mean in practice? To stretch the individual retirement account (hence the name) and take maximum advantage of the tax benefits, the beneficiary would take only the minimum that is required for the maximum length of time. This was especially useful for beneficiaries of well-funded Roth accounts, as their distributions were tax-free.
A provision in the SECURE Act changed all of this. Beneficiaries have only a single decade to drain the account’s resources. Unfortunately, the long-term stretch has gone extinct.
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