There have been several recent legislative changes regarding taxes and specifically their impact on taxes in retirement plans that are worth highlighting.
As the saying goes, there are two certainties in life: death and taxes. This wasn’t always the case – early settlers to the United States paid little to no income taxes at all because the Federal Government as we know it today wasn’t established until after the Revolutionary War, which ended in 1783. In the post-Revolutionary War years, the adoption of the US Constitution gave the Federal Government, specifically Congress, the ability to generate taxes and impose duties on its citizens.
Fast forward then to the Abraham Lincoln presidency, and on August 5th, 1861, congress passed the Revenue Act. This essentially created the first income tax as we know it today; however, back then the tax rate was 3% on annual incomes over $800. The federal income tax that we are familiar with and pay today was formally enacted in 1913. It’s worth noting the passage of the Revenue Act also established what eventually became known as the Internal Revenue Service or better known as the IRS.
Today, we pay a variety of taxes: federal, state, and in some areas local income taxes. As a friendly reminder for those that haven’t already, July 15, 2020 is the last day to file your taxes for 2019 without an extension and/or penalty. There have been several recent legislative changes regarding taxes and specifically their impact on taxes in retirement plans that are worth highlighting.
In December 2019, the SECURE Act became law. The goal of this legislation is to help increase retirement savings. What does this have to do with taxes you ask? By utilizing the power of tax deferred savings in an employer sponsored qualified plan (for example: a 401(k), 403(b) or in an Individual Retirement Account (IRA)), you can lower your Adjusted Gross Income (AGI), potentially paying less taxes while allowing your retirement savings to grow on a tax-deferred basis. A summary of some of the most common contribution limits to these types of plans is provided below, along with some highlights of the provisions outlined in the SECURE Act.
Qualified Plans:
- 2019 – $19,000 / $6,000 additional catch-up provision for ages 50+
- 2020 – $19,500 / $6,500 additional catch-up provision for ages 50+
Traditional IRA’s:
- 2019 – $5,500 under age 50 / $6,500 over age 50
- 2020 – $6,000 under age 50 / $7,000 over age 50
Health Savings Accounts:
- 2019 – $3,500 Self-Only / $7,000 Family / $1,000 catch-up for 55+ *
- 2020 – $3,550 Self-Only / $7,100 Family / $1,000 catch-up for 55+ *
(Combined limits employee + employer)
Highlights of the SECURE Act*:
- Stretch IRAs: An inherited IRA now must be paid out over 10-Years; however, these new guidelines don’t apply to the following beneficiaries:
- Spouse of deceased
- Beneficiary who has chronic illness or disability
- Beneficiary who is not more than 10 years younger than the deceased IRA owner
- A minor child who received the inherited IRA will take required minimum distributions based on their life expectancy until they’ve reached the age of majority, varies by state, and then the 10-year distribution period begins
- Required Minimum Distributions (RMD)
- RMDs do not begin until the age of 72, previously the was age 70 ½
- Contributions to IRAs
- No longer restricted to contributions up until the age of 70 ½, if certain conditions are met for example earned income, there is no age limit
- Portability of Lifetime Income Investment
- Plan participants may elect a distribution of lifetime income investment (for example, an annuity in a qualified plan) prior to a distributable event if the investment is no longer allowed in the plan. The distribution needs to either be made as a direct rollover into an IRA, other retirement plan or the annuity must be distributed
*Side note, this legislation goes into effect for the 2020 tax year.
Additionally, in response to the COVID-19 pandemic, in March 2020 congress passed the CARES Act which provided much needed economic relief and tax relief to those affected by this devastating pandemic. The provisions in the CARES Act included an extension from April 15, 2020 to July 15, 2020 to file your income taxes as mentioned before. I recently wrote a blog post that outlined the CARES Act in greater detail and can be found in our Main Street Blog under: “De-Coding the CARES Act” I’ve included a link below to this article and encourage you to check it out for a more detailed guide to the provisions in this Act and the impacts on taxes.
In summary, taxes have evolved from a simple equation for the early settlers in America to a complex system today. As I’ve highlighted there are ways to help you divert otherwise taxable income into powerful tax deferred plans such as 401(k), 403(b) and IRA’s to name a few. The power of tax deferred savings is realized over time, as your nest egg grows and compounds on a tax deferred basis and ideally paying a lower tax on that income when you go to withdraw no later than 72 according to today’s rules.
References
https://www.investopedia.com/articles/tax/10/history-taxes.asp
https://www.history.com/this-day-in-history/lincoln-imposes-first-federal-income-tax
National Life Group 2020 Tax Reference Guide
https://www.cnbc.com/2019/06/03/these-are-the-new-hsa-limits-for-2020.html
https://blog.nationallife.com/decoding-the-c-a-r-e-s-act/
Products issued by:
National Life Insurance Company | Life Insurance Company of the Southwest
The companies of National Life Group® and their representatives do not offer tax or legal advice. For advice concerning your own situation, please consult with your appropriate professional advisor.
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