The SECURE ACT and Your Savings Plan
Legislation passed in December last year made some critical changes to core retirement and estate planning strategies. Though none of them are revolutionary or catastrophic, the new rules are certain to impact your future retirement or that of a close family member.
The awkwardly-named Setting Every Community Up for Retirement Enhancement (SECURE) Act tweaked required minimum distributions, 529 plans, employer sponsored retirement plans and shortened the potential infinite lives of inherited individual retirement accounts, also known as stretch IRAs. The new regs make it easier and more attractive for smaller employers to offer retirement plans to their employees. They will also make it easier to include annuities in retirement plans.
Many Changes to IRAs
The required minimum distribution (RMD) age has been pushed back from 70½ to 72. The new legislation also canned the 70½ age restriction on contributing to a traditional IRA. Now we can continue to contribute to them for as long as we continue to earn income.
That acknowledges the reality of our graying work-force. Though these changes are positives, some might argue that postponing RMDs by a mere 18 months doesn’t go far enough as we continue to work and live longer.
The government will raise some revenue by eliminating stretch IRAs as a powerful estate planning tool. Prior to the SECURE Act, heirs could take relatively small distributions based on their projected lifespan. Those amounts might be lower than the growth rate of the investments, allowing some inherited IRAs to grow tax deferred for possibly decades and even be passed on to another generation.
Now, unless the account is going to a spouse, inherited IRAs must be exhausted within 10 years. There are a few exceptions to the sped-up mandatory withdrawals. The new rules don’t apply to any IRAs inherited before the start of this year and minors until they’ve reached the age of majority. There are also exclusions for minors who are chronically ill or disabled.
Contribution limits to IRAs remain the same in 2020: $6,000 or the amount of earned income, whichever is greater. Workers over 50 years old can max out at $7,000. Spousal IRAs are unaffected.
New Penalty-Free Withdrawals From IRAs and 529s
New parents each can take a one-time $5,000 withdrawal from IRAs to cover childcare expenses within one year of the birth or adoption of a child. Though they may pay income taxes on the withdrawal, they may return that money back into plans later as a rollover as well.
Uncle Sam has relaxed the rules on taking money out of the popular 529 college savings plans. Penalty- free withdrawals may be taken to pay for recognized apprenticeships and to repay up to $10,000 in college debt per beneficiary. An additional $10,000 may be used for each sibling of the 529’s beneficiary. On the downside, students won’t be able to claim the interest they pay from a 529 as an allowable student loan interest expense.
Employee Retirement Plans Become Easier to Offer but More Complicated for Employees
According to the Bureau of Labor Statistics, slightly more than half of the workforce was eligible to participate in an employer-sponsored retirement plan in 2017. The SECURE Act attempts to make it less expensive and risky for employers — especially small businesses — to help their employees better prepare for retirement.
Now employers can receive more tax credit to offset startup costs of new plans and automatically enroll employees. Employers in unrelated businesses or even industries can now band together in multiple employer plans, which helps spread administrative costs and makes offering more investment options affordable. In addition, employers in so-called MEP plans won’t be penalized if another participating company isn’t in compliance.
Now they have more time to start anew plan, too. Companies may retroactively start new plans after the close of their tax years if they start it before their required filing date. That makes it more likely companies will take the leap of offering a new plan after they’ve had a banner year and the owners could use the tax deduction.
Enrollment into employer plans is now extended to more part-time employees. Part-time workers who put in 1,000 hours or more the prior year or 500 hours or more for each of the prior three years must now be allowed to participate in the plan. Employers who offer safe harbor 401(k)s may increase their default automatic employee deduction from 10% to 15%.
Traditional 401(k)s require employers to limit contributions by highly compensated employees if lower paid employees aren’t contributing enough. That makes offering a plan less attractive to owners who might want to max out their contributions. Including part-timers could skew those numbers. Luckily, employers will be able to exclude part-timers from their annual discrimination testing.
The SECURE Act also removes one temptation that can contribute to underfunded retirement balances. Plans may no longer issue credit cards to borrow against their retirement accounts. Though it’s easy to see why those cards can provide some flexibility for families at critical times, it’s also easy to see how they can be abused through impulse borrowing on long term assets.
The insurance industry may have been the biggest winner from passing the SECURE Act. Employers will be required to send their plan participants an annual disclosure of how much each worker could expect to receive if they choose to receive an annuitized income stream instead of a lump sum. That’s a mandatory once- a-year advertisement for annuities. Employers will not be automatically liable if an annuity issuer goes under and can’t meet its payment obligations, provided the company did appropriate due diligence on the issuer.
This will either prove to be a boondoggle for the insurance industry, help make a potentially useful product more competitive and accessible. or both. Many workers would appreciate the ability to trade 401(k) balances for predictable monthly payments for their or their spouses’ lives, but too many annuities come with unnecessary bells and whistles. Without increased transparency, many workers could end up with less income in retirement than they would have earned with traditional retirement investing strategies.
Annuities held in retirement plans can now be transferred to new custodians, making them portable if the company’s retirement plan makes them ineligible, helping workers avoid undesirable surrender and transfer fees. Protecting assets from sudden liquidation is also a little handout for insurance companies. In a more optimistic scenario, the larger annuity market might drive some companies to create low cost, straightforward products. Shopping for an annuity should be as simple as buying a bond. Workers and plan sponsors should shop for annuities based on two factors: safety and the highest cash flow. Here’s one last outside the box thought: It’s very unlikely, but possible, unexpected increases in our life expectancy or poor investing of annuity balances could lead some companies to fail, which could precipitate a new economic crisis.
Contribution Limits in Employer Sponsored Plans
Though not part of the SECURE Act, 2020 contribution limits are rising in employer sponsored defined contribution plans. For those fortunate enough to be able to max out their retirement contributions, covered workers will now be able to contribute up to $19,500 with an additional $6,500 catch-up option for workers over 50. These limits don’t include any matching or required contributions by employers.
What Else Needs to Change
Financial planning has become overly complex. There are too many varieties of tax-deferred accounts, each with their own specific contribution and withdrawal quirks. It’s absurd that workers have to choose between health savings accounts, different kinds of IRAs, 401(k)s, 529 college saving plans and tax-deferred life insurance policies when many of them have overlapping withdrawal provisions and confusing penalties. At some point, there should be one consolidated tax-deferred savings account available to all Americans. That would make it easier for individuals to plan for and adjust to new circumstances. A consolidated tax advantaged plan would likely provide more flexibility for the government to adjust contribution and withdrawal limits as needed.
What Hasn’t Changed
The SECURE Act contains some welcome changes, though many heirs and their estate planners might be disappointed to lose the stretch IRA strategy. New annuitization options may reduce the risk of outliving our money, but our need to accumulate a large pool of assets for retirement hasn’t changed at all. America needs to save and invest wisely.
We all have different retirement expectations, needs and resources. There’s no catch-all target savings amount that can cover everyone. But it’s frightening to know that the median retirement savings for 35- to -44-year-olds was recently only $37,000. And with savings accounts earning only fractions of 1% and the Federal Reserve targeting inflation at 2%, we can’t be complacent about where we put our retirement savings either. Earning a high rate of return is just as important as putting aside as much as you can. Regularly investing into high quality growth stocks, or funds, if you’re investing in a 401(k), while using other asset classes to manage risk remains one of the best ways to grow wealth.
It’s challenging to forecast the long-term impact of the SECURE Act, but here are some guesses. Annuities will see banner growth in assets under management, but the market will demand more focused, transparent and far cheaper products. The multiple employer plan structure will make it possible for small companies to offer sophisticated retirement plans while saving money from economies of scale.
As more employers offer retirement plans, the ones that don’t will find it increasingly difficult to attract outstanding job applicants. Even after the cost savings, expense averse employers might rely even more heavily on independent contractors, who wouldn’t be eligible to participate in a company retirement plan. And one final reminder: Tax laws are complicated enough. New rules can make them even more challenging. Some of the changes included in the SECURE Act still need to be interpreted or implemented by government agencies, so it’s essential you check with your tax and other wealth advisers before you make any changes.