Touted as an aid to prevent Americans from outliving their assets, be aware of the downsides of this important pending legislation.
Provided by Angel McCall CFP®
In May 2019, the House of Representatives passed the SECURE act (Setting Every Community Up for Retirement Enhancement Act). Even though the bill contains provisions aimed at increasing access to tax-advantaged retirement accounts, your retirement accounts will be affected in a major way. Opponents point out that it is also a money-grab bill for the government by changing withdrawal rules which may impact retirement and estate planning strategies and a windfall for annuity vendors.
The Senate is expected to pass a version of the bill probably including key elements of their “RESA” (Retirement Enhancement Security Act) which would mitigate some of the “money-grabbing” aspects of the House bill.
While proposed legislation does smooth out some of the problems with retirement savings – like removing the IRA age limitation, expanding the start for RMDs, increasing annuity options and potentially increasing the likelihood of small employers starting retirement plans – there is still a strong argument that these changes, while positive, won’t help the retirement predicament very much. Many of the changes can be viewed as only benefiting wealth IRA owners who don’t need their RMDs yet and clearly benefit the insurance annuity product providers. The annuities provided do not seem to provide any inflation protection or benefits to beneficiaries. The biggest winners for these annuities will be the insurance companies and insurance sales people.
Americans will still be facing major issues not being addressed in Congress:
Social Security funding
Rising health care costs
Skyrocketing drug prices
Strains on Medicare and Medicaid, and
1/3rd of the population are not really saving for retirement
Here are the major provisions of the SECURE Act that may affect you.
1. Increase in the Required Minimum Distribution Ages
The current law requires minimum distributions (RMDs) from retirement accounts to begin once you reach 70.5. The SECURE Act sets the age at 70.5. The RESA Act proposes to change this requirement to age 75. One criticism of this provision is that it mostly benefits those with significant savings allowing the money to grow longer.
2. Removal of Age Limitation on IRA Contributions
Currently, IRA contributions are not allowed after age 70.5. The SECURE Act would remove this limitation for those who continue to work later in life.
3. Penalty-Free Distributions for Birth of Child or Adoption
The rule would allow an aggregate amount of $5,000 to be withdrawn from a retirement plan without the 10% penalty within one year of final adoption or the child’s birth. (Income taxes would be owed.)
4. Increase Small Employer Access to Retirement Plans
Currently, SIMPLE and SEP IRAs are available, but have not been broadly utilized. They could come together to set up and offer 401(k) plans at less cost than exists today.
Many employers offer no retirement savings options at all, leaving retirement savings solely up to the employee.
5. Reduces the number of work hours required before signing up for a 401(k) plan
This will open up plans to part-time workers.
6. Tax Credit for Automatic Enrollment
This credit to employers would help offset the costs of setting up a plan which includes automatic enrollment of all employees.
7. Lifetime Income Disclosure for Define Contribution Plans
Would require that at least once a year the participant would receive a projection showing how much income the balance in the account could generate.
Of course, the methodology for calculating this and the assumptions used would need to be worked out and provided to the participants.
8. Annuity Options Inside Retirement Plans
Included as a “safe harbor” provision, this will be a boon for insurance companies. For a variety of reasons, I almost never recommend that a retirement account be put into an annuity. Even though a 401(k) rolled into an IRA needs to be “managed,” it can provide cost of living increases and can be left to beneficiaries. Even though annuities provide a fixed, lifetime benefit, a person can usually do better without them.
9. The Hidden Money Grab of the SECURE Bill
If you have an IRA or a retirement plan that you were hoping you could leave to your children in a tax-efficient manner after you die, then this provision could cost them dearly.
Non-spouse beneficiaries of IRAs and retirement plans currently can minimize the amount of their Required Minimum Distributions by “stretching” them over their lifetimes. The longer your beneficiaries can postpone or defer them (and taxes on the distributions) the better off they will be.
However, buried in the SECURE act is a small provision kills the “stretch IRA.” (This provision also applies to Roth IRAs - these distributions are not taxable – but once the funds are rolled out of the Roth, their gains become taxable.)
Buried in the language of the SECURE Act, a beneficiary other than your spouse who inherits a traditional IRA or retirement plan must deplete the account within 10 years. This is a huge change from the old rules allowing withdrawals over a beneficiary’s lifetime.
If you are thinking, “It can’t be all that bad,” then check out this chart demonstrating the difference between you leaving $1 million IRA to your child under the existing law, and the result under the SECURE Act.
A $1M Traditional IRA is inherited by a 45 year-old child and the minimum distributions he is required to take are invested in a brokerage account.
Assumptions used for Graph:
1. $1 Million Traditional IRA inherited by 45-Year Old Married Beneficiary
2. 7% rate of return on all assets
3. Beneficiary’s salary $100,000
4. Beneficiary’s annual expenses $90,000
5. Beneficiary’s Social Security Income at age 67 $40,000
The only difference between these two is when the child pays taxes!
The solid line represents a child who can defer (or “stretch”) the taxes over his lifetime under the current rules. At age 86, that beneficiary still has $2,000,000.
The dashed line represents the same child if he is required to take withdrawals under the SECURE Act. Your child could be financially secure or broke at age 86!
The Senate is working on a proposal that allows a $400,000 exclusion per beneficiary, but distribution would need to be over five years instead of ten years like the House version. The Senate version would allow more estate planning opportunities and tax savings, but this provision seems to be tied to Section 529 proposed revisions that the House voted down.
The SECURE act will impose massive taxes on families of IRA and retirement plan owners – even those with far less than $1M. Even though the Senate version has a five-year acceleration instead of a ten-year, this version could be better for most because of the value of the exclusion – especially if you have multiple beneficiaries.
Citations1 - financial-planning.com/articles/house-votes-to-ease-rules-for-rias-correct-trump-tax-law [5/23/19]
2 - irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2019 [6/18/19]
3 - congress.gov/bill/116th-congress/house-bill/1994 [6/17/19]
4 - shrm.org/resourcesandtools/hr-topics/benefits/pages/house-passes-secure-act-to-ease-401k-compliance-and-promote-savings.aspx
5 - law.com/newyorklawjournal/2019/04/05/what-to-know-about-the-2-big-retirement-bills-in-congress/ [4/5/19]
6 – forbes.com/sites/jlange/2019/06/11/the-hidden-money-grab-in-the-secure-act/#66b95993bbd7