The SECURE Act and Your Retirement
As part of the approval of a recent spending bill, the House and Senate have also approved the SECURE (Setting Every Community Up for Retirement Enhancement) Act. In general terms, the goal of the legislation is to expand and preserve retirement savings programs. All changes became effective on January 1, 2020.
The bill provides a little bit of something for everyone. With that in mind, here is a snapshot of the key components of the act, organized by the group that will feel the most immediate impact:
Approaching retirement or recently retired
The date when individuals must begin taking distributions from their retirement accounts has moved from April 1 after the year they turn 70 ½ to April 1 after the year they turn 72. This change in the Required Minimum Distribution (RMD) age removes the confusion that the half-year can cause and allows extra time for tax-deferred growth of investments. For individuals who do not need income from their 401(k) or IRA, this is welcome news. Those turning 70 ½ in 2020 would be the first to benefit.
The Act also removed the age limit for contributing to a traditional IRA. Those with earned income can now contribute to their IRA past the previous age limit of 70 ½. This change is a recognition of the fact that individuals are living and working longer.
To offer a lifetime income option for retirees, the bill also paves the way for annuities to be more readily offered in 401(k) plans. Many plans avoid annuities based on the concern that they may be held liable for the performance of the annuity provider. The rules are intended to alleviate some of these concerns. This change allows for a pension-like product in a world where pensions are becoming more rare.
For smaller business owners looking to offer a 401(k) plan to employees, the cost and complexity have historically been a deterrent. These employers will now be able to join other businesses in a multiple-employer plan. The scale of these groups will provide efficiencies and cost savings.
To encourage these smaller employers to offer 401(k) plans or SIMPLE IRA’s, the bill provides a new tax credit of $500 for plans that offer automatic enrollment. This is intended to help reduce the initial costs of establishing a plan, but is also offered to employers that convert a plan to an automatic enrollment plan.
The bill also mandates that benefit statements be provided to plan participants at least once a year. This statement would provide an estimate of the lifetime income that their assets could provide. The Secretary of Labor will be defining the methodology to be used in calculating lifetime income. Since fiduciaries and plan sponsors will have no control over the assumptions feeding into the calculation, they will also not be liable for their accuracy. This should especially benefit mid-career workers. While ideally they will have a strong start to retirement savings, they also have time to make adjustments to savings if needed.
The expansion of small-business 401(k) plans, as discussed previously, will be a positive for all employees of smaller businesses. However, when considering the power of compounding, this change will have the greatest impact on employees with the longest runway to retirement. In 2020, employees can contribute up to $19,500 to their 401(k), with an extra $6,500 for those over 50. This compares to IRA contributions limit of $6,000, plus an extra $1,000 for those over 50. For employees of smaller firms who previously only contributed to an IRA, the access to a 401(k) will significantly increase their ability to save for retirement.
Another component of the 401(k) plan change requires that employers offer access to long-term, part-time employees. More workers (especially younger workers) are taking on multiple part-time jobs and projects in what has become known as the gig economy. This working arrangement has limited their options for retirement savings.
Employers will also be incentivized to auto-enroll employees and increase their contributions over time. Current rules allow for auto-enrollment to slowly increase to 10% of salary. The bill raises that limit to 15%. This is an important change to better position employees for retirement. While younger workers may not immediately appreciate the retirement savings, they will hopefully enjoy watching those savings grow over a few decades.
New parents will be able to withdraw $5,000 from retirement plans to cover expenses associated with birth of a new baby or adoption, without the 10% early withdrawal penalty. The election must be made within one year of birth or adoption. Keep in mind that taxes will still be owed on the withdrawal. This change offers flexibility to new parents but should not be considered as the first option when funds are needed. By reducing the balance of a retirement account, a young worker is losing decades of potential growth in a tax-efficient account.
Gift to the U.S. Treasury
One casualty of the bill will be the stretch IRA. Under the new law, non-spouse beneficiaries of IRAs will no longer be allowed to “stretch” the distributions over their lifetimes. This has been a very attractive option in the past to allow for additional years of tax-deferred growth and, for traditional IRA’s, slower payment of taxes on the distributions. Effective January 1, 2020, these non-spousal beneficiaries must liquidate an inherited IRA within 10 years. This not only removes the assets from a tax-advantaged account more quickly, but could push the beneficiary into a higher tax bracket, depending on the size and timing of the taxable distributions. This is great for tax revenue, not so great for beneficiaries. With tax rates likely to increase again in 2025, this will have an even greater impact in years to come.
The loss of the stretch IRA only increases the benefit of thoughtful estate planning. One strategy that could potentially become even more attractive is the purchase of life insurance to fund a trust, paid for by IRA distributions before the account holder’s death. Taxes would be paid on the withdrawals, but it could fund a life insurance policy of greater value than the IRA.
The original account holder could also convert a traditional IRA to a Roth IRA. The move would require that taxes be paid on the conversion, but fortunately the Tax Cuts and Jobs Act of 2017 temporarily lowered tax rates. This would allow money to pass to the beneficiary without the tax sting.
The bill will provide some positive changes for most savers. Investors should work with their professional advisors to be sure they are capturing the benefits. The days of retiring with a company funded pension may soon be a distant memory. With the risks of retirement funding now being borne by individuals, be sure you have a plan to retire well on your schedule.
Thomas Burleigh, CFP®
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