In May, the U.S. House of Representatives passed the most significant retirement-savings bill in more than a decade.
It’s called the Setting Every Community Up for Retirement Enhancement, or the SECURE Act of 2019.
Here are some key provisions:
More time in IRAs and 401(k)s. The bill would push back the age for required minimum distributions (RMDs) from 70½ to 72 years old.
Grant part-time workers benefits. Long-term part-time employees would be able to participate in their company’s 401(k) plans.
Boost small-business 401(k)s. Small businesses could band together in group plans.
Annuity adoptions. Would allow employer-sponsored 401(k) plans to add annuities as investment options on the menu.
529 plans. 529 plans would be expanded to pay for expenses related to an apprenticeship or to pay back as much as $10,000 in student loans.
Let’s take a closer look at what those mean.
Investors with 401(k) plans or other tax-deferred accounts would have another year and a half before Uncle Sam required withdrawals. Instead of taking money out at 70½, Americans would be able to wait until they turned 72.
The SECURE Act could also repeal the maximum age for traditional IRA contributions. Currently, the maximum age limit to contribute to a traditional IRA is 70½ years old. Repealing the age limit would allow workers to save longer for retirement, even after withdrawals start.
“We think this is a great move, as that half-year was confusing for many people,” said Independent Adviser newsletter editor Dan Wiener. “And while it’s just a short period, it also gives extra time to grow your investments before you have to start taking money out of your accounts.”
However, here’s the money grab: To make up for lost tax revenue, the House bill would require Americans who inherit an IRA to withdraw the money within 10 years of the account owner’s death, along with paying any taxes due. What’s important is that surviving spouses and minor children would be excluded.
Under current law, heirs spend down inherited IRA accounts over their lifetime, an estate-planning strategy known as the “stretch IRA.”
“The SECURE Act would essentially do away with the stretch IRA as we know it,” noted IRA expert Ed Slott. "It would be collateral damage as our government looks under the sofa for spare change or any possible revenue source. The stretch IRA is not supported by a powerful lobbying group, which may be a reason it is now potentially on the chopping block.”
The Senate version, known as RESA, is slightly less punitive and may instead call for a five-year payout period for inherited IRAs over $400,000 per heir. Details have yet to be hashed out, but both bills call for changes to inherited IRAs after Dec. 31, 2019.
“We’re very supportive of this bill,” said Anne Lester, head of retirement solutions at J.P. Morgan Asset Management. “Let’s not let the perfect be the enemy of the very, very good.”
Part-time work counts
As part of the goal to get more people saving, the SECURE Act could prompt Americans who don’t work full time to put away money for retirement.
The bill would require your employer’s 401(k)-type retirement plan to allow “permanent” part-time workers to participate. To qualify, you would need to have worked 500 or more hours a year (but fewer than 1,000 hours) for at least three consecutive years. There are 2,080 hours in the traditional 40-hour-a-week year.
401(k) options for small businesses
If House and Senate bills pass and become law, small businesses could have the option to join group plans alongside other companies.
This lowers administration and management costs and ideally makes higher-quality plans available to small businesses and their workers.
Current law allows small businesses starting a new retirement plan a $500 tax credit. The SECURE Act bill would increase the credit to as much as $5,000, and apply for three years. “The bill will do a lot to extend coverage to small businesses,” Lester said.
Annuity options, good and bad
The bill would allow 401(k) plans to add annuities as an option for employees.
The idea is that annuities solve the problem of lifetime income for workers who once received pensions. Annuities are insurance policies that convert retirement savings into income. Common in pension plans, annuities to date have not been popular in 401(k) plans.
Annuities have downsides: Fees are often high. There’s always a risk that the “guaranteed lifetime income” could turn out to be a mirage if the insurance company goes belly-up (it happened when Penn Treaty American went under in our fair state). Fears they could be left on the hook have prompted many 401(k) providers to steer clear of annuities.
Under the SECURE Act, retirement plans would now have “safe harbor” from being sued if annuity providers went out of business or stopped making payments. If they’re less likely to get sued, employers may be more open to annuities.
Consumer advocates warn that 401(k) investors and plans would be open to more risk. As drafted, the SECURE Act would enable 401(k) plan sponsors to use high-cost, lower-quality annuity providers and fails to clarify that employers would still be on the line legally for negotiating the annuity’s price.
In theory, the bill could help people manage income in retirement more effectively. But this provision of the SECURE act could mean average investors would be making high-stakes bets with their retirement savings on the ability of insurers to meet long-term obligations or get stuck with high-cost annuities that are not a fit with their goals, Wiener said.
That said, annuities have fans. Wharton professor Olivia Mitchell noted in a recent paper that the SECURE Act would encourage retirees to convert a portion of their 401(k) accounts at retirement into deferred annuities, her preferred insurance product.
“There is growing interest in proposals to include annuitization into retirement plans so as to ‘put the pension back’ into 401(k) plans and thus help retirees avoid outliving their assets. Even more interesting is the idea to include deferred annuities as a default in defined contribution plans,” she and coauthors wrote in a Brookings Institute report.
”Helping plan sponsors to default a portion of retirees’ retirement plan accruals into a deferred lifetime income annuity without negative tax consequences will do much to correct Americans’ traditional reluctance to annuitize,” the report said.
For instance, Wharton employees can invest for retirement through TIAA (Teachers Insurance and Annuity Association) products such as immediate annuities, which can be purchased with savings in a retirement plan. Mitchell doesn’t personally own any annuities through TIAA.
“So far, the firm does not offer deferred annuities, which are what I would like to see," Mitchell said. "For instance, I’d like to buy an annuity at age 70, or when I retire, that would start paying at age 80 or 85. These can be pretty inexpensive and produce a reasonable amount of income to boost old-age consumption.”
As to the percentage of the retirement nest egg that could be defaulted into a deferred annuity, she said: “My research shows that putting just 10 percent of one’s 401(k) at retirement into a deferred annuity payable from age 80 or 85 would greatly enhance retiree well-being.”
Why the big push from annuities? Probably the bill’s sponsors, including Pennsylvania lawmakers.
The insurance industry is among the biggest businesses in the commonwealth. The House bill was spearheaded by Rep. Richard Neal (D., Mass.), chairman of the House Ways and Means Committee; the committee’s ranking member, Rep. Kevin Brady (R., Texas); and Reps. Ron Kind (D., Wis.) and Mike Kelly (R., Pa.).
“Caution to the consumer about annuities and the high fees and surrender charges: They should be used properly. They have high commissions and they’re sold,” said David Geibel, managing director with King of Prussia-based Girard Advisory Services, owned by Univest. He also likes the multi-employer plan through the SECURE Act, as it “creates economies of scale for 401(k) plans. A multi-employer plan is good for small-business owners.”
529 plans and saving for kids
The student-loan provision is a lifetime cap, not an annual amount. However, you would be able to use it to pay back the loan for both the 529 beneficiary and any siblings, with each person having a $10,000 limit, according to Tim Steffen, director of advanced planning at the financial services company Baird.
“This continues a trend to expand the use of 529 accounts,” he noted.
The House bill would repeal the so-called kiddie tax changes beginning in 2019, although taxpayers could elect to use the old tax rules for 2018 if they wish.
This would be a welcome change for those who were surprised by increases in tax under the new tax rules, which subjected those children to the trust tax rates and brackets rather than using their parents’ brackets.
“This is especially true for college students who received taxable scholarships and `Gold Star’ families, those who are collecting military survivor benefits after losing a parent,” Steffen added.
A final positive: The SECURE Act would allow investors early access to IRA funds for any “qualified birth or adoption” by creating a new exception to the 10 percent penalty.