(Forbes) Congress just agreed to a bipartisan appropriations bill that will help avert another government shutdown. However, attached to the spending bill is a piece of legislation called the Setting Every Community Up for Retirement Enhancement Act (SECURE Act), which passed the House with a 417-3 vote earlier this summer.
Honestly, the passage of the SECURE Act came as a bit of a surprise as it appeared to be derailed during the fall. Now, just a few weeks before the end of the year, Congress is changing major tax laws implicating 2019 and especially 2020 going forward.
The most important provision of the SECURE Act – removal of the stretch RMD provisions – is a tax revenue generator, meaning a tax hike on many Americans. This goes into effect Jan. 1, 2020, assuming President Trump signs the bill into law, which seems all but a forgone conclusion.
The removal of the required minimum distribution (RMD) provisions for stretch IRAs for many beneficiaries will cause chaos for certain types of trusts written prior to this bill. Trusts written as so-called “pass-through trusts” could have to be reformed to match up with the current SECURE Act language. If not, existing trust language could restrict access to funds to heirs of trusts listed as the beneficiaries of IRAs and cause massive tax bills down the line.
Instead of being able to stretch RMDs out over the life of a beneficiary, many will have to take all RMDs of a retirement account by the end of year 10 after an account owner passes away. This can push higher RMDs into the prime working years – and highest tax years – of a beneficiary’s life.
The bill is also a huge win for the insurance industry and lobbyists, who massively supported the bill. This is both a good and a bad thing for consumers.
The bill eases the way for annuities to be included in 401(k)s, which is good for consumers because Americans need more access and sources of retirement income. Lifetime income helps increase the longevity of a retirement income portfolio in many situations.
The bad news? The way they are allowing more access is by removing or lessening some fiduciary requirements to vet insurance companies and products before they are allowed into the plan. This could cause negative ripple effects down the line for consumers, especially when coupled with a lessening of the standards imposed by the SEC this summer.
Lastly, there were some common-sense changes, too. The SECURE Act now allows those working past 70.5 to contribute to IRAs, which matches the rules for 401(k)s and Roth IRAs. This also opens the door for a lot of planning strategies like additional back-door Roth IRAs later in life.
Additionally, the SECURE Act pushed out the date to start RMDs till age 72, but this only applies to those who did not attain age 70.5 by the end of 2019. This, coupled with pending IRS rules around RMD factors, will reduce the amount of money retirees need to withdrawal each year in retirement due to the RMD rules.
This bill has a huge impact almost immediately. Financial advisors need a lot of additional training after this rule passes. Attorneys need to review their trusts and estate planning documents. CPAs need to understand the long-term tax implications. Consumers need to know that they likely need to update their retirement and estate plans.
From the outset, 2019 looked like it might be “The Year Of Retirement Reform” for Congress. Last year closed out with a number of retirement bills making real headway through D.C., committees, think tanks and lobbyists, and we’ve been poised for major legislation to emerge.
The SECURE Act will be the first real major retirement legislation since the Pension Protection Act in 2006. This comes after the Tax Cuts and Jobs Act back in 2017 essentially punted on all of the major retirement reform
While the bill has essentially 29 new provisions or major changes, I want to focus on just eight areas.
While the bill does smooth out some minor road blocks to retirement savings – like removing the IRA age limitation, expanding the start date 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 move the retirement security needle much or at all. Many of the changes can be viewed as only benefiting wealthy IRA owner's that don't need their RMDs yet and a clear nod to the product manufacturing lobby.
The major issues facing retirement security for most Americans still come from Social Security funding issues, rising health care costs through skyrocketing drug costs, strains on Medicare and Medicaid, and – with roughly one-third of the American population not really saving for retirement – small modifications to savings plans likely won’t help this group. This is not to say that the SECURE Act provisions aren't positive changes, just not really going to do much to deal with the real retirement issues facing Americans.
That being said, here are eight major pieces of the current version of the SECURE Act that I think are worth closer examination.
1. Increase Small Employer Access to Retirement Plans
Title 1, Sec. 101 of the bill make some significant changes to a variety of retirement rules. It expands the ability to run multiple employer plans and make the process easier overall. It essentially allows small employers to come together to set up and offer 401(k) plans with less fiduciary liability concern and less cost than exists today.
The goal here is to try to expand small employers’ capability to offer some form of retirement savings to employees. This has generally been a frustration of previous legislative attempts as the SIMPLE and SEP IRAs were developed in part to achieve this outcome, but ultimately have not filled in as a broadly utilized retirement savings plan for small employers. As such, the SECURE Act will take another stab at this huge issue as many small employers offer no retirement savings options at all, leaving the issue solely to the individual.
2. Increase Annuity Options Inside Retirement Plans
Sec. 204 seeks to update the safe harbor provision for plan sponsors to select annuity providers in order to offer in-plan annuities inside of a 401(k). Today, many 401(k)s stay away from annuities, in part because of concerns about liability in picking an annuity provider for the plan. The new rules would essentially ease this liability concern to some degree, potentially opening up the path for more annuities to be offered inside of retirement plans.
3. Increase Required Minimum Distribution Ages
Today the law requires that most individuals take out required minimum distributions (RMDs) from their retirement accounts once you reach age 70.5. The SECURE Act would delay this requirement to age 72. The RESA Act currently in front of the Senate seeks to push RMD requirements even further back to age 75.
However, one criticism of this provision is that it mostly benefits those with significant tax-deferred savings by allowing them to grow this money even longer. Other suggested changes to RMD rules have included allowing smaller accounts, such as those under $100,000, to be exempt from withdrawal requirements for the owner of the account.
4. Removal of Age Limitation on IRA Contributions
For years there has been a rule that essentially discouraged retirement savings in IRAs for people who continued to work later in life. After age 70.5, you could no longer contribute to an IRA, but amazingly, you could still contribute to a Roth IRA. Sec. 114 of the SECURE Act removes this savings limitation by repealing the age limitation for traditional IRA contributions.
5. Tax Credit for Automatic Enrollment
Sec. 106 introduces a new tax credit of $500 to help some smaller employers encourage automatic enrollment into their retirement plan. This small credit could help offset some of the costs of operating a plan at the beginning. Automatic enrollment has seen great success in increasing plan participation by employees.
6. Penalty-Free Distributions for Birth of Child or Adoption
A really interesting and welcome addition to the bill was a new exemption from the 10 percent penalty tax of 72(t) for early withdrawals from retirement accounts. The new rule, found in Sec. 113, allows an aggregate amount of $5,000 to be distributed from a retirement plan without the 10 percent penalty in the event of a qualified birth or adoption. The distribution would need to occur within one year of the adoption becoming final or the child being born.
7. Lifetime Income Disclosure for Defined Contribution Plans
The bill requires that defined contributions plans deliver a lifetime income disclosure to participants at least once every 12 months. This lifetime income disclosure would essentially show how much income the lump sum balance in the retirement account could generate.
The methodology for calculating lifetime income is still in the works. Additional disclosures and information on assumptions used would also have to be provided to participants.
8. Removal of “Stretch” Inherited IRA Provisions
The SECURE Act will make significant changes to inherited retirement plans like 401(k)s, traditional IRAs and Roth IRAs. In the past, beneficiaries of these accounts could typically spread the distributions over their own life expectancy.
However, the new bill includes what is viewed as a tax-generating provision that would require most beneficiaries to distribute the account over a 10-year period. This change will accelerate the depletion of inherited accounts for many large IRAs and retirement plans.
Typically, smaller inherited accounts are liquidated fairly quickly by beneficiaries already. However, the end of the so-called “Stretch” IRA or retirement account makes a lot of sense from a public policy perspective, especially after the Supreme Court has ruled that inherited accounts are not “retirement” accounts.
As such, it does not make policy sense to allow for an extended tax benefit through the beneficiary’s retirement.
The potential tax burdens of faster distributions of inherited retirement accounts will increase the need for proper estate planning and potentially more strategic Roth conversions during the life of the account owner, adding additional complexity to retirement and estate planning.
While the SECURE Act makes positive changes, takes a step forward, but doesn’t clearly advance the retirement security of those in most need of a boost.
