Earlier in 2019, I wrote about some retirement legislation that was pending in Congress. Well, surprise, surprise—it passed recently. (Interestingly, the bill was languishing in congress until it was added to a 2020 spending bill and seemed to slip in under the radar.)
It’s the most significant legislation since the Pension Protection Act of 2006 and is known as the ‘SECURE’ Act, which stands for “Setting Every Community Up for Retirement Enhancement.” I’m not sure I get the acronym, but that’s beside the point. (If you’re interested, or have a bad case of insomnia, you can read the full text of the bill here, all 1500-plus pages.)
The bill reminded me of what Job said: “The Lord gave and the Lord has taken away” (Job 1:20). When you read my take on some parts of it, you’ll see why.
1. You can delay taking RMDs until age 72 instead of age 70 ½.
Required Minimum Distributions (RMDs) are the government’s way of getting their piece of your retirement savings pie. (We have to render to Ceaser, but I think this is one of the least popular ways we must do it.)
Previously, when a retiree reached age 70 ½, they had to start withdrawing a minimum specified amount from their tax-deferred retirement savings accounts (traditional 401[k]s, IRAs, etc.) and pay taxes on their savings which have grown tax-free for decades. The SECURE Act has increased the age to 72. Based on the IRS Uniform Lifetime Table, someone who reaches age 72 in 2020 would have to withdraw approximately 3.9% of their end-of-year IRA account balance.
Since I retired in 2018, I have been making withdrawals from my Traditional IRA and paying taxes on those withdrawals. Therefore, the new law has minimal effect on me. I will keep doing what I’m doing while keeping an eye on the RMD percentages I reach age 72. But a retiree who doesn’t need money from savings (perhaps because they are continuing to work for pay, have a pension, etc.) will benefit from this change. They can leave it alone for a little while longer (and I emphasize the word “little”), which will give their money more time to grow.
I like this change as I’m sure it will benefit a lot of folks. But here’s a thought: Those with fewer savings who need them to last as long as possible—and would benefit the most from the 1 ½ years of additional growth—are probably already drawing from them because a small Social Security benefit is their only other source of retirement income. It seems to defeat the purpose. Plus, if the government really wants to help retirees make their savings last, why not delay it longer—perhaps to age 75, or 76, or how about indefinitely (but that’s probably not going to happen).
2. You can continue to fund a Traditional IRA after age 70 ½.
Previously, you could not contribute to a traditional IRA beyond age 70 ½ (which also happened to be the age you had to start taking RMDs, which makes sense). You could, however, continue contributing to an employer-sponsored traditional 401(k) if you remain employed. You could also continue to contribute to a Roth IRA, providing you met the income limits and have earned income.
Under the new law, you can contribute to a traditional IRA beyond age 70 ½, providing you have earned income.
I like this change too. Some who work past their FRA and into their 70s do so because they want to. Even so, why not be allowed to continue to save in an IRA, especially if they don’t have access to a 401(k). But I suspect that most do it because they have to—they can’t afford to retire. In that case, the ability to continue to save and let their savings grow can really help them later on.
Based on the new RMD provision, you have to start withdrawals from a traditional IRA at age 72. But if you are working at that time, you could still contribute to your employer’s 401(k) as well as a Roth IRA, if you want to.
3. Your heirs will have to pay taxes on an inherited IRA sooner.
This part of the law may be more than a little concerning, especially for those hoping to leave a sizeable IRA inheritance to their children or grandchildren. If you don’t plan to leave a large inheritance in a Traditional IRA, this won’t be relevant to you (or your heirs). But if you do, read on.
Under the old law, someone who inherited money in a Traditional IRA could use the “stretch IRA” provision of the tax code to stretch out their distributions and tax payments from the inherited account over a long time based on their life expectancy (kind of like an RMD for heirs).
The new law dramatically changed that. Your heir will have to withdraw everything and pay all the taxes on it within ten years. Fortunately, spouses are excluded, as are some who are chronically ill or disabled.
This change to stretch IRAs seems mostly to do with the IRS wanting their piece of the “inheritance pie” sooner rather than later. One commentator called it “tomb raiding.”
An accelerated payout with potentially higher future tax rates may put your heirs in a higher marginal tax bracket. That makes it likely that the government will get much more in taxes from them than it would have from you.
Of course, another way to look at it is that the government could demand full payment of taxes at your death (which they could justify based on the fact that you did not pay them while living). So in that way, they are “generous” to allow any postponement at all.
This one will have the estate planners scrambling, especially for high-net-worth families who plan to leave a large inheritance in taxable IRAs. If you’re in that category you may want to consider liquidating the accounts while you’re alive, paying the taxes (unless you’re withdrawing from a Roth IRA), and making gifts to your heirs over some number of years. (That could be more fun than when you’re dead anyway.)
Federal tax law allows each parent to give away $15,000 a year ($30,000 for a couple) in money or property to a child (or grandchild) without having to pay the “gift tax.” The gifts do not reduce the parent’s taxable income. Since they are withdrawing from a taxable IRA, they are required to report it as income—it is an IRA distribution first and a gift to someone second.
I have two children and six grandchildren, so I could theoretically gift a total of $240,000 a year (8 x $30,000) with no gift tax. The problem, of course, is that I may not know if I will need that money or not.
4. You may have an annuity option in your 401(k).
Some have said that the insurance company lobby had a lot to do with this provision of the plan. (Insurance companies sold $230 Bil. in annuities in 2018 and see the opportunity for much, much more as the boomers enter retirement.) I don’t know much about the insurance lobby, but it’s likely they were involved in some way.
Saving and investing for retirement is one thing; converting those savings into an income stream that will last a lifetime is quite another. Americans are not great at the former and stink at the latter (sorry, its true); enter, 401(k) annuities.
401(k) plans are typically invested in mutual funds, ETFs, and cash. The law opens the door to the inclusion of annuities inside 401(k) plans. However, it remains to be seen which types of annuities employers choose to offer, if at all. Employers have been reluctant to do so in the past due to potential legal liabilities related to the underwriting insurance companies, but the new law protects them from being sued if the insurance companies can’t make annuity payments in the future.
As I have written previously, I see no compelling reason to save for retirement in an annuity product that is inside a tax-deferred retirement account “wrapper,” be that a 401(k), IRA, or something else. Those who save consistently (and, therefore, are “dollar cost averaging“) in their 401(k)s and have the discipline to ride out the inevitable ups and downs should be just fine.
But highly risk-averse savers may be inclined toward using kind of deferred-income annuity. Their money will grow, but not nearly as much as if they keep it invested in a diversified stock and bond portfolio (heavier on stocks when they’re young). Their money may be “safer” with a guaranteed interest rate annuity product, but they will have much less of it when you decide to retire.
Or, instead of a low-interest-rate deferred-income annuity, they may lean toward a fixed-index or variable annuity (if offered). Those may provide better overall returns, but they also tend to be costlier and more complex and would still not keep pace with a simple, balanced stock/bond mutual fund or ETF portfolio.
All that being said, having an annuity option to help with the income (savings distribution) challenge makes a lot of sense to me. But everyone already has the opportunity to convert a 401(k) to an IRA and then purchase an annuity “inside” it if they want to. Where I (and many others) would draw the line if annuitization were to become mandatory. (Some think that this law is the first step in that direction.)
The optimal product for annuitizing some portion of a 401(k) (or IRA) in retirement will probably be a simple, single-premium, fixed-income annuity. Another option that many retirement planners are suggesting is a deferred income annuity that kicks-in later in retirement (at age 80, for example) to provide a form of “longevity insurance.”
5. Employees of some small and medium-sized businesses may get access to a 401(k) for the first time.
You may be surprised to learn that a LOT of small companies do not offer retirement plans to their employees, nor are they are required to. However, many would like to but lack the resources. (According to a 2017 survey by Pew Charitable Trusts, only have half of small and mid-sized businesses do.)
The new law makes it possible for groups of such businesses to form collaboratives to share costs and achieve the economies of scale that larger companies have.
The law also requires employers who do offer 401(k)s to allow part-time employees access to them if they work a minimum of 500 hours a year for three straight years or 1,000 hours in one year.
Separately, the law would also require employers who offer to 401(k)s to expand access to part-time workers who work at least 500 hours a year for three consecutive years or 1,000 hours for one year.
I don’t see much to disagree with here; anything that gives more people access to retirement savings accounts is a good thing, in my view. One could argue that providing part-time employees with a costly benefit like a 401(k) will put an unnecessarily heavy burden on smaller companies, but that assumes that a significant number of those employees enroll in the plan, which is unlikely given current trends.
6. You can make penalty-free early withdrawals for specified purposes.
Currently, withdrawals from retirement accounts before age 59 ½ are subject to early withdrawal taxes and penalties. The new law allows for early withdrawals without penalty to cover the costs childbirth or adoption.
I have mixed feelings about this one. On the one hand, l love that this could help relieve the medical cost burden of having children or the high cost of adoption. (As the adoptive parent of two children, I completely understand the need for adoption assistance.)
But on the other, I have never been a big fan of loans or early withdrawals from retirement savings accounts as you are borrowing from your future. You may be forfeiting many years of compounded growth. It would be better to use a combination of health insurance, HSAs, and other savings if at all possible. But, if none of those are available, then it is good to have penalty-free access to retirement savings for these purposes.
If you do have to use them, consider ramping up your contributions in the future, if you can, to make up for that.
The new law will benefit some, but…
All in all, this new law has some beneficial provisions. But as I said at the outset, there isn’t anything (other than making it easier for smaller companies to offer retirement plans) that targets the fundamental problem that many future retirees have, which is that they aren’t saving enough. And some aspects of it are downright problematic. This points to a foundational truth: More than ever, each individual must take full responsibility for their retirement. Nothing beats what Proverbs 13:11b tells us how to best accomplish that:
… he who gathers money little by little makes it grow (NIV).
This is a fundamental truth: Saving little by little, over a long period of time, while investing wisely, will win the retirement savings race. But anything that the government does to help us can be received with gratitude. The kindness and mercy of God toward us don’t hurt either!
