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The SECURE Act Changes the Rules of Retirement Plans

February 03, 2020
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At the end of 2019, Congress passed the biggest bill affecting retirement accounts in more than a decade. (You may have been unaware of it since the news cycle has been filled with the impeachment drama!) Today, we summarize the SECURE Act changes that may impact you in 2020 and beyond. Next week, we’ll have a follow-up article on the impact the SECURE Act will have on inherited IRAs.

The awkward acronym “SECURE” stands for Setting Every Community Up for Retirement Enhancement Act. Signed into law by President Trump before Christmas, the legislation is intended to help Americans increase their retirement savings. Let’s look at how it actually may accomplish that goal—as well as the challenges it brings.

How the SECURE Act Changes Retirement Plans

One major purpose of the SECURE Act is to encourage Americans to save more for retirement. Among other changes, it allows people to contribute longer and encourages employers to offer retirement plans to those who may not currently have an employer-sponsored plan.

With the passage of the legislation:

You can keep working and keep contributing to your IRA or Roth IRA.

  Now you can keep contributing beyond age 70-1/2. You cannot make a contribution for 2019 if you were age 70 1/2 or older as of Dec. 31, 2019. But thanks to the new law, you can make contributions for tax year 2020 and beyond. Previously, you could only contribute to a Roth IRA beyond age 70-1/2—if you meet the income criteria for the Roth.

You can still contribute to a Roth (if you qualify), but now you can also keep contributing to a traditional IRA. The ability to contribute to traditional retirement plans longer can allow you to defer income taxes to the future, when you withdraw money as income. It also allows the investments to grow tax-free until they are withdrawn.

This is good news as one of the biggest threats to financial stability in your later years is early retirement! Many people stop working and later wish they had kept earning and saving. This legislation encourages people to keep doing just that, rather than retire at some arbitrary age—ready or not.

If contributing to a Roth IRA or doing a Roth conversion, you’ll keep contributing after-tax dollars to build investments that will grow tax-free until withdrawn later for tax-free income. (That’s assuming the government doesn’t re-write the rules, and the SECURE Act drives home the fact that the government can change the rules! Specifically, be aware that inherited Roths now have new rules, as we explore in next week’s article.)

The start date for required minimum distributions (RMD) has been nudged back to age 72—and beyond.

If you’re still working as an employee after age 72 (and you don’t own over 5% of the company that employs you), you can postpone taking RMDs from your accounts until after you’ve retired, regardless of age. With many working well into their 70’s and beyond, this is a positive change to a ridiculous rule!

Before the Secure Act, the initial RMD was for the year you turned age 70-1/2. (If you turned 70-1/2 in 2019 and have not yet taken your initial RMD for that year, you still must take that RMD by April 1, 2020, or face a 50% penalty on the shortfall.)

Being forced to take distributions before you retire can leave you with FEWER retirement dollars in the long run. This new rule allows you to keep growing your dollars longer. Although we don’t love RMDs at all (why let the government tell you when you must withdraw income and pay taxes?) this is a great change.

Annuities will be supported and encouraged by SECURE Act changes.

Employers are now encouraged to offer annuities inside of retirement plans in several ways. Annuities will become more portable than before, allowing employees who change jobs or retire to move their annuity to another plan or an IRA without surrender charges and fees. Plan sponsors will have reduced liability if the products underperform or the insurer cannot meet financial obligations as long as they select an annuity provider that, among other requirements, has met the following conditions for 7 years:

  • Been licensed by the state insurance commissioner to offer guaranteed retirement income contracts.
  • Filed audited financial statements in accordance with state law.
  • Maintained reserves that satisfy all the statutory requirements of the states where the annuity provider does business.

(This extension of “safe harbor” protection to employers including annuities in their plans is bit ironic as historically, annuities are MUCH more predictable than stocks. Nobody “guarantees” Wall Street’s performance!)

In time, the SECURE Act will require plan sponsors to annually disclose on 401(k) statements an estimate of the monthly payments participants would receive if their total account balance were used to purchase an annuity for the participant and the participant’s surviving spouse.

Annuities can be a good or a bad thing, depending on your situation. Many annuities are complex and fee-laden, locking up dollars for many decades and offering low growth in return. However, beyond about age 70, single premium immediate annuities (SPIAs) can deliver excellent cash flow with very low risk.

And although we prefer whole life insurance as the “safe, boring” part of a portfolio—the right kind of annuity at the right time can bring balance and stability to a stock-heavy retirement plan. (Whole life policies can also be “annuitized,” in part or in whole.) Annuities add a degree of certainty about future income, especially contrasted with the typical Wall Street “plan” of a mix of stocks and bonds with no guarantees attached.

Employers can automatically enroll employees to contribute up to 15 percent of income.

We have mixed feeling about this part of the Act. The benefit: This new law can allow and encourage people to save more in their qualified retirement plan (such as a 401(k), 403(b), SEP or IRA) with little red tape. This can be a good thing! However, there are downsides if ALL (or the majority) of your money is trapped in a retirement plan.

For instance, you are subject to government rules and limitations as to how, when and how much money can be used. Some people reach their 50s or 60s and decide they would like to start a business or invest in real estate. That can prove difficult if all their money is locked up in retirement accounts with limited investment options and tax and/or penalty consequences for withdrawal.

Other people may neglect to save outside of their retirement account for a home down payment. As a result, they may spend tens or even hundreds of thousands in rent that they will never get back. (You can borrow from a 401(k), withdraw funds or even liquidate a retirement fund to buy a house, but you may pay hefty penalties, taxes, and interest to do so.)

Then there is the issue of asset allocation. Many Americans have stock-heavy portfolios and little in the way of savings OUTSIDE of their qualified retirement plan. That’s one reason we like to see most people saving only to the “match” level—not the maximum allowed.

When investing to the “match” level, you can invest more in other assets where you may have more control and different advantages than the (comparatively) limited options in a retirement plan. When a large percentage of income goes into a retirement account, sometimes the person making the contribution lacks a proper, liquid savings account or other assets that offer greater security and less volatility.

While some will argue it’s “for the employee’s own good,” we would love to see Americans have the flexibility to invest in whatever they want with their retirement dollars! Self-directed IRAs can partially solve the problem of diversification and asset allocation, but not all investments work well inside of a retirement plan. 

The SECURE Act will help make retirement plans available to more people.

Vanguard revealed early in 2019 that the median 401(k) balance for those ages 65 and older is just $58,035—clearly not enough! The SECURE Act encourages employers who have previously shied away from offering retirement plans to begin plans for those who previously did not have access to one.

The legislation creates the following incentives and provisions:

1. The tax credit for a small business establishing a retirement plan for employees increases from $500 to as much as $5,000.

2. Businesses also receive a $500 tax credit for up to 3 years for adding auto-enrollment for new hires.

3. Part-time workers must now be eligible for an employer’s plan if they work 500 hours in 3 consecutive years or 1000 hours in a single year and are age 21 or older. (This provision does not apply to 403(b) plans.)

4. “Multi-employer plans” may allow very small businesses to band together to get more economies of scale with their retirement plans.

5. Employer contribution-only plans can be adopted AFTER the end of the calendar year to allow employers more time to comply with the new law.

All of the above changes should encourage more Americans to save for retirement. And though we don’t love “retirement” and prefer to see people working as long as they can doing something they love, it’s essential that we all save and invest while we can!

Other SECURE Act Changes

The Secure Act includes some other important tax changes that have nothing to do with retirement:

  • 529 accounts can now be used for qualified student loan repayments (up to $10,000 each year).
  • Certain taxable non-tuition fellowship and stipend payments to graduate students are treated as compensation for IRA purposes, effective for taxable years starting with 2020. (This can help some people qualify to contribute to IRAs.)
  • The Act also permits penalty-free withdrawals of $5,000 from 401(k) accounts to defray the costs of having or adopting a child.

These seem like positive changes, and we like the fact that the SECURE Act is expanding how dollars can be used.

The Biggest SECURE Act Change: Inherited IRAs

In the “sequel” to this article, we’ll dive into the biggest change—and biggest challenge—of the SECURE Act. The rules around inherited IRAs have changed dramatically for non-spouses. This is good for the government (they’ll receive more in taxes and receive it sooner). Unfortunately, it might not be good news for those who have considerable balances in their retirement accounts!

Next week, we’ll review the new rules, who they affect, and what you can do to stop giving Uncle Sam a major cut of your—or your child’s—inheritance!

In the meantime, we are here to help! We offer meaningful alternatives to the typical solutions for cash, asset growth, and cash flow. Our specialties include investing in and outside of the stock market and creative life insurance solutions. Visit our contact page to send us a question, request an appointment, or reach out to a specific member of our team.