For those hoping to read the continuing description of my visit to the MIT AgeLab in Cambridge, MA, you’ll need to wait until my next blog post in April. For this blog, I felt it was more important to review The Setting Every Community Up for Retirement Enhancement (SECURE) Act, which is the most significant and sweeping retirement tax law since the Pension Protection Act of 2006 and Employee Retirement Income Security Act (ERISA) of 1974.
The SECURE Act passed in the House of Representatives in May by a bipartisan vote of 417-3. It was bogged down in the Senate until it was attached to the spending bill in December. That bill, which raised the debt ceiling and avoided another Federal Government shutdown, was passed by a vote of 81 -11. President Trump signed the Bill into law on December 20th and most provisions of the law took effect on January 1, 2020. This proves to me that Congress can be non-partisan; especially if it means more money for both parties to spend! For example, one provision alone is estimated by the Congressional budget office to bring in $15.7 billion over the next 10 years.
Of the many provisions of the act, here are what I believe are the most significant features:
- The Act eliminates the “stretch IRA” for most non-spousal beneficiaries. In my opinion, this is the most controversial provision. Prior to January 1, 2020 when inheriting an IRA from a non-spouse, distributions could be taken over the beneficiary’s life expectancy, thereby deferring taxation on the withdrawals. Now withdrawals must be taken within 10 years. There are no minimum annual distribution amounts, but the entire balance must be distributed within the tenth year after death of the IRA owner.So, in the case of a traditional IRA, we may recommend taking annual distributions or larger distributions in a year when you have lower earnings, thereby reducing the tax burden in any one year. With a Roth IRA, we may recommend taking the full distribution in the tenth year, thus allowing the Roth a full 10 years of tax-free growth. No income tax is due on distributions made from a Roth IRA. This is the provision estimated to bring in $15.7 Billion to the US Treasury.
- The Act allows for anyone with earned income to contribute to an IRA regardless of age, of course income limitations may still apply for Roth contributions. If you are over 70.5 and still working, you can add to your IRA. This is a growing trend whether by choice or necessity. Older workers who contribute to traditional IRAs can then convert to Roth IRAs and eliminate future Required Minimum Distributions (RMDs) on the Roth’s.
- RMD age moves up to 72 from 70.5 (this only applies to people turning 70.5 after January 1,2020). In my opinion this provision is not enough of a concession to the elimination of the Stretch IRA, but it does provide an extra 18 months of compounding before we are forced to start our distributions and pay taxes on them.
- There is now a penalty free withdrawal from retirement accounts for birth or adoption of a child. If parents have a retirement account, the Act lets each parent take out up to $5,000 without paying the 10% early withdrawal penalty. Income taxes on the withdrawal would still apply.
- Graduate and post-doctoral students who are compensated would be able to make IRA contributions based on that compensation. I consider this a technical correction long overdue.
- Part-time employees now have access to 401ks. The Act guarantees employees who have worked 500 hours per year for at least three consecutive years and who are over 21 access to 401ks.
- The act has several provisions to help businesses start or enhance the 401k offerings. First, small businesses can band together in Multiple Employer Plans (MEPs), potentially reducing costs. There is a provision for any business that starts a retirement plan to receive a $5,000 tax credit. Time will tell whether these ideas are enough to move the needle in covering the 45% of all civilian workers not currently participating in work place retirement plans.
- The Act enhances the auto-enrollment and auto escalation features of 401k plans. The Act increases the cap on “Qualified Automatic Contribution Arrangements” from 10% to 15%. The Advisors at New England Capital have long advocated our clients save 15% or more of their income for retirement. This provision encourages employers to add these provisions to their 401k offerings. From a behavioral finance view, I think this is great. The auto enrollment means that employees are automatically signed up for the 401k unless they opt out. Auto escalation means the percent contributed will automatically increase by 1% per year until 15% of their pay is being contributed.
- 401k will provide annuity options and information. The Act requires 401k plan administrators to provide an annual “lifetime income disclosure statement” to plan participants. Annuities will be allowed along with investment options in 401ks. This is interesting departure from the Department of Labor rules under the last Administration, which has been trying to limit high cost annuities sold by insurance companies from the retirement products offered to consumers. The insurance industry lobbied very hard to have these provisions included in the Act. Let’s hope the insurance companies issuing annuities to the 401k plans go beyond the “suitability” threshold and act in accordance with the “fiduciary” standard, which require them to put the client/participant’s best interest before their own.
- Credit card access to 401k loans will be prohibited. The act puts a stop to 401k administrators allowing employees to access plan loans by using credit and debit cards. Again, I and other New England Capital advisors have always said 401ks are retirement accounts and not piggy banks for current expenses.
The goal of the act is to revise and modernize the US retirement plan system. There are other provisions in the Act not mentioned here. If you have large IRA balances, or are expected to inherit large IRA balances, or if your IRA beneficiary is a trust, you should do some additional planning. If you have a specific questions on your situation and how the Act will affect you and your beneficiaries, please call our office.
Let’s hope the provisions of The Setting Every Community Up for Retirement Enhancement lives up to its name!
