SECURE ACT: The pros, pitfalls and possibilities of an imperfect fix to Americans’ poor savings habits
Many folks generally have an idea that the majority of Americans don’t have enough saved for retirement. But the actual data still shocks the conscience. Nearly half of Baby Boomers have no retirement savings to speak of, and a whopping 94 percent plan on Social Security being their only source of income in retirement.1 When we look further, more than 55 percent of Americans between ages 55-64 have less than $10,000 saved for retirement. Only 30 percent of Americans in the same age range have more than $50,000 saved for retirement.2
Since we can’t go back in time and change habits, the federal government has decided to step in – but it, too, faces a financial conundrum. On one hand, there is a significant need to address the reality that America is facing a “retirement crisis,” with a workforce that is underprepared for retirement and will most likely need to rely heavily on government programs like Social Security, Medicare, Medicaid and financial assistance programs in their later years. On the other hand, the government must be careful when drafting legislation that it doesn’t over-extend itself and relinquish too much tax revenue. It can’t wave a magic wand to solve the issue, and it is difficult to come up with the appropriate funds without cutting funding for other important programs.
Behold, the SECURE Act (a.k.a. “Setting Every Community Up For Retirement” Act): a good-but-not-great piece of legislation that attempts to address some significant retirement savings issues but ultimately results in minor tweaks around the edges of the over-arching problem. Though this piece of legislation may not be the magic bullet to vanquish the beast that is the lack of retirement savings, it does have several perks, and a few drawbacks, that will impact financial strategies going forward.
RMD age pushed out to 72 - Retirees are now able to wait until age 72 to begin taking their Required Minimum Distributions (RMD), or taxable distributions, from their pre-tax IRA accounts. This change provides retirees more opportunities to plan their taxable income in retirement and allow their investments to grow for an additional year and a half before taking mandated distributions.
IRA contributions past 70 ½ – Congress eliminated the rule that prevented IRA contributions after 70 ½, giving older Americans an ongoing opportunity to contribute to their IRAs as long as they have earned income, regardless of age. This feature is also available for Spousal IRA Contributions as well, which can enable an elderly couple to manage their taxable income well into their 70s if at least one of them continues to have earned income.
“Teamwork makes the dream work” – Employer-sponsored retirement plans such as 401(k)s and 403(b)s can be difficult and sometimes costly to administer, especially for smaller companies with just a few participants. As a result, Americans who work for small business were historically less likely to have access to advantageous retirement packages more commonly offered by larger employers. The SECURE Act opens the door for small businesses to collaborate with each other to structure 401(k)s and other retirement plans that they can all participate in, and offer to, their employees. It’s now up to the Department of Labor to determine the specific rules for these types of plans before they become available.
Lifetime income option – Along with an assortment of mutual fund options in your retirement plan, you also may now have the option to contribute to an annuity inside your retirement account that will provide a guaranteed fixed income source in retirement. This option will benefit participants who prefer a guaranteed source of income from their savings rather than the volatility that can come with investing in the market.
Student loans & Section 529s – Younger workers have found it difficult to start saving for retirement, because they are saddled with student loans from their college days. The SECURE Act offers a little bit of a perk to borrowers by allowing them to use the investable funds inside a Section 529 College Savings Account to pay down student loans (up to $10,000 per year). This is an especially attractive solution in states that offer income tax deductions on S-529 contributions.
Here are potential stumbling blocks that the SECURE Act provisions may create:
Inheriting IRAs could become a headache – Previously, when an individual inherited an IRA, he or she could spread distributions over their entire lifetime, which could end up being a 30- to 40-year period, allowing the money to remain invested for tax-deferred growth. Now, with the passage of the SECURE Act, the full balance of the inherited IRA must be distributed over a 10-year period, which could add tens or even hundreds of thousands of dollars to taxable income. This may force many people into a higher tax bracket, an even bigger issue for Americans in their peak income-earning years.
Review your beneficiaries – In the past, many estate plans have been developed to deal with the complexities of passing a taxable account on to the next generation. Many have left their IRAs to irrevocable trusts with staggered pay-out terms articulated in the language, so that the person inheriting the money would receive larger portions upon reaching specific ages or at different milestones. With the requirement that an inherited IRA be paid out over 10 years, those trusts may no longer be legally binding and may result in an inefficient estate plan. It’s a good idea to review the beneficiaries on your retirement accounts with SECURE Act changes in mind.
Taking these pros and pitfalls into consideration, below are a few strategies for thoughtful investors to examine. It is important to consult a financial advisor before making any adjustments, to ensure they align with your goals.
Leave tax-free money to the next generation instead – It’s likely that an elder retiree with an IRA and higher tax-deductible medical expenses is going to be in a lower tax bracket than an adult child in peak-income earning years. Rather than leave the investment to continue growing until it passes to the next generation, it might be more beneficial for the IRA owner to take larger distributions and use the funds to purchase a permanent life insurance policy naming the children as the beneficiaries leaving them with a tax-free life insurance benefit, or use the funds to pay down debt that might otherwise be left for the estate to settle.
Section 529 ownership and distribution strategies – When applying for student aid, applicants are required to fill out the FAFSA (Free Application for Federal Student Aid). This is a standardized application that evaluates the financial need of a student based on the assets and incomes of the student and his or her parent(s). The more financial aid a student receives, the less they have to borrow in student loans. By developing a more holistic strategy around the ownership and timing of S-529 distributions, the student could potentially receive more Financial Aid, resulting in a savings of tens of thousands of dollars in student loans and interest expense.
Roth conversions – We find ourselves in a unique time where:
- Individual tax rates are historically low,
- The Required Minimum Distributions age has been pushed out an additional 1 ½ years, and
- There is a lower incentive to leave pre-tax dollars to beneficiaries.
Given these factors, the opportunity is ripe to consider converting portions of a pre-tax IRA account to a Roth IRA. The Roth IRA can be passed on to beneficiaries, who will still be required to distribute the funds within 10 years of inheriting the money. However, since the funds can be distributed tax-free, the inheritor can keep the funds invested the full 10 years and take a large lump-sum distribution at the end of the decade without affecting their taxable income in any way. This strategy allows for the account to be invested for a much longer period of time and would not affect the taxable income rate of the beneficiary.
Charitable Remainder Trusts – Another option for the philanthropically minded family involves designating a Charitable Remainder Trust (CRT) as a beneficiary on an IRA instead of a living person. The CRT is a tax-exempt irrevocable trust designed to provide financial support to an individual during their lifetime, and once the named individual has passed away, the remaining proceeds go to a designated charity. Trust distributions for the individual are taxable as income, but the CRT is a tax-exempt entity, so an IRA that names a CRT as a beneficiary would not have immediate taxable implications.
As with any significant change in legislation, there are always going to be good and not-so-good aspects, but individual resiliency ensures they can adapt to leverage opportunities and overcome roadblocks, especially with wise council. Ultimately, it’s important to remember that “progress is better than perfection” and to keep the end goal of financial independence in sight.
If you have questions about the SECURE Act or would like to discuss your individual situation, please contact us. We are more than happy to schedule a time to discuss how you can best navigate these changing dynamics to reach your goals.
1 “Boomer Expectations for Retirement 2019.” Insured Retirement Institute, Apr. 2019, https://irionline.org/resources/resources-detail-view/boomer-expectations-for-retirement-2019.
2 Dennison, Sean. “64% Of Americans Aren't Prepared For Retirement - and 48% Don't Care.” GOBankingRates, Toggle Navigation Back, 7 Dec. 2019, https://www.gobankingrates.com/retirement/planning/why-americans-will-retire-broke/
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