SECURE Act, signed by President, a game-changer for retirement plans

Dec. 24--The most significant legislation affecting retirement became law -- as of Friday, Dec. 20.

Congress passed an important retirement-savings law called Setting Every Community Up for Retirement Enhancement, or the SECURE Act of 2019. The law takes effect on Jan. 1, 2020. After stalling for months, Congress suddenly passed the bills as an attachment to budget appropriations. Here are some key provisions:

-- More time in IRAs and 401(k)s. The bill raises the age for required minimum distributions (RMDs) from 70 1/2 to 72 years old.

-- Grant older workers benefits. As long as you're working, you can still contribute to your IRA after age 70 1/2. Previously, you couldn't.

-- Boost small-business 401(k)s. Small businesses can now band together in group plans.

-- Annuity adoptions. Would allow employer-sponsored 401(k) plans to add annuities as investment options.

-- 529 plans. They can be used to repay up to $10,000 in student loans, as well as for siblings.

Here are more details:

Giving investors with tax-deferred accounts another year and a half before Uncle Sam requires withdrawals allows us to save longer for retirement, even after withdrawals start.

"It's a recognition that age limits were arbitrary, and that Americans are working longer because they need to save more," said Wharton professor Olivia Mitchell.

However, here's the government money grab: To make up for lost tax revenue, the new law scraps what's known as a "stretch IRA."

Americans who inherit an IRA must now withdraw the money within 10 years of the account owner's death, along with paying taxes. Surviving spouses and minor children are still exempt.

Under the new law, those types of exempt heirs can still spend down inherited IRA accounts over their lifetime, an estate-planning strategy known as the "stretch IRA."

"In all instances, you can still do a spousal rollover," said Jennifer Smith, trust and estate attorney at MDSU in Wilmington.

So what's a better planning tool? Stretch IRAs are out. IRA expert Ed Slott argues that life insurance "will now be a more tax-efficient asset to pass to beneficiaries since the long-term stretch IRA is eliminated for most non-spouse beneficiaries."

(P.S. After many questions from readers, yes, existing inherited IRAs are grandfathered under the previous rules. Thanks for asking!)

The SECURE Act expands access to multiple employer plans, or MEPs, to pool resources and share the costs of a retirement plan for employees.

Small businesses now can join group plans alongside other companies. This cuts administration and management costs and ideally makes higher-quality plans available to more small businesses and their workers.

The law also enhances automatic enrollment and auto-escalation, allowing companies to enroll employees automatically into a retirement plan at a 6% rate of salary contribution, up from 3%.

Employers can now raise employee contributions to a maximum of 15% of annual pay. Workers can opt out of these features at any time.

Courtesy of the insurance lobby, the SECURE Act now allows 401(k) plans to add annuities as a retirement plan option.

The idea? Annuities may solve the problem of lifetime income for workers. Annuities are insurance policies that convert retirement savings into income. Common in pension plans, annuities to date have not been popular in 401(k)s.

Annuities have downsides: Fees are often high. There's always a risk that the "guaranteed lifetime income" could turn out to be a mirage if the insurance company goes belly-up. (It happened when Penn Treaty American went under in our fair state of Pennsylvania). Fears they could be left on the hook have prompted many 401(k) providers to steer clear of annuities.

Under the SECURE Act, retirement plans now have "safe harbor" from being sued if annuity providers go out of business or stop making payments. Now that it's less likely they will be sued, employers may open up to annuities.

Consumer advocates warn that 401(k) investors and plans will be open to more risk. The SECURE act means mom-and-pop investors would be making bets on the ability of insurers to meet long-term obligations, and could get stuck with high-cost annuities that are not a fit.

That said, annuities have fans.

Wharton professor Mitchell noted in a paper that the SECURE Act would encourage retirees to convert a portion of their 401(k) accounts at retirement into deferred annuities, her preferred insurance product. These annuities allow holders to delay income, installment or lump-sum payments until the investor elects to receive them.

Independent financial advisers -- not your employer -- should be the one helping select the right income annuity based on your situation, said Slott.

"A small amount of money in annuities is a great option. Unfortunately, these products are complicated, fee structures are black boxes, the way they're sold by insurance companies favors the industry and commissioned salespeople," agreed Mitch Tuchman, chief investment officer of Rebalance, an online investment advisory service.

As to the percentage of the retirement nest egg, Mitchell estimates that "putting just 10% of one's 401(k) at retirement into a deferred annuity payable from age 80 or 85 would greatly enhance retiree well-being."

Why the big push from annuities? The insurance industry lobbied heavily for this new law, and is among the biggest businesses in the commonwealth.

Caveat emptor, said Tuchman: "We've unleashed highly skilled sales people onto a population of HR folks and CFOs who might not understand what they're buying. They then hire consultants and that can bring a crooked element into 401ks."

The legislation expands 529 education savings accounts to cover registered apprenticeships; homeschooling; up to $10,000 of qualified student loan repayments (including for siblings); and private elementary, secondary, or religious schools.

The student-loan provision lets Americans repay student loans for a 529 beneficiary, with a $10,000 limit, according to Jeff Levine, director of financial planning at Blueprint Advisors. An additional $10,000 can be used to pay off student debt for each of the 529 plan beneficiary's siblings, he said.

A final positive: The SECURE Act would allow investors early access to IRA funds for any "qualified birth or adoption" by creating a new exception to the 10% penalty.

However, the money is still subject to tax. The $5,000 amount is the lifetime limit, and applies to any distribution from the retirement account within one year from the date of birth or legal adoption. The exception applies to children under age 18, or physically or mentally disabled and incapable of self-support.

A copy of the bill is available online here and at: https://www.congress.gov/bill/116th-congress/house-bill/1994/text?q=%7B%22search%22%3A%5B%22Setting+Up+Every+community%22%5D%7D&r=1&s=7.

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