Those New Retirement Regulations: Are They SECURE Or INSECURE?

The U.S. Congress loves warm and fuzzy acronyms. But it's the fine print that counts, not the name of a particular piece of legislation.

Just as the Affordable Care Act (ACA) made health insurance more expensive, the SECURE Act - that's the Setting Every Community Up for Retirement Enhancement Act - will make the future more insecure for many retirees and their heirs.

Insurance companies will certainly benefit, as the new law encourages employers to add annuities to their 401(k) plans. The benefit of annuities is that they can provide guaranteed income throughout a person's lifetime, which is important, because Americans are living longer and many are likely to outlive their savings.

However, most financial experts consider annuities to be a bad investment, as annual fees for a variable annuity are between 2.18% and 3.63%, depending on the product and features selected, according to Morningstar.

That far exceeds the fees participants in the largest 401(k) plans pay for investments and administrative services. Fees fell from an average of 0.34% of assets in 2009 to 0.25% of assets in 2016, according to BrightScope and the Investment Company Institute.

As insurance companies gain greater access to sell annuities through 401(k) plans, participants may be more exposed to sales pitches for products that may not be in their best interest, Andy Panko, owner of Tenon Financial LLC, told Forbes.

Though traditional pension plans typically are set up as annuities, offering lifetime payments, annuities are currently available in only 8% of 401(k) plans administered by Vanguard Group.

Many companies have been reluctant to offer annuities, because of potential liability if the insurer selected fails to pay claims. SECURE protects employers from being sued if they follow certain procedures.

"Currently," according to MarketWatch, "employers hold the fiduciary responsibility to ensure these products are appropriate for employees' portfolios, but under the new rules, the onus falls on insurance companies, which sell annuities, to offer proper investment choices."

Shrinking the stretch IRA

There are some clear benefits to SECURE, which The Wall Street Journal called, "the most significant changes to the nation's retirement system in more than a decade."

But to pay for its estimated $16 billion cost, Congress eviscerated the stretch IRA. If, like many Americans, you planned to pass your savings on to your heirs through an Individual Retirement Account (IRA), think again.

Stretch IRAs enabled investors to pass assets on to heirs and allowed heirs to spend the assets over their entire lifetime without additional tax implications. Now heirs will be required to shut down inherited IRAs and pay any taxes due within 10 years. They will not be required to take minimum distributions during that time, but cashing out an IRA all at once can result in a hefty tax bill.

The stretch IRA was ideal for middle-class investors, as it could be set up easily, without an estate-planning attorney and without creating a trust to hold assets.

You could invest money in a Roth IRA and let it accumulate earnings over your lifetime, then you could pass it on to your heirs and they could continue to allow earnings to accumulate over their lifetime without paying taxes on them, even when they take distributions.

Alternatively, if you invested in a traditional IRA, your heirs would not have to pay taxes until they distributed income from the IRA.

Now, even if you've already established an IRA to plan a legacy for your children, you will not be grandfathered in.

Given that the federal deficit this year is about $1 trillion, $16 billion in revenue is practically equivalent to a rounding error.

In an effort to encourage more Americans to save for retirement, Congress is punishing those who already have been saving for retirement by taking away their legacy.

Other changes

So what else does SECURE include?

Relaxed IRA age restrictions. With many Americans working past age 65, SECURE enables them to continue saving for retirement in IRAs as long as they are earning an income. In addition, those who turn 70½ after Dec. 31, 2019, will not be required to take minimum withdrawals until age 72. Previously, the law required minimum withdrawals starting on April 1 of the year after a person turns 70½.

Incentives for small companies. Currently, about 30% of private-sector employees work for employers that don't offer a tax-advantaged way to save for retirement.

SECURE makes it easier for small companies to join together in multi-employer plans (MEPs) to offer 401(k) plans, while sharing administrative costs. MEPs are attractive, because they shift some of the administrative burden and fiduciary responsibility to a plan administrator.

MEPs previously were allowed only for businesses with a common owner or some other relationship. Now the businesses are not even required to be in the same industry.

Brokers, asset managers, 401(k) record-keepers and insurers will likely benefit.

In addition, small employers can receive a tax credit to offset the cost of starting up a 401(k) plan or a SIMPLE IRA plan with auto-enrollment. The new tax credit is an addition to the start-up credit that was previously available.

Other changes. The new law also enables employers that automatically enroll employees in certain 401(k) plans to automatically raise their savings rates to 15% of annual earnings over time; before SECURE, the limit was 10%.

It also requires employers to allow certain part-time workers to participate in 401(k) plans.

SECURE allows the tax-free withdrawal of up to $10,000 from 529 education savings accounts for repayment of some student loans. It also enables parents to take a penalty-free distribution of up to $5,000 from a retirement account without penalty within a year of the birth or adoption of a child if the funds are used toward the cost of child birth or adoption.

The law also expands the definition of "income," which will make more people eligible to contribute to an IRA. Grants and other awards earned by anyone studying for an advanced degree will now be considered income for consideration when making an IRA contribution.

The intent of SECURE is to make it easier for Americans to save for retirement, as the Employee Benefit Research Institute estimates that Americans between the ages of 35 and 64 are $3.83 trillion short of what they need to save for retirement. About 41% of households are projected to run short of money later in life.

The new law may incorporate "the most significant changes to the nation's retirement system in more than a decade," as The Wall Street Journal claims, but it's unlikely to cause a major change in how - or how many - Americans save for retirement.

Brenda P. Wennin g of Newton is president of Wenning Investments LLC in Newton. She can be reached at [email protected] or 617-965-0680. For additional information, visit her blog at www.WenningAdvice.com.