Rewriting the Rules

Adam M. Grossman

WHEN POLITICAL parties set aside partisan bickering and agree on an issue, it’s worth taking note. Such was the case last week when the House of Representatives voted 417–3 in favor of a bill known as the SECURE Act. This legislation would represent the most significant set of changes to retirement rules in more than a decade.

Why the sudden bipartisan cooperation? For better or worse, both parties recognize that a growing number of Americans face a retirement crisis. According to Boston College’s Center for Retirement Research, fully half of households are “at risk” when it comes to retirement readiness.

The new legislation includes more than a dozen changes, big and small. Below are three provisions that I see as most significant, along with the steps I’d consider if they became law:

1. Expanded coverage. According to Pew Charitable Trusts’ research, more than a third of private sector workers don’t have access to a workplace retirement plan. In most cases, that’s because these plans are costly and complicated to establish, and there are steep penalties for falling out of compliance. The new legislation would include both financial incentives and administrative fixes to ease this burden. That should be good for our collective financial health.

The new rules would also help boost participation rates. Long-term part-time workers could no longer be excluded from company 401(k) plans, as they are now. And employers would be permitted to auto-enroll participants at higher contribution rates. Since the original auto-enrollment rule went into effect in 2006, participation rates have climbed steadily, and research has shown that—once enrolled—people generally continue contributing through thick and thin.

What to do? If your employer doesn’t currently offer a retirement plan, or if you aren’t permitted to participate, keep an eye on Washington. Assuming these new rules take effect, you may want to lobby your human resources department. Encourage your HR folks to establish a 401(k) and point them toward best practices, such as including low-cost index funds.

2. Death of the stretch. Expanding coverage will result in more workers deferring more income and therefore paying less taxes. To help pay for these measures, the legislation would tighten the rules in other areas—including eliminating the so-called stretch IRA.

What’s the stretch IRA? Suppose you inherit an IRA from a parent. Under the current rules, you’re required to take minimum distributions each year from the IRA. Unless the money’s coming from a Roth, you have to pay taxes on those distributions. But to minimize the tax bite, you’re permitted to stretch out the distributions over the course of your lifetime. This can be an especially valuable benefit if a parent passes away during your peak earning years, when your tax rate is likely at its highest.

But this valuable tax break may soon disappear. The new legislation would significantly limit the timetable for these distributions, forcing IRAs inherited after Dec. 31, 2019, to be liquidated within 10 years.

What to do? If you have substantial assets—more than you foresee spending during your lifetime—this new 10-year rule may require some serious rethinking of your retirement-income plans. The goal: Limit the overall portion of your IRA that’s lost to taxes—both during your lifetime and after your death.

This is complicated, because it requires estimating not only your own future tax bracket, but also your children’s. One way to hedge your bets: Consider Roth conversions during your lifetime. That would lessen the impact of potentially large required IRA distributions on your children’s tax returns.

Fortunately, the new legislation contains another provision that may facilitate tax-efficient Roth conversions. Under current rules for IRAs that aren’t inherited, you’re required to begin taking distributions once you reach age 70½. Those distributions boost your taxable income, often making Roth conversions financially unattractive after that age. But under the new rules, you’ll have another few years—until age 72—to begin those distributions. That would widen the window for additional Roth conversions at lower tax rates.

“The disappearance of pensions is, in my view, largely responsible for the retirement crisis we face today.”

Another option: If you have both taxable and tax-deferred assets, you could weight your withdrawals more heavily toward tax-deferred accounts during retirement, so the mix of assets you leave your children includes a smaller embedded tax bill. Under current rules, if you bequeath taxable account investments with large unrealized capital gains, that potential tax bill disappears—thanks to the step-up in cost basis upon death.

A final option: If you have charitable intentions, you can make qualified charitable distributions from your IRA once you get into your 70s and beyond. Now that 2017’s tax law has limited many people’s ability to itemize deductions, this may be an appealing strategy that’ll allow you to help your favorite charities, while reducing your taxable income today and leaving less traditional IRA assets to your heirs.

3. Greater access to annuities. The new rules would make it easier for employers to add annuities to their retirement plan’s menu of investment options. In addition, the new law would provide portability for these annuities, as an employee moved from job to job. Taken together, these new provisions would effectively allow workers to create their own personal pensions.

This is potentially very positive, because it would restore retirement’s traditional three-legged stool: Social Security, savings and a pension. For years, that was the recipe for a secure retirement. But in the 1980s, companies began phasing out pensions in favor of 401(k)s. The disappearance of pensions is, in my view, largely responsible for the retirement crisis we face today.

But will the availability of annuities be a plus for retirement savers? They’re a controversial investment, for two reasons. First, depending on the type of annuity, they may require you to roll the dice on your own longevity. Unlike typical 401(k) investments, you can’t leave an income annuity to your children (though they usually have a survivorship option for spouses). This prospect of losing a lifetime of savings is one big reason annuities can be unattractive. Second, annuities can be weighed down by layers of opaque fees. And the reason they’re so opaque? Because often those fees are unreasonably high.

What to do? If you have substantial assets, the right answer may be to simply ignore the new annuity option. But you shouldn’t be too quick to write it off. It’s possible that the legislation will spark a round of innovation in the annuity market and perhaps lead to lower-cost, higher quality offerings. If that’s the case, it might be worth allocating a portion of your annual savings to an annuity.

In fact, you could use another of the new law’s provisions to help guide your decision. In the House bill, there’s a requirement that retirement plan statements estimate what a worker’s balance might be worth in terms of future monthly payments in retirement. If that projection shows you coming up short with traditional 401(k) investments, you might instead opt for the security of an annuity.

Adam M. Grossman’s previous articles include Danger AheadKnow Doubt and Beat the Street. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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