Overview of the SECURE Act
Written by Martin Shields
As part of the end of year federal spending bill, the U.S. House and Senate passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act this week, which will go to the White House for signature before the end of the year.
The SECURE Act will cause several significant changes to retirement accounts. Some of the changes will help individuals and families build wealth and prepare for retirement, while others will be a detriment to this cause.
One of the main benefits of this Act is the change in age for Required Minimum Distributions (RMDs) from Traditional IRAs, 401(k)s, and Roth 401(k)s. The RMD age would get pushed back from the current age of 70½ to age 72, taking effect for those who turn 70½ after Dec. 31, 2019.
Another positive aspect is a key provision which would make it easier for small employers to join multiple-employer plans (MEPs). The Act will eliminate the requirement that employers in the same plan would need to have something in common, such as being in the same industry or geography. It will also eliminate the “one bad apple rule,” which states that if any employer in the plan violates tax-qualification rules, then all employers in that plan are deemed as violating the rules. These promising changes could offer small employers more choices and lower fees.
MEPs are potentially attractive to employers because they shift some of the administrative burden and fiduciary responsibility for a 401(k) plan to an administrator. Brokers, asset managers, 401(k) record-keepers, and insurers are expected to sponsor them.
Furthermore, the SECURE Act will also increase the tax credit which employers can get when they start a retirement plan- from $500 to as much as $5,000 a year for three years. Employers would also get an extra $500 a year for three years if they automatically enroll employees. The law allows employers that auto enroll workers to raise employees’ savings rates up to 15% of annual earnings over time, up from a 10% cap now. Employees are free to opt out.
The Act also repeals the age cap for IRA contributions. Under the current law, contributions to traditional IRAs could not be made after age 70.5.
Another change is allowing $10,000 of 529 plans to be used to pay off student debt. Similarly, employees would be able to take out $5,000 from 401(k) plans without penalty to help with the costs related to a child’s birth or adoption. The distribution would need to occur within one year of the adoption becoming final or the child being born.
If we look at the downside, the SECURE Act will make significant changes to inherited retirement plans, such as 401(k)s, traditional IRAs, and Roth IRAs, that may cause a negative impact.
In the past, beneficiaries of retirement accounts could typically spread distributions over their own life expectancy. However, the new bill includes what is viewed as a tax-generating provision that would require most beneficiaries to distribute the accounts by the end of the 10th year after the death of the account owner. This change will accelerate the depletion of inherited accounts. People are not required to withdraw from their own Roth IRA while they are alive, although their heirs must. This change will push folks to do Roth conversions and review any IRA trust documents.
This change to inherited IRAs will not apply for the following beneficiaries: the original account owner’s surviving spouse or minor children (generally until they reach the age of majority); a disabled or chronically ill person or any person who is not more than 10 years younger than the original account owner at the time of death.
Arguably the most controversial feature of the Act is a Safe Harbor for plan sponsors, which clears the way for more companies to include annuities in their retirement plans by taking employers off the hook for assessing an insurer’s financial health. This was inserted after strong lobbying by the insurance industry. Although annuities can be a great retirement income tool, they are also very complicated, illiquid, and expensive which can make them a poor option for most investors. The cost of the funds used in 401(k) plans has dropped dramatically in the past decade and the annual fund fee is now at 0.25% of assets, according to BrightScope. This stands in stark contrast to variable annuities in the retail market, where the average fee ranges between 2.18% and 3.63%, according to Morningstar Inc.
If you have any questions regarding the new law, the upcoming changes that will occur, or how they may impact your personal financial situation, please contact our firm to discuss.