The Basics of the Retirement Bill Congress Just Shoehorned Into a Spending Deal

At last count, 72% of Americans disapproved of the way Congress was doing its job, and we reckon if there were an “explain why you feel this way” fill-in-the-blank on Gallup’s survey, it would get some colorful responses.^[i] But there is one thing you can’t accuse Congress of: being bad at multitasking. For, smack in the middle of this week’s impeachment brouhaha, the House managed to pass a bipartisan spending bill. Like most omnibus spending bills, it had some unfinished business duct taped to it: the legislation once known as the SECURE Act, which passed the House a few months ago but languished in the Senate. That bill, which we covered here, is a good-and-bad mix of changes to retirement accounts. The Senate is likely to pass the whole shebang this week, with President Trump expected to sign it Friday in order to avoid a government shutdown. As it takes effect, there are a few things investors need to know and check up on.

Back in the spring, most of the punditry’s chatter focused on a provision that would clear the way for companies to offer annuities in 401(k) plans. Proponents focused on immediate fixed annuities, which they argued would remove some of the uncertainty they claimed was inherent in a defined contribution plan. They said it would make 401(k)s like a pension, only paid by an insurance company instead of the company you work for. That might seem all fine and dandy for those who miss the steady retirement payouts of old, but keen observers pointed out that this was a slippery slope likely to lead to more complex, expensive deferred annuities worming their way into retirement plans. We think this is probably correct, making it vital to scrutinize all investment options in your 401(k) carefully once this passes.

There are also some more immediate, operational considerations. Some are helpful. The age limit on IRA contributions (for those with earned income) is going away, and required minimum distributions (RMDs) for those who haven't yet begun taking them will start at age 72 instead of age 70.5. This change enables savings to grow tax-free for a little longer and saves a couple years’ worth of operational headaches. It also gives folks a couple more years to convert part or all of a traditional IRA to a Roth IRA, if they want to. Give your tax adviser a shout to see how this affects and benefits you.

Other provisions should also make it easier for small businesses to band together and offer a group 401(k), improving Americans’ access to this wonderful retirement planning tool. Part-time employees who log at least 500 hours in three straight years will also have guaranteed eligibility for their company’s retirement plan. So if you work at a small business that doesn’t yet offer a 401(k) plan, make sure your company’s owner knows about the new rules, and start lobbying her to join a multi-employer plan.

In the seemingly helpful but watch out bucket, people who have or adopt a child will be able to withdraw $5,000 from a retirement account to help cover related expenses without paying early withdrawal penalties. This sounds great, as birth and adoption are expensive. However, the withdrawals would still be subject to income taxes, and that is $5,000 less to compound over the next 20, 30, 40 or more years. If $5,000 grew at 8% annually for 40 years—an unrealistic assumption since markets don’t move in straight lines, but also below stocks’ average annualized return since 1926, so let’s go with it—it would be worth more than $108,000 at the end. Everything in life is a tradeoff, but this is a big one.

And now, the ugh watch out bucket: the elimination of a tool known as the “stretch IRA.” As the name implies, present rules for inherited IRAs allow non-spousal beneficiaries to distribute the account according to their life expectancy. Basically, start taking RMDs when you inherit it or when the IRA owner would have turned 70.5 years old, whichever comes first, and then keep taking them until you die or distribute the whole account. Beneficiaries’ ability to stretch distributions over decades made IRAs a popular estate planning tool. The SECURE Act kills this, requiring non-spousal beneficiaries to distribute the entire account within 10 years.^[ii] Not only does that force them to condense all the tax payments within 10 years, but it likely bumps them into higher tax brackets—ugh. It would apply to all tax-deferred retirement accounts, including traditional IRAs, 401(k)s and other defined contribution plans.

The good news is this change is not retroactive. If you have an inherited IRA, you do not suddenly have a 10-year time horizon for it. The change applies only to accounts whose owner dies on or after January 1, 2020. So if you have a tax-deferred retirement account that you plan to leave to someone other than your spouse, we recommend calling your tax adviser to discuss possible ways to mitigate the impact, like changing your beneficiaries. You might also consider doing a Roth IRA conversion. Roth IRAs are funded with after-tax money, grow tax-free, and aren’t subject to RMDs. Withdrawals are also tax-free. The tradeoff is that the conversion itself is a taxable event, so talk to your tax adviser. If you don’t want to take the tax hit in one fell swoop, you can do a series of partial conversions over several years. The higher RMD threshold gives you two more years than you would otherwise have.