On December 20th 2019 the SECURE Act was passed into law. It has been a little over a month since this legislation was passed and most of the details are now out in the open and generally understood. In this analysis we will break down what we believe is the most important parts of the Act as it relates to the general public. This is by no means a comprehensive analysis and covers what we believe are the highlights. We encourage all interested parties to do more in depth research, Congress.gov is a good place to start.
Quick and Dirty Summary:
- Required Minimum Distribution (RMD) age has been pushed back to 72 from 70.5.
- Contributions to IRA’s can now be made after age 70.5.
- Adoption and birth expenses can now be paid out of a tax deferred account penalty free, up to a point.
- Many part time workers will now be allowed to participate in employer retirement plans.
- Allows use of 529 accounts to pay off student loans.
- The “Stretch IRA” that allowed beneficiaries of IRA’s and 401k’s to take distributions over their lifetime is now gone.
The Downright Ugly:
- Annuities are incentivized to be used more broadly in retirement plans.
Overall, there are a number of positive aspects to the SECURE Act that are likely to help most pre-retirees and those approaching RMD age. The most impactful change is the shift in RMD age from 70.5 to 72. This change will allow tax deferred growth to continue for another 1.5 years. The additional 1.5 year window with no required distributions will also give people a little more time to optimize their tax planning through the use of Roth conversions and delay the taxable event that is the RMD. Additionally, people over the age of 70.5 can now continue to contribute to their IRA indefinitely. Continuing contributions can be helpful to those who are still earning income but be aware that it may be counterproductive in certain situations.
Historically, company retirement plans and other tax deferred accounts have been pretty restrictive on what they allow withdrawals for, but the SECURE Act has loosened those restrictions slightly. Specifically, people can now use tax deferred funds to help them pay birth and adoption fees up to $5,000 and 529 plans can now be used to pay off student loans (it’s about time). These changes help people who may need to dip into tax deferred funds and want to avoid paying uncle Sam any additional money. (for a list of distributions that are exempt from the penalty visit the IRS Website)
Getting people to participate in company retirement plans has always been a bit of a challenge for employers, but it has been even more difficult for the part time employees that weren’t even eligible to participate. The SECURE Act by no means fixes this problem but it does give more people access to company retirement plans which is always a positive. Now, part time employees that work 1000 hours throughout the year or have three consecutive years of 500+ hours can participate in company retirement plans. This will no doubt help those that want to take advantage of it.
Despite much of the good that this bill does, it also has some negatives. Tax deferred and exempt retirement accounts have always been great inheritance vehicles because they helped minimize taxes by allowing long distribution timelines. This was great for investors, but the IRS has realized that it wants its’ tax revenue and it wants it now, at least within 10 years. The SECURE act has eliminated the ability of IRA beneficiaries to stretch out the distributions over their lifetime and pay taxes in small chunks by forcing them to empty the account within 10 years of inheriting it. This change means that legacy planning is going to be even more important for those that strive to leave a assets to their beneficiaries. It may not seem like a big deal, but remember that IRA distributions are taxed at ordinary income rates so every dollar that comes out is subject to the marginal tax tax. For someone that leaves a couple million bucks to their children this could mean putting them in an incredibly high tax bracket and giving a big chunk of the money back to the government. Taking advantage of things like Roth conversions can help lessen the impact of this rule change if done properly.
The SECURE Act has many wonderful provisions that will no doubt help many people live more comfortably in retirement. However, there is one provision that may wipe away all the positives this bill produced; incentivizing the use of annuities in company retirement plans. Historically, plan fiduciaries have been hesitant to allow the use of annuities in most plans because unlike a mutual fund, stock, or bond an annuity is a contract and only as good as the party who underwrites it. Said more plainly, plan fiduciaries don’t want to get in trouble for problems with annuity contracts. The SECURE Act is taking that responsibility away from plan fiduciaries, so they are no longer liable for problems with the contracts or companies. This may seem like a small change, but insurance companies are the primary providers of annuities and they have a huge incentive to push these products into the system, commissions, and the means to do it through their massive lobby.
You may be wondering why inclusion of annuities is so troubling to us here at Delphi. Well, we are not going to discuss the inner workings of such complex products in this analysis but to put it simply and bluntly, they are terrible investment vehicles and can result in elderly poverty if not used properly. They have incredibly high fees, are very inefficient, and don’t adjust for inflation. They are sold as “safe” and “secure” with the idea of protecting your assets but the only thing they protect you from is wealth. Annuities are incredibly complex products that should only be used for very specific purposes and aren’t appropriate for most people, in our opinion. (To learn more about annuities download our report on the Top 10 Killers of Net Worth here, annuities are number 7 on the list if you were wondering)
Overall, we believe the SECURE Act is a net positive, but, as with any action our government takes, it comes with a downside.
If you have further questions please feel free to contact us, we are always happy to help.