On December 20, 2019, President Donald Trump signed into law The SECURE Act. This stands for Setting Every Community Up for Retirement Enhancement Act. With such a reassuring acronym, one would assume all of America is now on the fast track for a safe and enjoyable retirement. However, as with any political measure, there are bound to be pro’s and con’s, and therefore winners and losers. Here is a summary of each cost and benefit, and how the financial world will likely react to these sweeping changes.
According to the Joint Committee on Taxation, this bill will cost the government roughly $14.6 billion over the next decade. This is a number that has been touted as a huge contribution to each American’s ability to plan for the future from the generosity of Uncle Sam. Although, is not a cost to the government an eventual cost to the taxpayer?
Here is a brief summary of the benefits, benefits to the American citizen that is, and the relevant “costs” to the government.
- IRA Required Minimum Distributions- The most notable improvement will the pushing back of Required Minimum Distributions (RMD’s) from Age 70.5 to Age 72 (applicable to those who are not yet 70.5 by the end of 2019). Also, there will no longer be an age restriction for ability to make Traditional IRA contributions (previously stopped at Age 70.5). This delay in tax revenue is estimated to cost the government $8.9 billion in the next 10 years.
- 401(k) Improvements- There are several measures intended to make it easier for small businesses to set up 401(k)’s. The Safe Harbor rules have been simplified. The cap on which an employer can auto-enroll their employees has been raised from 10% to 15% of wages, to encourage greater retirement savings. Multiple employer plan structures will be allowed to hopefully create economies of scale. Long-time part timers will now have a better shot at saving for retirement as those who either worked 1,000 hours throughout the year or have 3 consecutive years with 500+ hours of service will now be eligible for their company plan. Lastly, plan sponsors will be encouraged to include annuities as an option in workplace plans.
- Small Business Tax Credits- There are also some enhanced tax credits available to small business owners such as pension start-up costs changed from the lesser of $500 or 50% of startup costs to a potential credit up to $5,000 (small is less than 100 employees). An additional tax credit of up to $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment will be available. This along with the 401(k) improvements is projected to cost $3.4 billion.
- College Planning- The use of tax-advantaged 529 accounts towards student loan repayments will now be permissible without penalty up to $10,000 annually. Funds can also be used towards apprenticeship programs. Senator Ted Cruz delayed passage of The SECURE Act in hopes of allowing the costs of homeschooling to be included, but to no avail.
- Parenting- the bill will now permit the penalty-free withdrawal of $5,000 from 401(k) plans to defray the costs of having or adopting a child. This is expected to cost $1.2 billion in lost tax revenue.
There is one massive change intended to offset the lost tax revenue mentioned above, and many economists believe this will actually far outweigh those costs. Which means the cumulative benefit may be greater for Uncle Sam than the American people.
- Overhaul of Inherited IRA RMD Rules- the new law states that all non-spousal IRA beneficiaries must take out ALL IRA or qualified plan distributions within 10 years of the account holder’s death (almost scarier, the Senate’s original version proposed a limit of just 5 years). There are a few exceptions, such as minor beneficiaries (although the 10-year rule kicks in at their age of majority), disabled beneficiaries, chronically ill, and beneficiaries who are less than 10 years younger than the deceased owner.
What’s so bad about this? Prior to 2020, an IRA beneficiary, suppose a child or grandchild, had the opportunity to withdraw their Required Minimum Distributions over their life expectancy. Naturally for a 30-year-old beneficiary this would permit them to slowly use up the IRA, offering flexibility and tax arbitrage via the “Stretch IRA”. Under the new rules, that person must completely liquidate the account within 10 years. In the event the beneficiary or his/her household has a moderate or high income, and the IRA or qualified plan is a large sum, those 10 years of distributions can throw the beneficiary immediately into a higher tax bracket. This could create a significant tax hit to their inheritance and current day income.
Financial planning reactions
There are several approaches likely to be implemented to adjust for this new rule and mitigate potential tax nightmares.
- Roth conversions- retirees may consider converting some of their pre-tax monies into Roth IRA’s, which can allow for eventual income tax-free distributions by themselves or their heirs.
- Qualified charitable contributions- 501(c)3 organizations are tax-exempt. In other words, contributing $100 of pre-tax IRA money will have the same effect to the charity as $100 of after-tax or Roth money. Meanwhile, this can avoid income taxation to the account holder.
- Life insurance planning- the unique income tax-free treatment afforded to life insurance death benefits can allow the beneficiary to recapture much of the retirement funds lost to taxation. This can also be very valuable to a widow, as the injection of tax-free cash may allow them to convert their remaining IRA’s into a Roth or cover any other expenses. Current day RMD’s may often be used to fund such life insurance premiums, essentially transition from a compounding tax liability to a compounding tax-free asset.
The tug-of-war between government involvement to help Americans prepare for their golden years, while still generating enough tax revenue to keep $22 trillion of debt at bay will surely continue. This recent act is a reminder than people must always be ready to adapt to unexpected changes and continually evaluate their financial plans.
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