Journal of Financial Planning: February 2020
Jamie Hopkins, Esq., LL.M., CFP®, RICP®, serves as director of retirement research at Carson Wealth and is a finance professor of practice at Creighton University’s Heider College of Business.
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The secure act, signed into law on Dec. 20, 2019, might not live up to its lofty name, but it’s among the most robust retirement legislation passed since 2006.
There are three main themes into which many of the Setting Every Community Up for Retirement Enhancement (SECURE) Act’s provisions fall.
First, the SECURE Act focuses on encouraging small employers and young investors to save for retirement. The biggest impact will likely stem from multiple employer retirement plans, which could allow more small employers to get retirement plans into the hands of their employees. The act also introduced numerous tax credits and benefits to encourage smaller employers to set up retirement plans and offer automatic enrollment features.
The act’s second largest focus centers around lifetime income. The act clears the way for more annuities inside of retirement accounts, requires plans to deliver lifetime income benefit statements each year, and makes it easier to roll over or transfer annuities inside of one retirement plan to another.
The third focus is on changes surrounding required minimum distributions (RMDs), which will have the most immediate impact and will likely drive most of the conversation for financial planners and their clients near and in retirement.
This article will explore nine of the act’s 29 original provisions in three sections, including my thoughts on the impact of each provision. This article will also explore how Roth conversions, life insurance, IRA trusts, beneficiary reviews, charitable remainder trusts, and qualified charitable distributions might be used moving forward with retirement income planning.
Expanding Retirement Savings
Multiple employer plans and pooled employer plans (Sec. 101). Multiple employers can join together today to maintain a qualified retirement plan, if they share a common nexus. However, if one company fails an ERISA requirement, the entire plan can be disqualified. The new rules will allow multiple employers to join together, even without a common nexus, protecting the qualified status of a plan, even if one employer fails to meet its requirements. This change will take effect in 2021.
Impact: This has been hailed as a huge step forward. It could lower costs for setting up retirement plans and could have a big impact in the long run. However, small employers might question these arrangements—and it is the perception of complexity and expense that prevent many employers from starting or joining plans. For instance, SEPs and SIMPLEs already offer essentially off-the-shelf, low-cost, lower-liability, lower-responsibility, and lower-filing requirement retirement plans that small businesses vastly underuse.
Additionally, the Congressional Budget Office (CBO) projected modest revenue losses here of $3.4 billion of the decade reviewed (2019 to 2029).1 When you compare this to the 10-year stretch provision (mentioned later, in the third section of this article), it is less than 25 percent of the revenue impact. I’m skeptical about the overall impact, but hope that this does open the door to many more Americans saving.
Increase in credit limitation for small employer pension plan startup costs (Sec. 104). This provision increases the tax credit for small employers that set up retirement plans. The SECURE Act increases the existing credit by modifying the existing format of a flat dollar amount to instead be greater of $500, or the lesser of: (1) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan; or (2) $5,000. The credit applies for up to three years after the start of the first plan year.
Impact: Adding tax credits to reduce the costs of plan setup won’t have a negative impact on retirement plan access, but it is unlikely to significantly drive employers to set up retirement plans.
Small employer automatic enrollment credit (Sec. 105). Small employers that modify a plan to offer one for the first time or start a plan with automatic enrollment can be eligible for a $500 credit that would be available for three years. This would be available for 401(k) and SIMPLE IRA plans.
Impact: It is not clear why we needed this provision. At this point, most retirement plans in the 401(k) space come with automatic enrollment, and it is unlikely that a $500 credit would be a primary driver in decision-making.
Lifetime Income Provisions
Portability of lifetime income options (Sec. 109). The SECURE Act allows for DC plans, 403(b)s, and 457(b) plans to allow direct trustee-to-trustee transfers or rollovers to IRAs of lifetime income investments or distributions of a qualified plan annuity.
Impact: This change is important for those who own lifetime income options in employer-sponsored retirement plans. This now allows penalty-free rollovers, so consumers do not need to surrender their annuity inside the plan, suffering surrender charges and fees, just to get their wealth out of the plan. Instead, consumers will be able to more freely move these income solutions from one plan to another and out to an IRA. Additionally, when coupled with the fiduciary safe harbor provision for adding annuities to plans, this makes a lot of sense. If 401(k)s start to see more and more annuities held within as investment options, consumers will need simpler rollover and transfer options, which this portability provision provides.
Disclosure regarding lifetime income (Sec. 203). This piece of the legislation has been floating around D.C. for the better part of a decade, but there has been lack of agreement on how to calculate lifetime income from a lump sum dollar amount. However, this provision of the SECURE Act directs the Secretary of Labor to start to develop a model disclosure and the rulemaking process. The disclosure should provide how much income an account can generate. Additionally, the provision made it clear that fiduciaries will not have liability based solely on the lifetime income disclosure model. This provision would require participants of ERISA plans to receive a lifetime income disclosure at least once every 12-month period.
Impact: This is crucial for improving participant understanding of what is important when saving for retirement. It is not about hitting a magic savings number; rather, it’s about income in retirement. People often do not understand how much income can be generated safely from a lump sum of money or savings. This should help people better understand their security for retirement and better focus on income generation and not just savings.
Fiduciary safe harbor for selection of lifetime income provider (Sec. 204). This part of the SECURE Act is perhaps one of its most hotly contested provisions. It’s designed to open up retirement plans to add lifetime income options like annuities without the fear of fiduciary liability when vetting the underlying investment contracts. This essentially removes uncertainty about the standard of care needed to review lifetime income options in a 401(k) or other DC plan.
Now, fiduciaries are given a safe harbor provision that waives their fiduciary liability requirement from any losses that might occur to a participant or plan beneficiary as a result of the insurance company’s inability to satisfy its responsibilities. However, the fiduciary must still meet certain requirements to qualify for the safe harbor. The fiduciary must review insurers with considerations as to whether the company can meet its financial obligations, consider the costs of the products provided, and must conclude that, at the time of the selection, the insurer is able to carry out its obligations, and that the cost is reasonable.
The fiduciary will be deemed to satisfy the previous requirement to understand the financial capability of the insurer if the fiduciary obtains written representation from the insurer that it:
- is licensed to offer the contracts;
- has, for the last seven years, not had its license revoked or suspended; has filed appropriate documents with the state regulatory department; has maintained appropriate state-mandated minimums in all states where it does business; and has not been under a supervisory operating structure;
- undergoes a financial assessment by the insurance commissioner at least every five years.
Also, the insurance company will notify the fiduciary of any changes to the aforementioned.
Impact: This provision will allow large insurers to get more annuity products in front of 401(k) participants. While the impact will not be immediate—fiduciaries still must vet the insurance companies—expect insurance companies to push immediately. Additionally, I would expect some traditional investment companies to look at joining the insurance industry or find ways to deliver these products with insurance companies with this provision in place. The risk: it is a lessening of the fiduciary standard of care.
We could also see young investors putting money into inappropriate insurance products too early in their careers. Many young investors are left to pick their 401(k) investment allocation without guidance. But, at the same time, more 401(k) participants need access to lifetime income sources. So, while increasing access is a good thing, concerns remain about how these investments are sold and distributed to plan participants so that the right person is invested in the best and most appropriate products.
RMD Changes
When it comes to RMDs, on one hand, the SECURE Act extended the required age for RMDs from age 70½ to age 72; but, on the other hand, it reduced the time period that many beneficiaries can distribute inherited retirement accounts, essentially eliminating the lifetime stretch IRA. This change is projected to have the biggest tax impact of all the SECURE Act provisions, bringing in $15.7 billion in tax revenue by 2029, according to the joint committees on taxation.2
The RMD rule changes will be the primary driver for short-term retirement income planning.
Repeal of maximum age for traditional IRA contributions (Sec. 107). Historically, once you reached age 70½ you could no longer contribute directly to a traditional IRA—non-deductible or deductible. However, starting in 2020, those over age 70½ can contribute to an IRA if they have earned compensation.
Impact: In the past, those in 401(k) plans could keep saving or you could save in a Roth IRA past age 70½. But those who were 70½ were cut off from traditional IRAs. It was a hurdle to saving and did not align with other rules. While the total amount of savings might be limited, there will be some people working after age 70½ that could use the additional savings and tax break of a deductible IRA contribution.
Increase in age for required beginning date for mandatory distributions (Sec. 114). If you are not age 70½ by the end of 2019, the new required beginning date (RBD) to begin required minimum distributions (RMDs) will be age 72. If you were already 70½ by the end of 2019, you will be subject to the previous RBD of 70½.
Impact: Pushing back the RBD allows retirees to grow their money, tax-deferred, for a year or two longer in their IRAs. The CBO says this is a tax break of nearly $8.9 billion over the 2019–2029 period. However, it is important to note that you can still withdrawal at age 70½ if you need the money, and this does not push off access to a retiree’s funds. While the overall impact of the push of RMDs to age 72 is small, the change coupled with expected IRS guidelines on changing the Life Expectancy Tables for 2021 would provide decent relief for those worried about their money lasting through retirement.
Modification of required distribution rules for designated beneficiaries (Sec. 401). The provision that modifies the stretch IRA beneficiary rules is expected to have the largest tax implications among those in the SECURE Act. In the past, many beneficiaries could inherit IRAs and defined contribution plans and stretch the required minimum distributions over their own life expectancy. However, under the SECURE Act, all inherited IRAs and defined contribution accounts will be subject to a 10-year stretch.
There are some exceptions for those defined as “eligible designated beneficiaries,” including the surviving spouse, a child of the individual who has not yet reached age of majority, a disabled individual, a chronically ill individual, and any individual who is not more than 10 years younger than the deceased owner. Therefore, surviving spouses will still be able to retitle or rollover and stretch over their life expectancy. Minor children will be able to stretch until the age of majority, and then the remainder will be subject to a 10-year distribution. Those less than 10 years younger than the beneficiary can still stretch, which—if the beneficiary is very young when the account holder passes—could still provide a long stretch.
Impact: The removal of the so-called lifetime “stretch” provisions for many beneficiaries could be a huge revenue boost for the government for two reasons. First, the new 10-year period shortens the period for many beneficiaries that the accounts can grow in a tax-advantaged manner. This means less tax-free or tax-deferred growth. Second, because the distributions need to be taken out over fewer years, the distributions will likely be larger. As an individual takes out larger taxable distributions, the taxable distributions might become subject to higher tax rates. So, in the end, this will cut down on tax-advantaged savings and subject more distributions to higher tax rates.
But it also better aligns the rules with existing public policy. In 2014 the Supreme Court ruled that inherited accounts are no longer retirement accounts and should not get creditor protections afforded to the original owner. Aligning with this rule, it would make sense that these accounts also do not get the same tax advantages of a retirement account, since they are wealth transfer vehicles at that point and not retirement savings accounts.
Conclusion
I often describe retirement income planning as trying to hit a moving target in the wind. The target is your client’s goals, which change over time. The target is moving because we do not know how long anyone will be in retirement and need to generate income from their assets. We need to plan for an uncertain period of time, but a certain amount of income.
We also have to account for wind. Things will change, as the Tax Cuts and Jobs Act of 2017 and the SECURE Act of 2019 have shown us. These public policy changes, along with inflation changes, market changes, and other risks will throw us off course if we try to go in a straight line from the start of retirement to the end. Instead, our plans need to be flexible and reviewed over time.
The SECURE Act’s impact on many best practices highlights that your clients might need retirement income changes to make sure they stay on track.
Endnotes
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See the “Setting Every Community Up for Retirement Enhancement Act of 2019 Report of the Committee on Ways and Means, House of Representatives, on H.R. 1994” at congress.gov/116/crpt/hrpt65/CRPT-116hrpt65.pdf. Note that all mentions of specific fiscal impacts of the SECURE Act in this article are found in the above report.
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See endnote No. 1.
Sidebar: Planning Strategies
Here are seven strategies that should be top of mind for all financial planners working with clients after the SECURE Act:
Roth Conversions
The Pension Protection Act of 2006 opened up the ability for anyone to do conversions—a common tool for retirement income and tax diversification planning. The SECURE Act includes two provisions that add value to Roth conversions.
First, pushing out the RMD age to 72 gives people more time to do Roth conversions between retirement and the start of RMDs. (While you can do conversions after RMDs begin, it becomes a lot more challenging.)
Second, with the 10-year distribution for inherited retirement accounts in place, converting IRAs and 401(k)s to Roth IRAs during retirement might make sense when looking at total family wealth. If the retiree can convert at a lower rate and over a longer period of time than the beneficiary, the conversion can help save taxes and pass over more true after-tax wealth. The 10-year distribution rule should spark conversations about multi-generational planning, tax rates, and long-term planning.
Life Insurance for Estate Costs
Using life insurance as a tax-advantaged way to pass legacy has not gone away, but with the removal of the stretch for many beneficiaries, it is important to review a client’s legacy needs and desires in light of these tax changes. It might make sense for many individuals to purchase life insurance as the primary legacy tool or to use the life insurance death benefits, which can be received income- and estate-tax free, to offset the higher taxes associated with a 10-year distribution period.
IRA Trusts
Many attorneys like to use trusts to hold IRAs to achieve the asset protection and stretch capabilities allowed through “pass-through” or conduit trusts. However, some of the language used in these trusts will now be problematic under the SECURE Act. In the past, IRA trusts would use language like “the beneficiary has access only to the RMDs from the IRA each year.” This was important to drive the stretch aspect of the plan and to achieve creditor protection.
However, the new 10-year stretch provision says all distributions must be out by the end of year 10, after the year of death of the IRA owner. This language means there is no RMD due years one through nine. In fact, you can wait all the way to year 10 to take any distributions, which might make sense with a Roth IRA. However, with a traditional IRA or 401(k), if you wait until year 10, you will get additional tax-deferred growth, but you will have a very large taxable distribution, in many cases subjecting the distribution to higher taxes.
As such, the previously used IRA trust language could lock up the funds for 10 years and then cause them to be taxed at higher rates than planned. Anyone using trusts for IRA planning should review their trust language to make sure it conforms with the SECURE Act’s beneficiary language.
Spousal Split Trap
Surviving spouses still get stretch capabilities for inherited accounts. As such, a client can leave the entire amount of his or her retirement accounts to their surviving spouse, who can use the funds and then leave the remainder to their heirs, who would then likely be subject to the 10-year distribution period. However, this might not be the best planning strategy in all cases.
Review whether the surviving spouse needs the income and assets from the deceased retirement accounts. If the surviving spouse does not need the income from the accounts, you might want to advise leaving some of the money to other heirs. If the client leaves half of the IRA to the kids at the death of the first spouse, that will trigger a 10-year distribution period on half of the assets. Perhaps the surviving spouse lives for 10 more years. At this point, the first 10-year period has run, and now the children inherit another set of retirement assets with a new 10-year period. This has allowed the IRA assets to be split up over two different 10-year distribution periods, lessening the total amount of taxable money distributed and potentially lessening taxes. In short, it won’t always make sense to leave the full account from a tax perspective to the surviving spouse.
CRAT and CRUT Planning
Perhaps the best way to mimic the “stretch” provisions of an inherited IRA or 401(k) under the new rules will be to use charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs ). By setting the beneficiary of an IRA as a charitable remainder trust, your client can pick a lifetime income beneficiary as their child. This can spread the distributions of the trust out over their lifetime, reducing taxable income each year, and getting some tax advantaged growth inside of the CRT.
The client will also generate a tax deduction for their estate, perhaps to offset some Roth conversions in that last year of death. Interest rates, the need for a tax-deduction, charitable intent, creditor issues of children, and desire to generate an income stream will all come into play here with planning. However, there should be a rise in CRT use after the SECURE Act.
Backdoor Roth
The so-called backdoor Roth strategy got a boost by the Tax Cuts and Jobs Act of 2017 and again got a boost by the SECURE Act. First, Roth IRAs look like an even better way to manage beneficiary income taxes under the 10-year stretch provision. Second, the removal of the age 70½ contribution cap can allow those working in retirement to do Roth IRA conversions and the backdoor conversion by contributing after-tax to an IRA and converting it tax-free to a Roth IRA. I don’t see a lot of people needing this strategy, but some financial planners work with business owners and higher-income-producing clients that might phase out of the Roth contribution ranges. As such, this opens up a new way to do backdoor Roth conversions after age 70½.
Gig Savings
Removing the 70½ age for contributions to IRAs will benefit those working part time and in the gig economy. The ability to set up an IRA after age 70½ and contribute directly as a deductible IRA can generate valuable tax savings. In fact, with two spouses you could generate an additional $14,000 of savings and a $14,000 tax deduction. This could be valuable for those who continue to work in retirement. However, it is important to note that contributing to a deductible IRA after age 70½ could impact your ability to do qualified charitable distributions (QCDs).
The SECURE Act added a “anti-abuse” provision to tie the removal of age 70½ contributions to QCDs. Any QCD will be reduced by the amount of deductible IRA contributions made after age 70½ that have not already been reduced by a deductible post-70½ IRA contribution. For example, if a client contributes $7,000 to a deductible IRA after age 70½, any QCD he or she attempts would be reduced by $7,000 before it’s treated as a QCD. —J. H.