In its year-end rush to pass a bill that funds the government, Congress included a significant revision of the rules that apply to company 401(k) plans and individual retirement accounts. Some of the provisions of the SECURE Act will make it easier for employers to offer retirement plans at work, as well as increase contribution limits and investment options. But other aspects of the plan will affect withdrawal opportunities, especially for heirs of large IRAs.
Here’s a review of the key changes and how they may require you to adjust your financial planning.
The Good News
—The new law makes it easier for small employers in different industries to band together to offer low-cost 401(k) plans to their employees. You can be sure that the big plan sponsors like Fidelity, Vanguard and Schwab will now see this as a cost-effective way to gather assets, helping those small businesses set up new 401(k) plans. The small businesses that create retirement plans will receive a tax credit for 50 percent of plan start-up costs, plus an additional credit if the plan includes automatic enrollment.
—The “magic number” of 70 1/2 goes away starting January 1. Those required minimum distributions (RMDs) will then start after age 72, making start dates easier to figure out and letting your money grow for an extra year and a half. Also, older workers will be able to able to continue contributing to their IRAs from earned income, because the current 70 1/2 age cap for contributions is removed.
—Overall retirement savings should increase, as employers can now automatically raise employees’ savings rates to 15 percent of annual earnings, up from the current 10 percent cap. And they’re allowed to automatically enroll employees at an initial contribution rate of 6 percent of salary, up from the current 3 percent.
—Part-time workers, who qualify by working 500 hours for three consecutive years at the company, may also be allowed to participate in 401(k) plans.
The Mixed News
—401(k) plans will now be allowed to offer annuities as an investment option. That creates guaranteed lifetime income for at least a portion of retirement savings. Employers will not be liable if the insurer offering the annuity goes out of business. But employers will have the responsibility of choosing lower cost annuity offerings — a true benefit because many retirees who roll over their assets are enticed into high-cost annuity products, unaware of more competitive offerings. So this annuity option is a mixed blessing; it assumes that the products offered in the plan are fairly priced while assets grow and fairly calculated when lifetime payouts start.
—Following the birth of a child, you will be able to take out up to $5,000 without payment of the 10 percent early withdrawal penalty. That’s an important benefit for those who need it, but in the long run is likely detrimental to the goal of maximizing retirement savings.
The Bad News
Congress broke a long-time promise — upon which many people based their financial plans — that if you didn’t spend all your IRA before you die, your heirs could “stretch” out the growth of the inherited IRA over their own lifetime. Now, your heirs will be required to “empty” your IRA, which they inherit, by the end of the 10th year after death.
Of course, the dreaded RMDs are designed to force you to withdraw most of your IRA over your actuarial projected lifetime anyway. But for those who die unexpectedly early, the government will now take a bite out of your unused IRA by forcing your heirs to take the 10-year withdrawal period, paying income taxes as they do so.
From a personal finance point of view, and from a societal point of view, this new law will encourage retirement savings to fill a gap now estimated at $3.8 trillion for households between ages 36 and 64. The law will benefit insurance companies and asset managers, whose products will earn fees as the nearly $6 trillion 401(k) market grows in coming years.
But the law also serves as a reminder that the structure of retirement plan taxation is always subject to the whims of Congress. And that’s The Savage Truth.