Note: this was originally published in January 2020
We at McGrannLAW broke in the New Year with a bang – hard at work learning about the significant changes 2020 will make to retirement and estate planning so you don’t have to do the dirty work.
This year will usher in some significant changes to the landscape of financial planning, both on the consumer side (individuals and employers) and on the broker side. Knowing about these changes is critical for protecting your hard-won financial security and legally imperative for those in the financial services industry to know (and hopefully come to love).
On December 20, 2019 something of a unicorn came into existence: a bipartisan bill signed by President Trump that received little fanfare. Attached to the appropriations bill, the SECURE Act ushers in some much-needed changes to the retirement system in the United States – but also introduces some troubling new options ripe for abuse by unscrupulous financial advisors.
It’s no secret that the great majority of retirement plans are underfunded, and that’s when there is a retirement plan outside of social security. The SECURE Act’s most significant changes affect businesses that offer 401(k)s and provide incentives for small businesses to offer such plans to employees.
Small businesses have long complained that it is cost-prohibitive to offer market-competitive 401(k)s. To make address some of these complaints, the SECURE Act does the following:
- Creates a tax credit of $500 per year to businesses who create a 401(k) or SIMPLE IRA plan with automatic enrolment for its employees. This is in addition to the start-up credit businesses already receive.
- Provides increased access to multiemployer plans for small businesses. This is particularly important in that the Act lifts the requirement for businesses to share a “common characteristic” (such as industry) to create or join such plans. This of it this way: the SECURE Act makes it easier for small businesses to pool resources to offer 401(k)s that are competitive with much larger businesses’ 401(K) plans.
- In a significant shift, employer-sponsored retirement plans are now available to part-time employees. Before the SECURE Act was signed into law, businesses were not required to offer enrolment to workers who worked less than 1,000 hours per year. The revised rules set new levels: employees are eligible if they’ve worked one year at 1,000 hours or three consecutive years of now fewer than 500 hours.
The final unquestionably good change resulting from the SECURE Act is raising the age at which retirement plan participants must take required minimum distributions. For decades RMDs kicked in when an account holder reached 70 ½ years of age – a number based on life expectancies over a generation out-of-date. The SECURE Act has changed the age when one must take an RMD to 72. Please note that if an account holder reached 70 ½ during 2019, he or she must begin to take required minimum distributions.
Given the increased life expectancy, this extra year and a half permits account holders – who now frequently also work longer – to continue to contribute and accrue interest for some extra time. This is a fairly modest change, but nevertheless a welcome start.
Finally, owners of 529 accounts (investment accounts for educational uses) are now permitted to use account funds to make up to $10,000 in repayments on qualified student loan debt.
There are provisions in the SECURE Act that provide flexibility to new parents and holders of educational 529 accounts to access retirement or 529 funds without penalty in specified circumstances. Both of these options are potentially beneficial but require thought as to whether taking tax-free distributions for these purposes is necessarily the best way to finance things like having a baby.
The SECURE Act permits new parents to withdrawal up to $5,000 within one year of having or adopting a baby without the early withdrawal penalty. Parents may repay into their 401k or IRA these funds, but are not required to. On the one hand, the new flexibility to do this helps new parents in a pinch – having a baby is expensive! On the other hand, it might be worth thinking about whether removing retirement funds is a superior option to others. Ultimately, would taking a short-term loan at a decent interest rate be less expensive than removing $5,000 from the safety of a managed retirement plan and its steady build of compound interest? This particular provision is one that sits as one of those “well, we could do this….” options, rather than, “here’s how we do this.”
Being able to use 529 account funds to service educational loans is a welcome development. (I’ve always wondered why there was a prohibition of using 529 accounts to service school loans.) . There are a few things to keep in mind here, though. First, 529 payments are limited to $10,000 per 529 plan beneficiary. $10,000 is nothing to sneeze at, but for most people with student debt, that will look like a pretty small sum. Second, 529 plan payments are limited as to what they can be used for in servicing student loan debt. While a 529 payment may be used to pay principal and interest on the education loan, those payments will not count toward the interest payments used to establish the student loan interest deduction. Third, plan beneficiaries will need to be careful as to whether their domicile state has adopted of the SECURE Act rules, otherwise the plan beneficiary will be in the clear for federal tax purposes, but could accrue state tax liability.
In order to account for some of the lost tax revenue of the above changes, the SECURE Act eliminates stretch IRAs. Stretch IRAs were a common strategy for extending the tax-deferred status of an IRA when inherited by a non-spouse beneficiary. Essentially, stretch IRAs could be used to pass the corpus of an IRA with perpetual tax-deferred growth, with taxes paid only when distributions were taken.
Stretch IRAs are now a relic thanks to the SECURE Act. IRAs inherited by non-spouses must now take a full payout from the inherited IRA within 10 years of the original account holder’s death. (Thus, even if the initial heir passes before those 10 years have run, the clock for complete payout does not reset.) Ultimately, this is an understandable change, although it does constrict the estate planning tools in a family’s toolbox.
And so we must address the truly problematic side of the SECURE Act. For the first time, employers are permitted to include annuities as options within 401(k) plans. Let’s walk through why this is a bad thing.
Employers traditionally carry a fiduciary duty to their employees when creating the 401(k) plan. The employer was required by law to ensure that the 401(k) it offered to its employees was suitable and appropriate for its employees’ portfolios. This aligned the interests of the employer and employee. With the allowance of annuities into the game, that fiduciary relationship is ruptured, shifting to insurance companies the responsibility to ensure that the offered annuities are appropriate investments for the employer’s employees.
Annuities are superficially attractive investment options, as they offer a guaranteed income throughout the life of the policyholder. However, there is a reason most sophisticated financial planners shy away from annuities as options for their clients: they’re incredibly complex and risk penalties and fees if not used perfectly. Permitting annuities into this space amounts to a giant giveaway to the insurance industry and places employees’ best interests in the hands of a third-party insurer. It is easy to imagine this development ripe for abuse.
There will be some who disagree with us on this assessment, but we firmly believe in this judgment – as do some of our most trusted broker partners and financial planning stalwarts.
Go talk with your financial planner and estate attorney! The SECURE Act introduces some significant changes to the retirement landscape and it’s critical to make sure you and your family are set up for success. It’s always easier to protect yourself proactively than to put out a three-alarm fire.
If you would like to talk about the SECURE Act and its implications for your family or your business, please GET IN TOUCH!