Every now and then, lawmakers in Washington make noise about changing various sections of the tax advantaged retirement accounts I’m so fond of recommending to my clients. Now that we’re living substantially longer, and a greater portion of our lives is actually spent in retirement, there’s a good argument that we should increase age limits, mandatory distributions, and other rules governing IRAs, 401(k)s and other types of accounts.
I usually don’t pay much attention to this speculation until there’s a bill on the floor that has a strong chance of becoming law. The majority of the legislation drafted in this area doesn’t get far, and often doesn’t even get out of committee.
Nevertheless, the house and senate have both recently introduced bills that would change how retirement accounts work. I’m no political expert, and don’t have the foggiest idea what the chances are of one of these bills passing. But from what I’m reading there’s more momentum for retirement reform now than there’s been in the last several years. Plus, more than one client asked my thoughts on the subject recently so I felt a summary post would be appropriate. This post will cover what happened & why it might be important to you.
In February the senate introduced a bill called the “Retirement Enhancement and Savings Act” (or RESA), aimed at fixing America’s retirement savings problems – both in the public and private sectors. This isn’t the first bill on retirement reform that’s been introduced recently. Multiple versions containing similar provisions have been introduced since 2016, which speaks to the growing interest in helping Americans save for retirement.
Meanwhile, the house passed the SECURE Retirement bill (Setting Every Community Up for Retirement Enhancement Act) about a week and a half ago in a 417-3 vote. This bill contains many of the same provisions as RESA, and the bipartisan support on both sides of congress could mean one of the bills may actually make it into law sometime soon.
What’s In the Bills?
There are several interesting sections in these bills. By and large both pieces of legislation make it easier for small businesses to offer retirement plans, which is certainly a good thing. They also open the door on offering annuities in retirement plans, and make some substantial changes to IRAs. I should note here that I haven’t read either bill in its entirety – I’m going off what I’ve read/heard/seen in the news coverage. I’ll try to summarize the relevant provisions that are common to both bills.
Multiple Employer Plans
Multiple employer plans allow smaller companies to band together and offer one, larger, unified workplace retirement plan. There’s some cost and compliance headache involved with offering a retirement plan, which can be spread across multiple businesses with this type of set up. The biggest drawback to multiple employer plans today is that they come with a lot of red tape when compared to a single employer plan. The provisions in RESA and the SECURE retirement Acts eases some of those burdens, making it easier for small companies to offer them. This is a good thing, as it should enable more small businesses to offer a retirement plan when they wouldn’t otherwise have one.
Annuities in Defined Contribution Plans
Most pension plans around the country offer a selection of annuity payouts when you begin collecting benefits. After accruing benefits for a number of years, you typically have a choice to receive benefits for:
- The rest of your life
- The rest of you & your spouses’ lives (potentially with a haircut on the amount your spouse would receive once you die)
- A certain number of years, or “period certain”
It’s rare for 401(k) and other defined contribution plans to offer annuity payouts in the same way, but it’s possible when bringing in an insurance company. Rather than taking the investment risk and responsibility of offering a guaranteed payout, an annuity option from an insurance company can serve the same purpose. I’m not a fan of annuities in general, but some people strongly prefer guaranteed income.
From a plan sponsor’s perspective, offering an annuity in a 401(k) is unpopular because of the risk involved. In the event that an annuity provider ever went bankrupt, plan sponsors could currently be held liable for any benefit payments lost by participants. RESA and SECURE both include provisions that protect plan sponsors offering annuities from this liability. In the form of a new “safe harbor”, the provisions would make annuity options in 401(k) plans much more appealing and easier to install.
Both bills contain a few provisions that would change the way IRAs and other retirement plans operate. The first is that both bills eliminate the age cap to IRA contributions. Currently you’re not able to contribute to an IRA once you reach the age at which mandatory distributions will begin from the account (age 70 1/2). This change would make IRAs a bit more flexible, and conform to 401(k) and 403(b) rules (you can still contribute to your company’s 401(k) or 403(b) into your 70s if you’re still working there). I haven’t run into too many people in their 70s or later who want to make IRA contributions, but I guess it’s nice to have the option.
The second interesting provision in both bills is to raise the age at which mandatory distributions begin. This is a change I wholeheartedly agree with. IRA distribution rules were passed with ERISA in 1974, and I don’t believe the RMD ages have changed since then. That was 45 years ago, and life expectancies are far greater today. Interestingly, SECURE’s provision delays the RMD age to 72, while RESA kicks it all the way out to 75. Either of these ages, or anywhere in between, would be welcome by me.
Finally, both bills contain provisions eliminating the “stretch” IRA, which has to do with your distribution options after inheriting an IRA. Currently you’re free to choose between:
- Withdrawing all funds in the account within 5 years of the inheritance, or;
- Taking an annual distribution based on IRS tables, “stretched” over your life expectancy
It’s usually more beneficial to stretch the distributions out over the rest of your life, as opposed to clearing out an IRA within the first five years. This allows the balances to grow and compound tax deferred for a longer period of time.
This provision was a bit puzzling to me, but I’d guess it was included for revenue purposes. Eliminating the stretch IRA is undoubtedly less beneficial to anyone inheriting an account. But to lawmakers conscious of losing tax revenue from the other provisions, the stretch IRA is low hanging fruit that would add tax revenue, helping to even the scales. After all, the purpose of both bills is to help Americans save for their own retirement. You don’t save to build up an inherited IRA, nor do you choose whether you inherit one at all.
How the Bills Could Impact You
All in all, the biggest change for anyone approaching retirement is likely the extension of RMDs. This could be very convenient, as it could lengthen your “gap years”, and provide a bigger window for Roth IRA conversions at lower marginal tax rates. The other provisions could also be impactful if your employer begins offering an annuity in your 401(k), or bands together with others to offer a multiple employer plan. What’s interesting to me is that neither bill touched Social Security. Extending Social Security retirement dates is a logical next step after extending RMDs, but is also a sacred cow that politicians are reluctant to tinker with. I understand that it’s challenging politically (when you need to get re-elected every two years) to bring up Social Security. But sooner or later we’ll be forced to make some changes.
As always, your personal situation will dictate whether you should make changes to your retirement plan if either of these bills become law. And to be clear, both are still quite a ways off. But there is certainly momentum, and I wouldn’t be surprised if I were amending my clients’ financial plans to reflect a later RMD age sometime in the next 6-12 months.
What do you think?
Would a later RMD age be helpful to you personally?
How would you feel about having an annuity offered in your 401(k)?