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Financial (In)Security: The Pros And Cons Of The SECURE Act

On January 1, 2020, a new law called the SECURE Act was passed bringing about new regulations that can—and will—affect anyone trying to plan for their retirement.

Let’s take a look at all of the aspects of the SECURE Act and how they may affect your financial future.

The Good

Pooled Employer Plans

With the SECURE Act, small businesses will now be allowed to “pool” together to create larger qualified retirement plans for their employees. This is designed to help small companies afford to provide plans for their employees and to create potentially lower costs for employers and employees due to size and scope of plans.

Automatic Enrollment Escalation

When new employees are enrolled in their company’s qualified retirement plan, the plan sponsor is allowed to enroll an employee automatically with an initial contribution percentage and to escalate each employee’s contribution percentage annually. Under the SECURE Act, the new escalation limit is 15%. Employees may choose to override this default setting, but since many employees don’t bother to enroll or to update their plans regularly, this encourages good saving habits without creating required action or attention.

Tax Credit for Small Employers

In order to help small businesses provide retirement plans for their employees, the SECURE Act will provide a tax credit that covers up to $5,000 of plan costs for the first three years that the plan is in place.

In addition, the act will give a tax credit for employers who auto-enroll their employees in their plans.

This is one of my favorite aspects of the new law, as any provision to encourage more employers to provide plans for their employees is a good thing.

Graduate School Compensation

Student aid paid to graduate or postdoctoral students is now deemed as “compensation” for the purposes of determining IRA contribution amounts. The premise is that graduate students will benefit from starting their retirement savings earlier, which is certainly true—as long as it doesn’t create the reliance on larger student loans to do so.

IRA Contributions Past Age 70 ½

Workers over age 70 ½ will no longer be prohibited from contributing to traditional IRA accounts. People are working longer than ever and in many cases are presumably doing so because they haven’t reached financial independence. Allowing IRA contributions past that age will be an incentive to keep saving for retirement beyond 70 ½.

Credit Card Loans on Defined Contribution Plans

The SECURE Act is making the funds in retirement plans more difficult to access by no longer allowing participants to borrow money from their plans through credit and debit cards. This will help participants avoid debt and protect them from derailing their own retirement plans.

Portability of Annuity Contracts

This allows annuity contracts to be moved from one qualified retirement plan to another if the original plan no longer authorizes the specific contract. This will help some plan participants to avoid high fees or penalties created when a plan sponsor changes underlying investment options.

Plan Eligibility for Part-Time Workers

Beginning in 2021, employees working between 500-1,000 hours a year for three consecutive years will be eligible to enroll in their employers’ retirement plans, with the caveat that the employer won’t be required to match the contributions. This will benefit long-term, part-time workers by granting them access to tax-favored retirement savings comparable to their full-time colleagues, and won’t be expensive or operationally burdensome for employers.

Expansion of 529 Plans to Apprenticeships and Loan Repayments

With so many families starting to explore alternatives to traditional college for their children, this is a fantastic way to help make sure that 529 plans are useful for as many people as possible. Student loans are such a huge problem for young graduates, and allowing 529 funds to be used for repayment is long overdue and will hopefully increase from $10,000 to a larger amount in the future.

The Bad

Withdrawals for Birth or Adoption of a Child

Plan participants in defined contribution plans will be allowed to make penalty-free withdrawals with optional repayment of up to $5,000. In general, any provision that allows early, non-hardship access to retirement funds harms retirement savings—usually for the people who will need additional retirement savings the most.

Since these distributions will still be taxable income and only the penalty is being waived, the benefit to participants is very small and the potential loss of tax-deferred compounding could be sizeable. This is something that should be avoided unless in very dire circumstances.

Increase in Age for Required Minimum Distributions (RMDs)

The age at which holders of traditional IRAs and qualified retirement plans will be forced to start taking annual distributions has been increased from 70 ½ to 72, but only for people turning age 70 ½ after December 31, 2019.

While this isn’t in itself a bad idea, the negatives lie within the implementation, as there are very complicated rules (and a few exceptions) that will make it easy to make mistakes in this process.

Disclosure of Account Balance as an Annuity Stream

While it had good intentions, I can’t get on board with this aspect of the Act. It creates a new obligation for plan sponsors to provide estimates and illustrations for participants that show the hypothetical outcomes of converting their defined contribution account balances into lifetime annuity payments. While it was created as a way to provide additional guidance and information to participants, what it really does is require irrelevant and misleading information that will only confuse people.

The Ugly

Safe Harbor for Selection of Annuity Provider

Employers will now be required to engage in (and periodically repeat) an “objective, thorough, and analytical search” of annuity providers, including the annuity provider’s capability of making payments to participants, plan features and costs, licensure status of insurers and state insurance commissioner requirements. This provision is a huge victory for the large insurance lobby, but they’re the only winners here.

This is a huge undertaking for employers and will end up being much more expensive for plan participants. Of all the provisions in the SECURE Act, this is one of the two worst.

Modifications to Stretch IRAs

This provision eliminates the ability for non-spousal beneficiaries of IRAs and retirement plans to “stretch” the required distributions over their lifetimes and will instead require all funds to be withdrawn within 10 years of the death of the participant.

As a financial planner, this almost offends me. This throws decades of planning out the window and requires a full reevaluation from a financial, tax and estate planning perspective. This amounts to a very large cash grab from the government and makes IRAs, Roth IRAs and other retirement accounts far less valuable than in the past. This is absolutely the worst provision in the SECURE Act.

The lesson:

The SECURE Act is now law, and it’s important to understand how the provisions will affect your financial future. Working with a financial advisor is a good way to make sure you stay proactive in your planning so new laws and regulations don’t derail your dreams of retirement.

If you have any questions about the different provisions of the SECURE Act, you can ask me on Twitter at @BrotmanPlanning.

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