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Will We See More Changes to Retirement Savings?

Given the sharp political divide in our country right now, it's  rare to see legislation that enjoys widespread bipartisan support. Yet in May, the House voted on a bill that would make substantial changes to our retirement system, and it received near unanimous support. The SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019 passed in the House of Representatives in a 417-3 vote, but the bill has stalled in the Senate as legislators debate some of the key provisions. 

While we don't know if or when the Act might pass, or what the final details of the bill will look like, it's important to understand what has been proposed and how it might impact you. Below I'll identify some of the changes that I believe could have the biggest impact, along with some thoughts on each.

Shortened Withdrawal Period on Inherited IRA's - If you inherit an IRA from someone other than your spouse, you are generally required to take a distribution each year based on your life expectancy. Because the distributions from an IRA are taxable as ordinary income, this ability to "stretch" the distributions out over a long time period is a big advantage when inheriting an IRA. The SECURE Act, as it passed the House, would change this rule to require you to take the full amount of the IRA out within 10 years of inheriting it, with some exceptions. The current version of the Senate bill would require the account to be liquidated within 5 years, with an exception of up to $400,000 per beneficiary that would still go by the old rules.

I believe this is the most important provision in the bill, though it probably won't be discussed as much as others. This rule change was likely added to help "pay for" some of the other aspects of the bill, but that could mean a big tax bill for beneficiaries of IRA's who will be bumped up to higher tax brackets due to the distributions.  If such a change does go through, Roth IRA accounts will become even more valuable and Roth conversions will likely become a more popular strategy. Inherited Roth IRA's would be subject to the same distribution rules, but they are tax-free so if your beneficiaries will be in a higher tax bracket than you are now, it might make sense to do partial Roth conversions at lower rates.

Delayed Start of Required Minimum Distributions - If you own a retirement account such as an IRA, 401(k), or 403(B), the IRS generally requires you to begin taking distributions from that account by April 1 of the year after you reach age 70.5. The SECURE Act increases this age to 72, though the current version of the Senate bill does not include a similar provision.

While this is a relatively minor change, it would be beneficial for anyone who doesn't need their required minimum distributions to cover cash flow needs. We often advise clients to do Roth conversions in their low income years before their required minimum distributions begin since they are in a lower tax bracket, and this would provide additional years for that strategy.

Removed Limitation On IRA Contributions after age 70.5 - Under the current law you are not allowed to contribute to a traditional IRA after the age of 70.5, even if you are still working. Both the House and Senate versions of the bill would repeal this prohibition and allow contributions after this age.

We are seeing more clients who continue to work in some capacity in their 70's. As medical advances enable us to live longer, healthier lives, we expect this trend to continue and that means everyone will need more saved for retirement to last their entire lives. Being able to contribute to an IRA past age 70.5 would be a small but welcome change.

More Annuities in your Retirement Plan - Right now it is rare to see annuities offered in retirement plans, in part due to plan providers' concerns about their liability in picking an annuity provider for the plan. The SECURE Act would create a safe harbor for plan providers to protect against potential lawsuits when offering annuities. 

There are pros and cons to this provision, just as there are good and bad annuities. It should come as no surprise that insurance companies are strongly supporting this rule change as it will likely open up a large new marketplace for their annuity products. This has led many to worry about what kind of costly annuity products might make their way into retirement plans, as Tara Siegel Bernard writes at the NY Times. However, there is hope this could lead to more low-cost, fixed income annuity options becoming available to retirement plan participants, as we are seeing firms like BlackRock looking to enter the space.

Year of Birth/Adoption Expenses - If you take money out of your retirement plan before you reach age 59.5, you are generally subject to income tax on that distribution, along with a penalty tax of 10%. There are a number of exceptions to that penalty, but the SECURE Act would add an exception for up to $5,000 of costs related to the birth or adoption of a child.

This is another small change that will impact a number of people. Having a child and adopting a child are both huge financial burdens and allowing people to use money they have saved for retirement to cover these costs without penalty makes sense. While we would rather see people build a cash reserve outside of retirement accounts to cover these expenses, that is not always possible for everyone.

Expanded Use of 529 Accounts - Distributions from 529 plans are tax-free, if used for qualified education expenses. Last year's tax reform bill expanded the definition of qualified education expenses to include "up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school." The SECURE Act would further expand the use of 529 distributions to allow them to be used to repay student loans and apprenticeships.

It seems odd that you weren't already allowed to pay off student loans with 529 accounts, since the loans were for qualified education expenses in the first place, so this is a welcome change. An earlier version of the SECURE Act also included a provision that would allow 529 accounts to be used towards homeschooling costs and supplies for students in grades K-12, but that was removed before final passage. It appears this change could be the cause for the current holdup of the bill in the Senate, so it's possible that could get added back before the bill is passed.

The overall goal of this legislation is to improve our current retirement system and to broaden access to retirement savings accounts. The House bill includes 29 updates to the retirement system, many of which will have broad-ranging consequences. We will continue to monitor the progress of this bill and will provide an update if it is eventually passed into law. We've already begun considering planning strategies that might be advantageous given some of the different provisions of the bill, but for now we just want you to understand what changes could be coming as we wait to see what happens.

-Chris Benson, CPA/PFS

The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.