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As a somewhat surprising end-of-year move, the SECURE Act was attached to a government funding bill. Why this is surprising isn’t because the bill was passed, but that it got passed this year after some major backlash.
This past summer, it looked like the SECURE Act’s passage was all but a foregone conclusion after flying through the House with a 417-3 vote. While most of the bill’s focus is how the annuity provisions and required minimum distribution rules will impact retirees, a lot of features in the SECURE Act will also impact young savers and investors.
Let’s start by looking at the initial backlash and why this will impact younger savers. As Steve Parrish, Co-Director of the Retirement Income Center at The American College of Financial Services put it “if all ships rise with the tide, this new law should help young savers re-think their financial priorities. The SECURE Act is the first major retirement legislation since the 2006 Pension Protection Act. The attention it will provide Americans concerning retirement crises will hopefully spur more young savers to think about their own retirement.”
However, all attention to it has not been positive. After passing the House in the summer of 2019, a handful of prominent news articles in The Wall Street Journal and other publications attacked certain provisions of the SECURE Act as a backdoor tax increase. In reality, it’s true. One of the main parts of the bill modifies the so-called “stretch” tax provisions that allows inherited IRAs to be stretched out over the lives of multiple beneficiaries. The rule’s modifications, which you can read more about here, serve as a big tax revenue source for the government.
The tax increase doesn’t impact everyone evenly. In fact, the tax increase and revenue will mostly come from those who inherit retirement accounts, not from the account owners themselves. Essentially, the tax bill will be paid by heirs in the future when they withdraw money out of inherited IRAs and 401(k)s over a now-condensed 10-year period.
By shortening the time period an heir has to take required minimum distributions, the government reduced the long-term tax benefits of inheriting an IRA and will cause larger taxable distributions, likely increasing a beneficiary’s tax rate.
While these changes tend to be negatives for young savers who might inherit retirement accounts in the future, the bill also has a few positives for young savers. The SECURE Act creates a new early withdrawal penalty tax exemption of up to $5,000 from an IRA to use for childcare costs in the year after adopting or the birth of a child. While I’m usually against adding more ways to tap into retirement accounts early as it leads to less retirement savings, this provision allows the saver to pay back the money and help parents with the high costs of caring for new children.
In the past, certain types of income like non-tuition stipends and fellowship money didn’t count as compensation for purposes of IRA and Roth IRA contributions. Now, those receiving these stipends could qualify to save money in an IRA or Roth IRA. If this is their only income, a Roth IRA would be a better savings vehicle since the student’s tax rates will be so low, there’s minimal value in an IRA deductible contribution for income tax purposes. Instead, after-tax money going into a Roth that could provide tax-free gain would be much more beneficial.
Another provision of the bill is set to increase the number of lifetime income options and annuities inside of 401(k) plans. The insurance industry widely supports this because it eases the fiduciary requirement to vet insurance companies and products before adding them to a plan.
While there’s a lot of value for retirees to have annuities and guaranteed income sources, it’s unclear if we want young savers to contribute to annuities. In most cases, they’d benefit from staying in the market and focusing on long-term investment growth over security early in their careers. This could backfire, though, if young savers use these insurance products too soon in their careers.
Lastly, while much of the SECURE Act focuses on multiple employer plan provisions to increase the number of small businesses offering retirement plans, their impact is uncertain. I’m skeptical of their impact, although I hope I’m wrong because more small employers and employees need retirement plan coverage.
Two new tax credits were added to help small business owners offset the costs of setting up a new retirement plan and to encourage automatic enrollment. If these provisions work, it’ll be a big benefit for young savers as they’ll have more access to retirement savings, more automated savings and more companies offering plans.
According to Professor Parrish, “So often it is the younger worker who is part of the gig economy or who works for a small employer. The small company may now be more willing to offer a plan because of the ease of joining a multiple employer plan, the tax credit for auto-enrollment in the SECURE Act, and other provisions encouraging plan creation.” However, he also noted that initial attempts to spur on small employer retirement plans often hit a wall as “SIMPLEs and SEPs never took off as intended”.
While the SECURE Act has a lot of pieces focused on retirement income sources, Employee Retirement Income Security Act rules and retirees, the provisions could have a broader impact on young savers, too. However, as of right now, the true impact the bill will have on young savers is at best uncertain – some areas could even be viewed as a concern. The SECURE Act is likely to be in effect by January 1, 2020, so it’s time to start preparing now.