Feeling Insecure about the SECURE Act?
August 1, 2019 By Sage Advisory
by Andy Poreda, Research Analyst at Sage Advisory
After the SECURE Act passed quickly through the House of Representatives on May 23 with near-unanimous support, it has unfortunately stalled in the Senate. All signs point to Senator Ted Cruz (R-Texas) as the likely culprit. Cruz has voiced frustration over certain provisions that were removed, such as allowing individuals to use tax-advantaged savings in 529 college accounts to pay for home-schooling expenses, apprenticeships, and other educational programs. However, these provisions were stealthily removed at the last minute from the final bill, causing outrage among certain politicians, including Senator Cruz. Another group that has voiced disapproval, and in some cases – extreme frustration, has been the financial services community.
One area of contention is the safe harbor component of the SECURE Act, which was designed to increase the availability of annuities for retirees. Currently, when a retirement plan sponsor selects an insurer to offer annuities to its retirees, the plan sponsor is on the hook for any liabilities associated with an insurer’s inability to make guaranteed payments. Hence, many plan sponsors are reluctant to offer annuities at all, with only 12% providing annuities as a distribution option, according to a Callan 2019 Defined Contribution Trends Study. The SECURE Act’s safe harbor rule essentially frees plan sponsors of this liability if they select insurers that meet certain guidelines. Many critics have argued this rule essentially grants insurers a license to run away with people’s money. In their minds, annuity products are far too complex and costly, and therefore any benefit from the potential utility they could provide is completely eroded.
While we at Sage can understand this sentiment, we believe it’s important to provide retirees with annuity options, especially deferred fixed income products such as a Qualified Longevity Annuity Contract. A recent Transamerica survey discovered that the average 60-year-old has only $172,000 saved in various retirement accounts. In today’s low-interest-rate environment, $172,000 may not be enough to purchase an annuity that would provide a significant income stream, as $172,000 provides a 60-year-old female about $800 monthly in a single-life-only annuity policy. However, if that same woman withdrew the money from her 401(k) plan, she would likely run out of money sometime in her 80s, depending on the portfolio’s allocation and returns. The Society of Actuaries predicts that men have a 20% chance of reaching age 90, while women have a 32% chance. Therefore, we must enable individuals to pool life longevity risk, and as it stands now, annuities are the only viable option to hedge against a longer life. Limiting them would be a huge mistake.
The other big topic that has negatively swayed public opinion on the SECURE Act is the elimination of the “stretch IRA” provision. Current estate planning laws allow for individuals to pass down IRA accounts to their beneficiaries, who can then continue to accrue tax-deferred returns while being required to take out only minor distributions over their lifetime. The SECURE Act forces non-spouse beneficiaries to withdraw all funds within a 10-year period (though minor beneficiaries get 10 years after turning 18). The SECURE Act’s treatment of stretch IRAs would have resulted in a windfall of tax revenue that was intended to fund other SECURE Act measures; conversely, it would also adversely affect the wealthy – so it is no surprise that it is on the chopping block. President Obama unsuccessfully tried for years during his tenure to kill the policy, viewing it as a tax-break for the wealthy and their heirs. It’s likely that many individuals have factored in the provision when making their estate-planning decisions, and no one likes it when someone changes the rules midway through a game.
Aside from the fairness issue, the retirement situation in the United States is so disastrous for millions of people that we need to find ways to set up the average American for financial success in retirement. Since 73% of inheritance gifts total less than $50,000 (with only 2% being greater than $1 million, according to the Federal Reserve Board’s Survey of Consumer Finance), and because IRA accounts represent only a portion of inheritances, it is likely very few individuals will be severely impacted.
As might be expected, the bottom half of households ranked by wealth are only getting 3% of total inheritance transfers. These families represent those that are least set up for success financially in retirement, not the ones that are receiving large inheritances. Congress must attempt to be revenue-neutral on this bill and not add further to the national debt, so the IRA stretch provision ultimately seems like a reasonable casualty. Financial advisors will likely be able to help their clients adapt anyway, as there are other products readily available in estate planning. Life insurance products and charitable remainder trusts are also tax-deferred investments and may make more sense in the future depending on the situation. Changes in estate planning tactics will likely lead to Congress not fully realizing the anticipated $15.7 billion in tax revenue from elimination of the stretch IRA, but that will be an issue for them to figure out later when the dust settles.
According to the U.S. Government Accountability Office, 48% of Americans aged 55 and older have nothing saved for retirement. We are witnessing a crisis, and we need to act now. The SECURE Act may not be a panacea, but the myriad of benefits certainly outweighs the perceived negative effects. Hopefully the select few who still oppose the bill will try to instead focus on the positives, such as removing barriers for multi-employer 401(k) plans, implementing tax credits for small businesses to encourage 401(k) plan creation, and eliminating age limits on contributions to 401(k) accounts. The longer we wait, the more dire America’s retirement picture will become.
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