Part one of a two-part series on SECURE’s new retirement regulations.
The U.S. Congress loves warm and fuzzy acronyms. But it’s the fine print that counts, not the name of a particular piece of legislation.
Just as the Affordable Care Act (ACA) made health insurance more expensive, the SECURE Act — that’s the Setting Every Community Up for Retirement Enhancement Act — will make the future more insecure for many retirees and their heirs.
Insurance companies will certainly benefit, as the new law encourages employers to add annuities to their 401(k) plans. The benefit of annuities is that they can provide guaranteed income throughout a person’s lifetime, which is important, because Americans are living longer and many are likely to outlive their savings.
However, most financial experts consider annuities to be a bad investment, as annual fees for a variable annuity are between 2.18% and 3.63%, depending on the product and features selected, according to Morningstar.
That far exceeds the fees participants in the largest 401(k) plans pay for investments and administrative services. Fees fell from an average of 0.34% of assets in 2009 to 0.25% of assets in 2016, according to BrightScope and the Investment Company Institute.
As insurance companies gain greater access to sell annuities through 401(k) plans, participants may be more exposed to sales pitches for products that may not be in their best interest, Andy Panko, owner of Tenon Financial LLC, told Forbes.
Though traditional pension plans typically are set up as annuities, offering lifetime payments, annuities are currently available in only 8% of 401(k) plans administered by Vanguard Group.
Many companies have been reluctant to offer annuities, because of potential liability if the insurer selected fails to pay claims. SECURE protects employers from being sued if they follow certain procedures.
“Currently,” according to MarketWatch, “employers hold the fiduciary responsibility to ensure these products are appropriate for employees’ portfolios, but under the new rules, the onus falls on insurance companies, which sell annuities, to offer proper investment choices.”
Shrinking the Stretch IRA
There are some clear benefits to SECURE, which The Wall Street Journal called, “the most significant changes to the nation’s retirement system in more than a decade.”
But to pay for its estimated $16 billion cost, Congress eviscerated the stretch IRA. If, like many Americans, you planned to pass your savings on to your heirs through an Individual Retirement Account (IRA), think again.
Stretch IRAs enabled investors to pass assets on to heirs and allowed heirs to spend the assets over their entire lifetime without additional tax implications. Now heirs will be required to shut down inherited IRAs and pay any taxes due within 10 years. They will not be required to take minimum distributions during that time, but cashing out an IRA all at once can result in a hefty tax bill.
The stretch IRA was ideal for middle-class investors, as it could be set up easily, without an estate-planning attorney and without creating a trust to hold assets. You could invest money in a Roth IRA and let it accumulate earnings over your lifetime, then you could pass it on to your heirs and they could continue to allow earnings to accumulate over their lifetime without paying taxes on them, even when they take distributions.
Alternatively, if you invested in a traditional IRA, your heirs would not have to pay taxes until they distributed income from the IRA.
Now, even if you’ve already established an IRA to plan a legacy for your children, you will not be grandfathered in.
Given that the federal deficit this year is about $1 trillion, $16 billion in revenue is practically equivalent to a rounding error.
In an effort to encourage more Americans to save for retirement, Congress is punishing those that already have been saving for retirement by taking away their legacy.