Congress may be on the verge of enacting the most significant overhaul of retirement policy in more than a decade. The Setting Every Community Up for Retirement Enhancement Act (SECURE) has passed the House and appears likely to win Senate and White House approval.
Supporters of SECURE say it provides long-overdue policy updates that will make it easier for Americans to save for retirement. But is SECURE all that it’s cracked up to be? Yes, it would make a handful of changes to the retirement saving landscape. But most of the new policies are relatively benign — except for a controversial provision that deals with stretch IRAs.
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Billionaire Warren Buffett famously chooses his breakfast at McDonald's every morning based on how promising the day seems. If things look promising, he'll splurge for a bacon, egg and cheese biscuit. And if they don't, it's two sausage patties. I've put together my own McDonald's-based scale to evaluate SECURE.
I’m going to use a numeric scale from 0 to 5. A 5 is like getting a Double Quarter Pounder with Cheese combo meal. At 2.5, it’s a Hamburger Happy Meal. A grade of zero means you end up having to skip the drive-thru altogether.
So, let’s get started rating some of the key elements of SECURE.
• Under current law, required minimum distributions (RMDs) from 401(k) plans and traditional IRAs generally must begin in the year you turn 70½. SECURE raises that age to 72.
Some proponents of this provision of the act think this is a significant change, arguing that the additional 1½ years of growth translates into meaningful savings before you tap the funds.
But in my experience, this time frame won’t create a significant boost in savings. What’s more, this provision will only postpone taxes for another 18 months. And RMDs from IRA and 401(k) generally only clock in at around 4% of your saving. By the time most of us reach age 70½, we are typically taking the RMDs to provide some of our retirement income.
My conclusion: It's a 2.5 on our scale for retirees and retirees-to-be.
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• SECURE includes a provision intended to ease the way for small-business owners to offer 401(k) plans.
The legislation gives small-business owners the option to band together to offer 401(k)s or similar plans. This provision is designed to persuade companies without retirement plans to begin offering them.
Both in my current professional experience and my previous experience as a small-business owner, these plans are already out there. And in the past 10 years, the cost to business owners to administer these plans has already begun to drop. I simply don’t see how government intervention is required on this issue.
My conclusion: This scores a 2 on our scale for employees of small businesses.
• The SECURE Act would encourage 401(k)-style plans to offer annuities.
Congressional proponents of this move believe it could help participants transform their savings balances into steady income for the rest of their lives. But investors can already take their retirement savings, roll it into an IRA and then buy annuity products from just about any financial services company. As a “government tailwind” for annuities kicks in, I could see even higher fees associated with these products, leading to a “cash grab” by the companies that offer them.
My conclusion: While not all annuities are bad, this provision gets a rating of a 1.
• Now, on to the most controversial and, in my opinion, the worst component of SECURE — the death of the "stretch" IRA.
For years, investors have been able to leave their IRA assets to a non-spouse beneficiary, who once the assets are passed to them, can then utilize the savings in a tax advantaged way. Using this setup, the mandated withdrawal period for the remaining account’s assets can be “stretched,” allowing the assets to grow sometimes for decades. This growth is possible because required minimum distributions (RMDs) are based on life expectancy. So, the younger the beneficiary, the lower the RMD amount each year, and the longer the IRA can stretch and grow over time.
SECURE would require that all of the remaining money must be taken out in 10 years or fewer. It can be taken in one lump sum or smaller chunks, but the entire amount must be taken in 10 years from the date of inheritance.
This provision is a hidden death tax.
Take these two examples for illustration.
Say you are in your 40s and inherit a million dollars from an IRA. Under the stretch rule and IRS calculations for RMDs, you would only have to take out $20,618 a year, or just north of 2%. This distribution won’t have a tremendous impact on your tax bill, and the vast majority of the money can continue to grow.
But consider the case of a 35-year-old who decided to wait until age 45 and take one lump-sum payment (which is allowed) under the new rule. Imagine that $1 million grew over the next decade to $2 million. Sure, this sounds like a good financial problem to have; however, because the entire $2 million would have to be taken at once, this creates extreme tax consequences.
The withdrawal would put this individual in the very highest tax bracket, at approximately 37% for federal taxes and 5.5% in Georgia state taxes. Add those numbers up, and she’s paying 42.5% of her $2 million in taxes, or $850,000!
Sure, our 35-year-old could take distributions steadily over the 10 years to lessen the tax burden, but under the current rules, this same 35-year-old could spread out the tax burden over decades.
My conclusion: This breaks our scales and actually goes negative. Skip the drive-thru, folks.
SECURE passed the House by an astonishing 417 to 3 votes. This count shows massive bipartisan support for SECURE. If the bill passes in the Senate, we’ll have new laws for retirement saving and for how our assets are treated once we pass away. Overall, SECURE is innocuous, but eliminating stretch IRAs seems to be nothing more than Uncle Sam reaching deeper into our pockets.
Wes Moss has been the host of “Money Matters” on News 95.5 and AM 750 WSB in Atlanta for more than seven years now, and he does a live show from 9-11 a.m. Sundays. He is the chief investment strategist for Atlanta-based Capital Investment Advisors. For more information, go to wesmoss.com.
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