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SECURE Act - Can It Help or Hurt Your Retirement?

| MoneyRates.com Senior Financial Analyst, CFA
min read
The SECURE Act is a new law designed to improve access to tax-advantaged accounts and limit the risk that older Americans might outlive their assets.

Retirement-plan-notebook-chartA new tax law called the SECURE Act gives Americans more choices about how to save and invest for retirement. Whether or not this is good news depends on how you use those choices.

The title of the SECURE Act is an acronym for Setting Every Community Up for Retirement Enhancement. It's not an instant cure for the retirement-saving problems millions of Americans have, but it takes some steps in the right direction.

Those steps include potentially increasing access to tax-advantaged retirement plans and acknowledging that careers and lifespans these days are often longer than in the past.

Though these changes are largely seen as good news, there is a controversial aspect to the law. The decision to allow an additional type of investment option for 401(k) plans pleased the insurance industry but raised concerns among others in the financial community.

Regardless, the SECURE Act is largely about choice. It doesn't force changes on people, but it does give them more options. So whether the SECURE Act is good or bad for your retirement savings depends on how you use those choices.

How the SECURE Act Impacts 401(k) plans

Much of the SECURE Act involves rules for 401(k) plans. Here are some of the highlights:

1. More workers may now have access to 401(k) plans

The tax-advantaged 401(k) plan is a retirement plan sponsored by employers. While the retirement savings that fund these plans largely come out of the paychecks of plan participants - that is, the employees - it also costs companies a fair amount just to offer these plans.

Some employers actively contribute money to these plans on behalf of their employees in the form of matching contributions or other contributions to employee account balances.

However, even companies that don't chip in on behalf of employee-retirement savings face fees for setting up and administering these plans. The effort involved in overseeing these plans and keeping employees informed about their choices drains organizational resources.

For small companies, these administrative costs are especially burdensome. There is a certain amount of cost just to get a 401(k) plan started. In addition, small companies may not have legal or human resources specialists who can spend the amount of time it takes to run one of these plans.

As a result, many small companies haven't been able to afford to start a 401(k) plan. The SECURE Act seeks to lower this cost barrier.

The SECURE Act allows small companies to pool their resources by participating in 401(k) plans that include employees from multiple companies. The hope is that, by sharing the cost and the administrative burdens, small companies will find it more cost-effective to offer a 401(k) plan to their employees.

How this will play out remains to be seen. It may fall to third-party financial firms to organize multi-employer 401(k) plans in which smaller companies can participate.

The key to whether this provision of the SECURE Act increases access to 401(k) plans in any meaningful way could be whether it is cost-effective or not.

2. Longer eligibility to participate in 401(k) plans

For years, age 70 1/2 has been something of a magic number under retirement-plan law. The SECURE Act changes that.

One of the changes under the SECURE Act is that retirement savers can now continue contributing to retirement plans past the age of 70 1/2 as long as they are still working. Previously, people had to stop saving for retirement once they reached that age.

This is significant because it allows people to better match their retirement savings with the nature of their careers. While most people may have retired by age 70 1/2, for people who choose to work longer, this change gives them the option of continuing to save for retirement as long as they continue to earn a wage.

3. Added time before 401(k) participants must take required minimum distributions (RMDs)

Another way the SECURE Act changes the significance of age 70 1/2 is that this is no longer the age at which people have to start taking RMDs.

Most retirement plans are designed for their balances to be drawn down over the course of a person's retirement. To encourage this, tax law requires people to start taking RMDs - essentially, forced withdrawals from a retirement plan - once they reach a certain age.

The SECURE Act raises that age from 70 1/2 to 72. This may seem like a subtle change, but it allows people to benefit from the tax-free investment growth of a retirement plan a little longer.

Raising the age at which RMDs start should slow down the pace at which people are required to draw down their retirement-plan balances. Besides prolonging the tax benefit of those plans, this may also help people better preserve their retirement savings.

Retirees are often uncertain about what to do with their RMDs. Because those distributions are designed to stretch over a typical retiree's remaining lifespan, the temptation is to spend the RMD amount each year. However, because lifespans vary and expenses may increase as more medical care is needed later in retirement, it is important not to spend down savings too soon.

By slowing down the pace of RMDs, the SECURE Act may encourage retirees to spend down their savings a little more slowly. That may prove valuable to their long-term retirement security.

4. Variable annuities may be added as plan options

The controversial part of the SECURE Act allows for a type of investment product called variable annuities to be offered as options on 401(k) plans. There is disagreement as to how good these products are for retirement-plan participants.

Annuities are products offered by insurance companies. You give the money to the insurance company to invest; and they pay it out to you in the future according to an agreed-upon schedule.

There are two types of annuities - fixed and variable.

  • Fixed annuities were already allowed as 401(k) options. As the name suggests, with a fixed annuity, the eventual payout is predetermined up front so you know what you will be getting.
  • Variable annuities are a new 401(k) option. With a variable annuity, the payout you get will depend on how well the investments made by the insurance company perform.
    This puts investors in the same position they are generally in with their retirement plans now, where investment performance makes a big difference in how much they will eventually get out of their plan balance.

Previously, variable annuities were not allowed to be used in 401(k) plans. The SECURE Act changes that.

Naturally, insurance companies that offer variable annuities are happy about the change. Other investment professionals have their doubts.

Without the guaranteed payout of a fixed annuity, it isn't clear what a variable annuity does for 401(k) participants that they couldn't already get from other plan investment options. However, variable annuities add another layer of expense.

As with all investment choices, this comes down to taking a close look at the specifics. If you are considering a variable annuity in a 401(k) plan, take a close look at the expense it will add compared to other plan options - then ask whether the variable annuity offers any unique benefits that are worth that expense.

How the SECURE Act Impacts IRAs

In addition to the changes to 401(k) plans, the SECURE Act will also affect individual retirement arrangements (IRAs).

Some are the same as for 401(k) plans: The SECURE Act allows a person to continue contributing to an IRA past age 70 1/2 as long as they are still working. It also allows them to delay taking RMDs until they reach age 72.

However, the SECURE Act also impacts what happens when someone other than a surviving spouse inherits an IRA. In these cases, the SECURE Act eliminates what were previously known as stretch IRAs.

Previously, if someone other than a surviving spouse inherited the IRA, the beneficiary had the option of taking distributions from the plan over their lifetime. Thus, some of the tax benefits from the IRA could stretch beyond the original owner's lifespan and through the lifespan of the inheriting beneficiary.

Now, though, someone other than a surviving spouse who inherits an IRA will have to take all the proceeds of that plan within ten years. This tighter distribution window accelerates the tax consequences for the beneficiary.

If you are inheriting a sizable IRA and you are not the surviving spouse of the IRA's original owner, you should work with a qualified financial planner to figure out how to handle the tax consequences. The best approach will depend very much on your individual situation, including age and income.

Retirement Planning: What to do because of the SECURE Act

A general theme running through some of the SECURE Act's changes is an acknowledgement of the modern work environment - longer careers, longer lifespans and more small employers.

If you have planned your retirement savings on a retirement calculator, the passage of the SECURE Act means you should rerun those calculations. The ability to contribute to a retirement plan longer if you continue to work past age 70 1/2 and the ability to delay taking RMDs could meaningfully change your retirement-saving projections.

On its own, the SECURE Act is not a cure for the retirement-saving problems facing many Americans. However, by creating a little more flexibility, it does give retirement savers more options for how to approach those problems.

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