In a rare showing of bipartisan cooperation in Washington, D.C., there is general agreement on both sides of the aisle that people need to be saving for retirement. On May 23, 2019, the House of Representatives passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act (the “Act”) by a vote of 417-3. The bill now heads to President Trump’s desk for his signature after the Senate approved it in a 71-23 vote on Thursday. The SECURE Act will usher in the most important changes to the retirement plan landscape in 13 years – since the Pension Protection Act (PPA) was passed in 2006.
Undoubtedly, the American workforce is facing a major retirement savings crisis. The bleak reality is that many people simply are not prepared for retirement. It is a complex problem, driven in part by a shift away from traditional pensions toward a do-it-yourself savings system. Reports indicate that 25% of Americans have no retirement options at their job and 42% of private sector workers don’t have access to a retirement savings plan. That is primarily because small businesses are hesitant or intimidated by offering either a 401(k) plan or some sort of payroll deduct IRA program. This is an issue of accessibility. People are living longer and working much later in their lives. The best way to get people to save is to offer a workplace retirement plan and, ideally, automatically enroll them in that plan.
The House version of the Act and its 29 new key provisions attempt to address the retirement savings crisis. A primary goal of the Act is to encourage employers that do not maintain retirement plans for their employees to set them up. It is a stepping stone to try to solve the looming retirement crisis.
Following is a summary of the key provisions of the SECURE Act.
Participation in Multiple Employer Plans (MEPs)
A primary goal of the Act is to incentivize businesses to put plans in place. One way it is doing that is by making it easier for small businesses to band together to offer 401(k) plans. This could potentially give small businesses access to lower cost plans with better investment options and lower administrative fees. The goal here is to try to expand small employers’ capability to offer some form of retirement savings to employees. One way is to permit unrelated employers to band together and participate in “open” multiple employer plans (MEPs), taking advantage of economies of scale and potentially reduced fiduciary liability. The Act further encourages small employers (100 or fewer employees) to establish plans by increasing an existing tax credit that helps offset plan start-up costs from $500 to a maximum of $5,000 per year for the first three years. The Act expands employers’ abilities to offer multi-employer plans (MEPs), as long as they have the same trustee, fiduciary, administrator, plan year and investment options. This provision will make it easier for small employers to sponsor a retirement plan and improve retirement savings.
Access to Retirement Plans for Part-Time Employees
The Act requires 401(k) plans to permit employees who work at least 500 hours but less than 1,000 hours in three consecutive 12-month periods to contribute to the plan. This provision allows long-term part-time employees to participate in 401(k) plans. This helps those Baby Boomers who continue in part-time work, instead of full time retirement, to further save for the day when they fully retire.
Lifetime Income Disclosure on Participant Statements
The Act requires inclusion of an estimate of the monthly amount a participant could receive as a single or joint life annuity, based on the participant’s current account balance. Basically, this means that benefit statements will now include a disclosure that would illustrate monthly payments a participant would receive if the total account balance were used to provide a lifetime income stream. This will help employees stay apprised of where they stand and what they need to do regarding retirement savings.
Penalty-Free Withdrawals for Birth or Adoption Expenses.
The Act allows individuals to withdraw up to $5,000 from their retirement accounts for expenses related to the birth or adoption of a child without the 10% early withdrawal penalty. This provision helps offset or cover costs associated with a new birth or adoption, as long as that distribution is made within a year.
Fiduciary Safe Harbor for Selecting Insurer to Provide Annuities.
Annuities are an investment that provides regular disbursements throughout a period of time in exchange for an upfront, lump-sum payment. Essentially, annuities provide a fixed and steady stream of income during retirement and can help prevent individuals from outliving savings. Many 401(k) plans do not offer annuities as a form of distribution to employees. One concern has always been that if plan fiduciaries select an annuity provider and the provider later cannot make payments under the annuity as anticipated, such fiduciaries could be exposed to liability under ERISA. Most 401(k) plans don’t offer the option to purchase annuities. The Act creates a safe harbor for employers, making them more likely to offer these plans.
If certain conditions are met, the Act would protect plan fiduciaries who select an insurance company to provide annuities in the event the insurer is unable to satisfy its obligations under the contracts. If a plan sponsor eliminates a guaranteed lifetime income investment as an option, the Act permits participants to transfer the investment to another plan or IRA. These changes will allow more annuities to be offered in 401(k) plans.
Increase in Automatic Escalation Cap in the Automatic Enrollment Safe Harbor.
The Act would raise the current 10% of compensation cap on automatic contribution escalation in the 401(k) automatic enrollment nondiscrimination safe harbor to 15%.
Increased Flexibility under 529 Plans.
The Act provides that parents can withdraw up to $10,000 from 529 plans to repay qualified student loans. Further, the Act allows 529 education savings plans to be used for apprenticeship program expenses.
Repeal the Maximum Age for Traditional IRA Contributions
Under the current law, for years there has been a rule that essentially discouraged retirement savings in IRAs for people who continued to work later in life. After age 70 ½, you could no longer contribute to an IRA. The Act repeals the maximum age for IRA contributions as long as the participants are still working.
Increase in Age When Required Distributions Must Begin
The Act would raise the starting age for Required Minimum Distributions (RMDs). It would require individuals to begin taking distributions from their retirement accounts after they turn 72, instead of the required age of 70 ½ under the current regulations.
Changes to the RMD Rules for Non-Spouse Beneficiaries
The Act makes significant changes to inherited retirement plans like 401(k)s, traditional IRAs and Roth IRAs. In the past, beneficiaries of these inherited accounts could typically spread the distributions out over their own life expectancy. This technique is known as a “Stretch IRA.” The Act would require the non-spouse beneficiary of a deceased participant to withdraw the balance in the decedent’s account within 10 years of death, with some exceptions. The 10-year requirement would not apply when the beneficiary is the surviving spouse of the participant, a disabled or chronically ill non-spouse individual or an individual not more than 10 years younger than the participant or minor children. For minor children, the 10-year requirement would begin once they reach the age of majority. In cases where the participant fails to name a qualified designated beneficiary, however, an IRA would still need to be fully distributed within five years of the participant’s death (when death occurs prior to the required beginning date for RMDs), which is consistent with the current law.
This provision is a revenue raiser; it ensures 401(k) plans and IRAs are not being used indefinitely as a tax-deferred vehicle by inheritors. This would escalate the depletion of inherited accounts for many large IRAs and retirement plans. The potential tax burdens of faster distributions of inherited retirement accounts will increase the need for proper estate planning and potentially more strategic Roth conversions during the life of the account owner, adding additional complexity to retirement and estate planning.
Potential Traps for the Unwary
Elimination of the stretch IRA is the most notable change for estate planning purposes. Specifically, retirement accounts payable to trusts are likely to be the area of most concern to estate planning attorneys.
The SECURE Act may result in unintended consequences when retirement assets are left in trust instead of directly to individual beneficiaries. Under the Act, some trusts may not meet the requirements for a payout over the beneficiary’s life expectancy. Even when a trust qualifies under current law, it may fail to meet the new requirements that would be imposed under the SECURE Act. This is because unless all of the beneficiaries are minor children or disabled or chronically ill individuals, the deferral will likely be limited to the new 10 year distribution requirement.
The one exception may be a conduit trust. This is by far the most prevalent type of IRA standby trust today, because it is guaranteed to qualify as a see-though trust. But this structure requires that all distributions from the retirement plan are immediately distributed to the beneficiary. As a result of this distribution requirement, inherited IRAs left to the disabled or chronically ill are often in the form of an accumulation trust instead of a conduit trust. In many cases, structuring the trust as an accumulation trust is essential so the assets do not exceed the means-test threshold, disqualifying individuals with special needs from public benefits and services. Additionally, few estate plans containing conduit trusts have contemplated a mandatory outright lump-sum distribution, or within 10 years to the beneficiaries. In fact, mandatory distributions tend to run counter to the grantor’s goals and objectives of the accumulation trust.
If the SECURE Act becomes law, it will be imperative to ensure that beneficiary designations, testamentary trusts or revocable trusts fully incorporate the implications of mandatory distributions within 10 years of death for beneficiaries.
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