House Bill’s ‘Guaranteed Lifetime Income’ Good for Investors or Just Good Politics?
For all the talk of political gridlock in the nation’s capital, the House of Representatives has passed a bill meant to benefit investors. Could it make things better for savers like you? Let’s take a look.
On May 23, the House approved the most significant retirement-savings legislation in more than a decade. It’s called the Setting Every Community Up for Secure Retirement Enhancement (SECURE) Act of 2019. Here are the key provisions:
- More time in IRAs and 401(k)s. Push back the age for required minimum distributions (RMDs) from 70½ to 72
- Grant part-time workers benefits. Long-tenured part-time employees can contribute to their company’s 401(k) plan
- Boost small business 401(k)s. Small businesses can band together in group plans
- Push annuity adoptions. Encourages employer-sponsored 401(k) plans to add annuities as investment options—we have mixed feelings on this piece
Now that you’ve seen the highlights, let’s dive a little deeper.
Take RMDs Later
People who have money in 401(k) plans or other tax-deferred accounts would now get another 18 months before Uncle Sam requires them to take withdrawals. Currently, required minimum distributions (RMDs) must begin at age 70½; the new bill increases it to age 72. At the same time, the cap for contributing to traditional IRAs would also go from age 70½ to 72.
We think this is a great move, as that half year was confusing for many people. And while it’s just a short period, it also gives extra time to grow your investments before you have to start taking money out of your accounts.
How does the House propose to make up for lost tax revenue?
The new law would require people who inherit an IRA after Dec. 31, 2019 to withdraw the money within 10 years of the account owner’s death, along with paying any taxes due. (Surviving spouses and minor children are excluded.)
Under the current law, heirs can take the rest of their lifetimes to liquidate these accounts, an estate-planning maneuver known as the “Stretch IRA.”
Part-Time Work Counts
As part of the goal to get more people saving for retirement, the SECURE Act might help folks who don’t work full time.
The bill requires 401(k)-type retirement plans to let “permanent” part-time workers participate. To qualify, you need to have worked 500 or more hours a year for at least three years (there are 2,080 hours in the traditional 40-hour-a-week year).
While this may not help these employees earn enough of a wage to actually contribute, it is a great benefit for those who can afford to save, especially if their employer matches contributions or uses its retirement plan for profit sharing.
401(k) Options for Small Businesses
If the bill becomes law, small businesses will have the option to join group plans alongside other companies. This will lower administration and management costs and make it more likely for these companies to offer retirement savings benefits—ideally, it could bring costs way down and make higher-quality plans available to them and their workers.
Encourage Annuity Adoptions
The last provision is the one that seems to be getting the most coverage and the most enthusiasm from the bill’s sponsors: Pushing 401(k) plans to add annuity options.
The idea is that annuities will “solve” the problem of providing the lifetime income workers used to get from pension plans. With pension plans becoming a thing of the past, they argue that this is the next best thing.
We’ve covered variable annuities before, but let’s go over them again in the context of the SECURE Act.
Annuities convert retirement savings balances into lifelong income. Commonplace in pension plans, the vehicles are not as big in 401(k) plans. Currently, just 9% of employers offer annuities as an option in their 401(k)-style plans.
That may seem low given that 80% of 401(k) plan participants are interested in a “guaranteed lifetime income” option, according to the Employee Benefit Research Institute.
But annuities have some downsides: Fees are often high. There is also always a risk that their “guaranteed lifetime income” could turn out to be a mirage if the insurance company behind the annuity goes belly-up. It’s the fear that they could be left on the hook that has made many 401(k) providers steer clear of annuities.
The SECURE Act would give employers more protection if the insurer behind the plan’s annuities goes bust and stops making payments. If they’re less likely to get sued, employers will be more open to annuities, and plan participants will get the “guaranteed” lifetime income option that sounds so good.
The legislation absolves employers of liability if they opt for an insurer licensed by and in good standing with all states where the company has offices. It does not require employers to look at the insurers’ financial-strength rating, though.
Consumer advocates warn that the moves would leave 401(k) investors and plans alike open to more risk. As drafted, it would enable 401(k) plan sponsors to use high-cost, lower-quality annuity providers. And the draft legislation fails to adequately clarify that employers are still on the line legally for negotiating the annuity’s price.
If this all works as intended, it could help people manage their income in retirement more effectively. But this provision of the SECURE act could mean average investors are making high-stakes bets with their retirement savings on the ability of insurers to meet their long-term obligations or are stuck with high-cost annuities that are not a fit with their goals.
Are Annuities Really the Answer?
At Adviser Investments, we’re certainly paying attention to the growing ranks of U.S. retirees at risk of outliving their money. Annuities and their income benefits may be good for certain people, but we don’t typically recommend them as investments.
In fact, they aren’t really investments. They are insurance products geared toward investors seeking a guaranteed income stream. Purchase an annuity, and you sign a contract. Other than a brief “free-look” period when you can back out penalty-free, you’re bound to that contract until it expires.
The insurance aspect is where the term “annuity” comes in. You pay extra fees on top of those on the underlying investment. In turn, an insurance provider offers some level of guarantee on the value of your account and its future income.
The contract also usually restricts penalty-free access to your money for a specified number of years. Once you annuitize, the insurance company typically takes the full value of your account and you are promised a stream of reliable income for a set period or for the rest of your life.
The concept of annuities sounds great—guaranteed income in retirement! But the expenses and limitations can have a negative impact on your account’s return in the long run. The better wealth management strategy for most investors in our experience is to combine a more traditional retirement savings account with a separate life insurance policy.
Next Steps for the SECURE Act
Despite the sweeping bipartisan support for the House bill (it passed 417-3), it still faces some hurdles in the Senate.
The proposed legislation reverses part of the 2017 Tax Cuts and Jobs Act, which may meet with resistance in the upper chamber of Congress. Some Senators have also pushed for even more sweeping changes to laws related to retirement and education savings plans.
While the SECURE Act is not breezing through the Senate as quickly as expected given the tailwind from the House, lawmakers on both sides of the aisle have expressed optimism that it will eventually clear the Senate and make its way to the president’s desk.
We’ll be avidly watching the bill’s progress and determining the opportunities and pitfalls of any legal or policy changes for our clients. Stay tuned to Adviser Investments for updates.
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