The SECURE Act
Congress Refines Retirement Savings; for Better or Worse?
Setting Every Community Up for Retirement Enhancement Act of 2019, known as the SECURE Act, includes 29 features intended to increase access to tax-deferred retirement accounts to allow more people to save for retirement. Some of the most commonly discussed features include:
- Make it easier for small businesses to set up 401(k)s by increasing the cap under which they can automatically enroll employees in “safe harbor” retirement plans, from 10% of wages to 15%.
- Provide a maximum tax credit of $500 per year to employers who create a 401(k) or SIMPLE IRA plan with automatic enrollment.
- Enable businesses to sign up part-time employees who work either 1,000 hours throughout the year or have three consecutive years with 500 hours of employment.
- Encourage plan sponsors to include annuities as an option in workplace plans by reducing the employer liability if the insurer fails to meet its financial obligations.
- Extend the age at which retirement plan participants need to take Required Minimum Distributions (RMDs) from age 70½ to age 72.
- Allow the use of tax-advantaged 529 Plans for qualified student loan repayments (up to $10,000 annually).
- Shorten the life of an inherited retirement account by limiting the “stretch” to ten years instead of the currently-used life expectancy of the beneficiary.
More than 50 per cent of employees in the US work in small businesses, entities that currently are not required to provide 401(k) plans. These tax-deferred plans are governed by ERISA, which has complex requirements and large penalties for employers who do not follow the rules properly. That combination has naturally resulted in few small business owners being willing to offer retirement plans. Employees are free to set up their own Individual Retirement Accounts (IRAs), but IRAs “max out” at a much lower figure than 401(k)s.
The SECURE Act passed easily in the House with a vote of 417 to 3 in May 2019. It has not fared the same way in the Senate. As the Senate focused on other priorities before the August recess, the SECURE Act remains to be taken up. If the Senate makes significant changes from the version passed by the House, it will require committee hearings and a possible re-vote in the House.
The proposed changes to the rules on inherited IRAs are significant from the perspective of estate planning. These changes matter for the rules on inherited IRAs where the House and Senate take materially different views on a somewhat technical but important question for estate planning. In essence, tax shelters for inherited wealth could be reduced by limitations on the length of stretch IRAs in the SECURE act.
The Senate’s version of the SECURE Act is the proposed Retirement Enhancement and Savings Act (RESA). There is ambiguity between the wording of the House bill and the Senate’s bill on the issue of reducing the stretch out for an inherited IRA. House SECURE Act sponsors have proposed paying for part of the cost of their bill by changing the rules for stretch IRAs.
As the rules on IRAs currently exist, when a retirement account in inherited, the beneficiary must immediately begin to take RMDs. However, the withdrawals from an IRA can typically be stretched over the expected lifespan of the recipient, if conditions are met. It seems probable that the SECURE act would cut this implicit tax benefit used by estate planners, and shorten the life of an inherited IRA such that the funds must be withdrawn, with income tax paid, within 10 years of the death of the original IRA holder. This provision does not apply to spouses, who are treated more favorably.
Focusing only on this aspect of the SECURE Act, it is not surprising that it has such overwhelming support in the House. Requiring the beneficiaries of inherited IRAs to pay tax on the full value of the account within ten years of the death of the original owner of the account will certainly raise tax revenue. The SECURE Act could represent an implicit tax increase that may become law masked by the desirable aspects of increasing access to tax-deferred savings.