The SECURE Act Is Here! What You Should Know. (before you buy that annuity)
MNice Investor talked about the possibility of the Stretch IRA going away with passing of the SECURE act back in June 2019:
RIP Stretch IRA (Maybe?)
SECURE stands for Setting Every Community Up for Retirement Enhancement. The accuracy of the name is debatable, unless you are selling annuities.
For many of you, SECURE will have little impact on your retirement. For the individual investor, here are the highlights:
Required Minimum Distribution (RMD) age moved from 70.5 to 72
Eliminating the Stretch IRA
More annuities options in your 401k plan
Raising the RMD age
Say what you want about the new act but increasing the age at which retirees have to begin cashing out their retirement plans will most likely not cause too many fireworks at the holiday dinner table. And the new age makes more sense, given we are living longer than we did in the 1960s, when the age 70.5 was established. From a planning perspective, it also makes the RMD age math easier. Celebrating a half birthday usually stops around age 4 or 5.
One major impact of this will be the ability to tweak taxes during the sweet spot years between retirement and collecting Social Security. A few extra years to make the most of the lower tax brackets will prove valuable.
Elimination of the Stretch IRA
One major negative of the new act for most retirees is the end of the Stretch IRA. This is what I wrote about last June. The Stretch IRA is called Stretch because it allowed the beneficiary to stretch out the taxable payments over their lifetime, possibly reducing, or at the very least delaying, their tax burden. Under the new rules the beneficiary has to take a full distribution within 10 years.
While extending the RMD age will most likely reduce tax revenue for the IRS, unless they change the IRS distribution tables, the elimination of the Stretch IRA will most certainly increase tax revenue.
With the government running such large deficits, looking for less-direct, less controversial ways of raising revenue may become more common.
The SECURE act also makes it easier for companies to include annuities within their 401k investment lineup. The use of annuities is debated so often is because the fees and commissions are considerably higher for annuities than other investments. This misaligned incentive often leads to annuities being sold, not advised. “Advisors” will spend copious amounts of time attempting to work annuities into a financial plan just for the higher fees, regardless of whether the annuity benefits the client.
The use of annuities in 401ks is even more debatable since one of the main benefits of an annuity is tax deferral and a 401k already has tax deferral. It is like having a muni bond in 401k, the tax benefit is redundant. You are paying for something you don’t need.
Like any tool, most annuities are neither good nor bad, they are just used for bad due to bad incentives. There are some people who don’t mind paying the higher fees for the features and guarantees offered by an annuity, just so they are aware of the tradeoffs for those things.
When I speak to someone who has already bought an annuity, they rarely were explained the opportunity cost of investing outside an annuity. To be truly advised, an investor has to be shown what the money could return without the high fees and limited investment options. They have to understand what they are getting and what they are giving up.
Much of the salesmanship around annuities is that they provide lifelong income and help avoid outliving your money. While this is true for an immediate annuity, it is often used to sell deferred annuities. Deferred annuities have been what we have been speaking about up until now.
Investors always have the opportunity to trade money for an immediate annuity stream at or in retirement; that is what annuitization is. Money does not have to be in a deferred annuity to be annuitized. Investors often roll 401k dollars into an IRA and then annuitize.
The question becomes, is the investor better off growing assets with normal 401k mutual fund fees of 0.35% or in a deferred annuity with fees of 3.5%? The answer may be the deferred annuity, but as the insurance companies start to tap a new and large revenue stream, I hope the employees are educated and truly advised to make wise choices.
Stay tuned to MNice Investor for more blog posts on what you should know about the SECURE Act!