Text on screen: PIMCO Educational Presentation
"The SECURE Act: Key Provisions and Implications" with host John Nersesian
• The impact of the loss of the stretch IRA on heirs
• Retirement account contributions and distributions under new rules.
• New rules for employer-sponsored plans
John Nersesian: Hi, I'm John Nersesian from PIMCO’s advisor education team and we're here today to talk a little bit about The SECURE Act. As you probably know, there has been a lot of attention paid to The SECURE Act, which was signed into law at the end of 2019 and effective January 1 of 2020. We hope that the following summary of the SECURE Act will provide you with a basic understanding of the implications and help you direct any increase that you might receive.
So, preparing for a successful retirement is a crucial financial goal for many Americans.
Chart: A bar chart compares the probability males and females aged 65 of average health live to select ages. 55% of males have a chance to live to age 81 and 35% have a chance ot live to age 92; 65% of females have a chance to live to 81 and a 46% chance to live to 92. As a couple, 50% have a chance to live to 81 and 92.
An increase in life expectancy combined with rising health care costs a decline in traditional employer pension plans and other factors have all created a significant retirement savings crisis for many Americans. The SECURE Act, which stands for setting every community up for retirement enhancement was overwhelmingly passed by the House of Representatives earlier this year and was signed into law by President Trump on December 20th of 2019. The bill has been hailed as one of the most significant pieces of retirement reform helping to raise retirement preparedness for millions of Americans.
Now, the act includes four key components which we will dive into in greater detail.
Number one: The elimination of stretch IRAs for beneficiaries by requiring distributions within 10 years of the account owner's death.
Number two: An expansion of IRA contribution opportunities for older workers.
Third: A change in the required minimum distribution or RMD to allow for additional compounding.
And then finally an increase in retirement account access for workers by providing certain incentives to employers.
Let's take a look at these provisions in greater detail.
The first one we'll start with is the elimination of the stretch IRA.
Text on screen: Elimination of the stretch IRA - old rule: all non-spousal beneficiaries subject to required minimum distributions, exception for non-designated beneficiaries; new rule - most non-spousal beneficiaries must liquidate inherited retirement accounts by December 31 of tenth year after owner's death, applies to most accounts where owner died after December 31, 2019.
Now, the act includes many benefits for retirement savers, but this is a significant potential setback.
Spouses will still have the opportunity to take distributions from an inherited IRA, either over their life expectancy or the life expectancy of the original account owner. But now non-spouse beneficiaries will be required to distribute all inherited account assets. This includes traditional and Roth IRAs by the end of the 10 years, following the account owner's death.
Now, there are some exceptions.
Text on screen: Elimination of the stretch IRA - not impacted: current owners of retirement accounts, beneficiaries of accounts where owner dies prior to January 1, 2020, eligible designated beneficiaries, IRAs with non-designated beneficiaries; impacted - all other "primary" beneficiaries including minors that are not the child of the account owner, eligible designated beneficiaries who lose status, all successor beneficiaries.
That includes the account donor spouse, a disabled individual, those who are not more than 10 years younger than the IRA owner and minor children. And so, here are the significant implications:
Number one, this will obviously shorten the tax-advantaged compounding period that is traditionally afforded to inherited retirement account assets and this will limit future account balances that are available to fund retirement expenses for those beneficiaries.
Number two, while the potential benefit of a stretch distribution period for younger beneficiaries has been eliminated there may be an opportunity to plan for maximum benefit.
Now, while assets must be removed within the 10-year window there's no specific distribution schedule, which would allow beneficiaries the flexibility to time their largest distributions during their lower income years, which would subject those distributions to potentially lower marginal rates.
Third, because the distribution period has been compressed, required distribution amounts will be larger than before and this increases the beneficiaries’ taxable income, subjecting the amounts to a higher marginal rate. Now, please recognize that retirement account distributions are generally subject to a maximum ordinary income tax rate, currently of 37% but they are exempt from both the net investment income tax of 3.8% and the Medicare tax of 0.9%.
Next, conduit trusts – that's a tool that's often used for asset protection and RMD planning – now would face a very unusual situation.
Text on screen: Conduit trusts and how they impact new rules: trust beneficiary, trust distributions, training of IRA distributions and potential issues.
Where there are no required distributions in years 1 through 9, but a required lump sum distribution in year 10 to satisfy this new provision. This change could create significant unintended cash flow limitations and a very large tax burden in certain years.
Now, what do you do about it? Well, there are a couple of planning strategies that we've identified that investors should definitely consider with the help of their advisor.
Number one, they've got to revisit their beneficiary designation choices, particularly those who had named younger children under the assumption that their children would be able to take a distribution over a longer period of time.
Number two, investors are going to want to model their future RMDs to better understand the impact of that retirement income and the associated income tax impact of these distributions.
Third, investors should definitely reconsider their choice whether or not to contribute to a traditional IRA or a Roth retirement vehicle, both IRAs and 401Ks – when and if available. Now, while traditional account balances provide a benefit of reducing taxable income in the year of the contribution – Roth accounts, of course, provide tax free distributions later in life.
Next on the list: How about the Roth conversion that would allow the current account owner to selectively recognize income during the conversion year today at potentially lower rates, which would provide tax-free assets for their beneficiaries to distribute later on?
Text on screen: Convert to Roth IRA considerations: advantages and disadvantages. Strategy: account owner converts IRA to Roth IRA, paying the tax on behalf of the beneficiary.
The income limitation for Roth conversions, as you know, was eliminated in 2012 and that created a whole new planning opportunity for higher income individuals. Please keep in mind that there was a recent change regarding the Roth conversion opportunity. That's the re-characterization characteristic.
Previously investors were able to re-characterize a Roth conversion, essentially undoing that conversion to avoid the negative consequence of paying taxes on a larger amount and reinvesting moneys of a lesser amount. That re-characterization option is no longer available after TCJA.
Next, account owners should consider the qualified charitable distribution, the QCD, that was made permanent in 2015. It allows an individual over the age of 70 and a half who's facing RMDs to make a direct charitable gift of up to $100,000 in a single calendar year.
Text on screen: Consider qualified charitable distribution considerations: advantages and disadvantages. Strategy: added incentive for charitably inclined to make gifts from IRA.
This distribution would satisfy either all or a portion of their RMD, while avoiding the associated increase in income and that's particularly valuable for those who are electing the standard deduction which, as you know, was made higher – currently standing at $24,800 dollars for 2020.
The second key provision that we will now focus on, looks at traditional IRA contribution opportunities.
Text on screen: Age limit on IRA contributions removed
• Must still have earning income (or a spouse who does) – Expanded definition of "income" for contribution purposes (e.g. taxable non-tuition fellowship/stipend)
• Matches employer plans, Roth IRAs
• Anti-abuse rule when combining deductible post-70.5 IRA
• No change to tax deduction rules
So, we know that the act will repeal the current maximum age cap. It's currently at 70 and a half for contributions to traditional IRAs, which will provide additional retirement accumulation opportunities for those who are obviously still working at this age. This will match the current regulations in place for 401K plans and Roth accounts. These changes are beneficial and they come as life expectancies continue to increase and as workers continue to work and save for a longer retirement period.
The third key provision affects RMDs for the account owners.
Text on screen: RMD age increased to 72. Effective January 1, 2020, RMDs generally start in the year an account owner turns 72. A look at those impacted along the with advantages and disadvantages.
Qualified retirement accounts including 401Ks, pensions, traditional IRAs – are all subject to RMDs. Beginning in the year that the account owner turned 70 and a half – that's now increasing to 72 which will potentially ease the associated tax burden and allow for additional tax advantage compounding. The new age requirement would only affect those who have not reached the age of 70 and a half by December 31 2019. They are still subject to RMDs at age 70 and a half.
The fourth key provision is an increase in retirement account access for workers, essentially changes to the corporate retirement plan landscape.
Text on screen: Increased retirement plane access (changes for employer plans): more flexibility in allowing multi-employer plans and new provisions available to small employers.
So, the act intended to enhance current retirement savings opportunities for workers in a number of different ways.
First, it's going to make it easier for small businesses to work together to offer 401K plans to their workers and that will also provide tax credits to incentivize these firms to implement automatic enrollment features. The credit will range anywhere between $500 to $5,000 and will be available for up to three years.
Text on screen: Easier for part-time employees to participate in plans, comparing old rules and new rules.
Next, while employers were generally able to exclude part-time workers from participating in 401K plans, now the Act will require companies to make long-term part-time workers, defined as those who work more than 1,000 hours in one year or a minimum of 500 hours over three consecutive years. They'll now be eligible for retirement benefits.
Text on screen: Increased use of annuities: changes for employer plans. Lifetime income provisions: greater fiduciary protection for plan providers when selecting annuity providers for a plan, plans must provide a lifetime income disclosure, in-service distributions of annuity contracts now allowed.
And then finally, the Act will allow an increased use of annuities inside 401K plans by reducing plan sponsors fiduciary risks under ERISA, that is generally associated with these products. That will certainly increase annuity usage and may help to provide guaranteed lifetime income for future retirees.
Text on screen: Pimco.com/advisoreducation
Includes: White papers and blogs, Resources to use in your practice, On-demand Continuing Education (CE), Comprehensive Curriculum outlining offering
So, in conclusion, retirement preparedness remains a top priority for many Americans and a challenge as well. The SECURE Act provides many compelling changes to help savers prepare for a successful retirement experience.
Our team stands ready to help you. We've prepared an article that has been posted on PIMCO.com that we would love to make available to you and we're glad to take your calls directly. If you have certain questions or client opportunities that you'd like to discuss with us please feel free to contact your local PIMCO account manager for additional information. Thanks so much for joining us!
Text on screen:
Key Takeaways: Advisor Action Steps
• Review all retirement account beneficiary designation for appropriateness
• Evaluate the true impact of the lost Stretch IRA
• Have IRA owners consider Roth conversions, life insurance or other ways to mitigate new rules
• For clients turning 70.5 in 2020, considering turning off automatic-RMD payments
• Remind clients that QCDs are still available at age 70.5
• Review new employer plan rules with business-owner clients
Chart: A line graph looks at retiree healthcare cost estimates as they increase over time from 2006 to 2019. A 65-year-old couple retiring in 2019 is estimated to need $285k to cover healthcare and medical expenses throughout retirement.
For more insights and information visit pimco.com/advisoreducation
PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
All investments contain risk and may lose value.
These materials are being provided on the express basis that they and any related communications (whether written or oral) will not cause Pacific Investment Management Company LLC (or any affiliate) (collectively, “PIMCO”) to become an investment advice fiduciary under ERISA or the Internal Revenue Code, as the recipients are fully aware that PIMCO (i) is not undertaking to provide impartial investment advice, make a recommendation regarding the acquisition, holding or disposal of an investment, act as an impartial adviser, or give advice in a fiduciary capacity, and (ii) has a financial interest in the offering and sale of one or more products and services, which may depend on a number of factors relating to PIMCO (and its affiliates’) internal business objectives, and which has been disclosed to the recipient. These materials are also being provided on PIMCO’s understanding that the recipients they are directed to are all financially sophisticated, capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies. If this is not the case, we ask that you inform us immediately. You should consult your own separate advisors before making any investment decisions.
These materials are also being provided on the express basis that they and any related communications will not cause PIMCO (or any affiliate) to become an investment advice fiduciary under ERISA or the Internal Revenue Code with respect to any recipient or any employee benefit plan or IRA because: (i) the recipients are all independent of PIMCO and its affiliates, and (ii) upon review of all relevant facts and circumstances, the recipients have concluded that they have no financial interest, ownership interest, or other relationship, agreement or understanding with PIMCO or any affiliate that would limit any fiduciary responsibility that any recipient may have with respect to any Plan on behalf of which this information may be utilized. If this is not the case, or if there is any relationship with any recipient of which you are aware that would call into question the recipient’s ability to independently fulfill its responsibilities to any such Plan, we ask that you let us know immediately.
The information provided herein is intended to be used solely by the recipient in considering the products or services described herein and may not be used for any other reason, personal or otherwise.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the current opinions of the manager and such opinions are subject to change without notice.This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2020, PIMCO
Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626.