Insights

Fixing the Retirement Income Crisis - Winners and Losers

May 29, 2019

It’s no secret that many Americans are struggling to save for retirement. A recent survey conducted by the Federal Reserve found that one-quarter of working respondents had no retirement savings or pension at all. Among those who have some type of self-directed account, like an IRA or 401(k), sixty percent indicated a low level of comfort making investing decisions with their savings.(1)

Congress to the rescue!  
On the same day the Fed released its survey, the House voted overwhelmingly for a bill called the Setting Every Community Up for Retirement Enhancement Act, or SECURE, for short. With the Senate working on a similar bill, most observers expect something close to the SECURE bill to be signed into law in a matter of weeks.

The legislation includes a few welcome changes – among them, allowing workers of all ages to make retirement plan contributions, extending the start date for Required Minimum Distributions (RMDs) from 70 ½ to 72,  and incentivizing small employers to set up 401(k) retirement plans. The changes are most likely to benefit those with ample savings who don't need their RMDs. There is a strong argument that they won’t do much for those with no savings or those who are confused about their savings options.

The bills’ backers are excited about provisions making it easier for 401k participants to convert their savings into a steady income for life. Until now, employers offering 401k plans have been reluctant to offer “lifetime income products,” otherwise known as annuities, out of fear of employee lawsuits should the annuity provider, typically an insurance company, fail to make promised payments. The SECURE act offers employers some protection in this unfortunate scenario.

An annuity’s promise of steady lifetime income comes with trade-offs. Inflation will diminish the value of a fixed payment over time. There may be significant penalties for taking early withdrawals or making other changes. More flexible annuities may be available, but additional features add new layers of fees, making annuities an expensive option compared to other investment vehicles.

To neutralize its tax revenue implications, SECURE also stipulates that IRAs inherited by anyone other than a spouse (or a beneficiary who has special needs or is the owner’s minor child) be liquidated within ten years of the owner’s death. (The Senate version mandates distribution within five years for inherited retirement assets exceeding $450,000.)

Current rules allow non-spouse IRA beneficiaries to “stretch” distributions over the rest of their lives, meaning smaller distributions to the beneficiary with a lower income tax burden in any given year. Requiring distributions within ten years of the original owner’s passing is meant to accelerate the government’s receipt of the associated taxes. It does so to the detriment of younger beneficiaries who will no longer have the option to enjoy a long-term payout from a tax-deferred asset. Our present value analysis shows that beneficiaries are likely to receive significantly less with a 10-year distribution window than they receive under the current “stretch” provisions.

The Score Card
1. Losers - Workers who are not saving now because they lack the funds, or perhaps because they don’t know how, not because they lack ways to save. Encouraging small businesses to offer 401(k) plans does not fully address this fundamental problem that looms ever larger.

2. Losers - Families with inheritable retirement assets who will lose an important estate planning tool, the stretch IRA.

3. Winners – The estimated 15% of all those between the ages of 70 and 80 who are still working. Also benefiting are those who can wait another year or two before taking required distributions.

4. Winners - Annuity providers who can sell their products to employers offering 401(K) plans that are currently estimated to hold $5.5 trillion.

5. Winners - The current chairman of the House Ways and Means Committee and his predecessor who are proclaiming a bipartisan “win.” Together, they have received support totaling $1.7 million from the financial industry over the last two years.(²⁾

 Wouldn’t we all be much better off if Congress turned its attention to fixing Social Security and Medicare?

Footnotes:

 1. Report on the Economic Well-Being of US Households in 2018  https://www.federalreserve.gov/publications/files/2018-report-economic-well-being-us-households-201905.pdf

 2.Richard Neal (Democrat) https://www.opensecrets.org/members-of-congress/industries?cid=N00000153&cycle=2018&type=C

    Kevin Brady (Republican) https://www.opensecrets.org/members-of-congress/industries?cid=N00005883&cycle=2018&type=C