The 2016 Retirement Landscape: 5 Predictions

"It's tough to make predictions, especially about the future," said Yogi Berra, the late baseball great.* But let's give it a try: Here's my forecast of the five most important stories that will unfold on the retirement beat in 2016.

No market predictions here: In my view, the smart retirement investor owns a well-balanced portfolio of low-cost index or exchange-traded funds, contributing in rising and falling markets. Instead, let's crystal ball pending changes in the rules of the road for retirement advice, interest rates, inflation, Social Security, and Roth IRA conversions.

Feel free to hold me to these predictions at the end of 2016--but keep in mind that "the future ain't what it used to be." Yogi also said that.

An End to Biased Advice The U.S. Department of Labor's (DOL) long-running effort to create rules requiring all investment advisors to put the best interest of clients first will be completed this year. Republicans in Congress failed to kill the so-called "fiduciary rule" for retirement-account advice by attaching a rider to the big tax-and-spending bill passed in December that would have prevented or delayed the DOL's final rule proposal.

The DOL is on track to release a final rule this year, and to implement it over the following two years. That will make 2016 a landmark year in retirement investing--assuming no further legislative roadblocks are thrown in the way. "Best interest" will replace the current vague requirement that an investment only need be "suitable" for a client.

The idea is to close loopholes that govern retirement-investing advice from banks, brokers, mutual fund companies, and insurance agents. In many cases, they currently can bill themselves as advisors when they simply are selling whatever products are in their own best interest--products with higher fees and risk and lower returns. The new DOL rule will mean investors won't have to figure this out on their own--anyone advising you will be required to keep your interests at heart by keeping costs low and protecting your savings from excessive risk.

The huge IRA rollover market, in particular, will see significant change in a fiduciary world. The new rules will govern any recommendation to roll money out of a qualified plan rather than leaving funds in plan as well as the investment advice provided once a rollover is completed. Concerns have been raised about the impartiality of rollover advice by the U.S. Government Accountability Office, the Financial Industry Regulatory Authority, and others.

Inflation Makes a Comeback Will inflation pick up enough to get seniors a raise in Social Security benefits for 2017? This year, the Social Security cost-of-living adjustment (COLA) remained flat due to unusually low energy prices, which have kept overall inflation rates down. The Social Security COLA is determined by a formula that ties it to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which doesn't reflect the higher inflation facing seniors due to healthcare costs.

Flat COLAs are rare, and this one created a potentially big problem for some seniors on Medicare. A "hold harmless" provision in federal law requires that no premium increase for Part B produce a net reduction in Social Security benefits. That means anyone already enrolled in Social Security this year (roughly 70% of Medicare beneficiaries) were protected from a large projected premium hike, leaving the remaining enrollees to shoulder the entire burden of rising program costs--a 52% Part B hike. Thankfully, that outcome was prevented by a Congressional fix.

Will inflation actually pick up in 2016? The Federal Reserve thinks so, and so does Morningstar. But some energy analysts think oil prices could fall further this year. The Social Security Trustees Report issued last summer forecasts a 3.1% COLA for 2017.

Rate Increases Will Benefit Retirees Retirees will begin to see light at the end of the tunnel on stubbornly low interest rates by year-end. They have been suffering through a near-zero-rate environment ever since the onset of the Great Recession--and returns have often been negative after inflation. But relief should be in sight by year-end--assuming the forecast of higher inflation holds up.

The Federal Reserve's decision last month to lift the federal-funds rate by 0.25% marks a significant turning point for retirees relying on fixed-income investments. The quarter-percent move alone won't bring relief; but if the inflation numbers head north, the Fed is likely to keep moving in the direction it has outlined--raising rates by about 100 basis points in the next year. At that point, retirees could start earning interest that would at least keep up with inflation. Over time, higher rates would also have a positive impact on the pricing of long-term-care insurance policies and perhaps income annuities.

A rising-rate environment will create challenges for bond investors, and target-date funds (TDFs), in particular, bear watching. TDFs have become the 800-pound gorilla of 401(k) investing, and they have higher bond exposure than at any time in recent memory, according to Morningstar data. The prospect of simultaneous stock market volatility and declining bond-fund values could make for a rocky year in TDF performance.

No Social Security Reform, Just Blather We won't see a serious policy debate about Social Security reform in a presidential election year. But we will get a high dose of blather from candidates about cutting Social Security benefits or even privatizing the program. The campaign season is young (hard to believe, isn't it?), but already we've heard some Republican contenders endorse higher retirement ages and means-testing. Others are calling for maintaining benefits for today's seniors but cutting them for young people.

All of these ideas would take us in exactly the wrong direction on Social Security.

Raising Social Security's full retirement age (FRA) sounds reasonable since we're all living longer. But it would be a de facto benefit cut, since a higher age lifts the bar for reaching full retirement age. (If you doubt this, ask why this move would count as a Social Security reform if it doesn't save the program money?) Moreover, a higher FRA would apply cuts in an uneven, unfair way. That's because longevity is rising mainly among affluent, better-educated Americans, so the benefit cuts would hit lower-income retirees hardest.

In addition, means-testing Social Security is a fuzzy concept. Benefits are determined by your lifetime earning history, so introducing an income test at retirement would be at odds with that structure. And Social Security already is means-tested through the bend points that determine benefit payouts. It is possible to adjust bend points further to target benefits for lower-income retirees. But if that is done at all, it should be done in the context of an overall expansion of Social Security benefits.

We can afford that easily by gradually raising payroll tax rates and lifting the cap on wages subject to taxation.

A Clampdown on the Backdoor Roth The backdoor Roth conversion is on the way out, so take advantage of it while you can. Probably not during this presidential election year, but if and when Washington gets around to major tax reform, the backdoor Roth will be on the chopping block.

Backdoor conversions make no sense in the context of the broader income-eligibility rules for IRAs. Joint filers who wish to contribute directly to a Roth are subject to an adjusted gross income limit ranging from $183,000 to $193,000 this year. But the sky's the limit for conversions--the so-called backdoor Roth.

A clampdown on the backdoor Roth would mean less near-term tax revenue for the government, since income taxes are paid at the time of conversion. Theoretically, it would generate more revenue down the line, since would-be-converted amounts would continue to grow in traditional IRAs, with taxes due at the time of withdrawal.

Roth conversions aren't right for everyone, but they can be very helpful as a way to diversify retirement holdings for tax purposes. Doing at least some Roth conversion makes sense--perhaps just enough to "top off" your tax bracket, if you can fund the tax liability from sources other than your IRA. Clampdown or not, it makes senses to plan based on what we know today, not on what might happen down the road.

*The quotation often is attributed to Berra, but it may actually have been Mark Twain or perhaps a Danish physicist. Regardless, it's true, no matter who said it.

Mark Miller is a retirement columnist and author of The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work, and Living. The views expressed in this article do not necessarily reflect the views of Morningstar.com.