The Year-End Appropriation Bill and Your Retirement

Congress proved it could manage to impeach a president, keep the government’s lights on, and legislate important new policy this week. (The metaphor everyone always uses is walk and chew gum, which seems a low bar. It’s more like they argued and decorated a Christmas tree, which is what the 2020 Appropriations Act is: Everyone got to hang something on it for the holidays.)

Included in that appropriations bill, which became law on Dec. 20, are some big changes to the retirement system.

Most people saving for retirement probably will not notice anything all that different, but many near-retirees will, and if legislation works as hoped, some workers could see a big upgrade in their retirement plans. On the flip side, for those thinking about bequests, the “stretch” IRA is now a lot more rigid.

The Good: Later RMDs and More Opportunities for Workers at Small Businesses to Save for Retirement As I've written before, sliding back the age at which retirees must take money out of their traditional 401(k) or IRA accounts from 70.5 to 72 will make a lot of people happy. The extra year-and-a-half should be welcome on its face, and requiring distributions to start at a half-birthday has always been confusing.

Given how little controversy this attracted, it’s reasonable to expect that this change will be followed by more. The IRS is moving ahead with changes that will further reduce RMDs for most people, and Congress may further push out RMDs in the next retirement bill, as Senators Rob Portman and Ben Cardin have proposed.

The retirement package also contains provisions to help level the playing field between small employers and large ones. As Morningstar has written before, the U.S. defined-contribution system has evolved into two distinct segments: large-company plans, which are mostly established and robust; and small-company plans, which are often absent and are frequently weak even when offered.

This bill doesn’t completely solve the problem, but it tries to help small employers offer the kinds of retirement plans big employers already can by allowing unrelated employers to join a pooled retirement plan. The hope is that these plans will use economies of scale to offer better, cheaper investment options, and that these pooled arrangements will entice more small employers to offer plans. Further, the bill adds additional tax incentives for small employers to offer a retirement plan and to automatically enroll workers in it to further improve retirement security for workers at small employers.

The Bad: The "Pay For" Pulls Some Elasticity Out of Stretch IRAs Some of the retirement provisions cost the government money by (hopefully) increasing tax-deferred retirement savings and by offering new tax credits. To pay for this, Congress is ending the stretch IRA, which allowed most heirs who inherit a Traditional IRA or other defined-contribution account get a tax break by only requiring them to take distributions based on their life expectancy.

To raise about $1.5 billion a year over the next 10 years, Congress will now require most people, other than spouses or disabled children, to withdraw their inherited IRA balance within 10 years. These beneficiaries could defer the withdrawals for 10 years or take them incrementally, which might help keep them in a lower tax bracket. In contrast, under the old system, when a 40-year old inherited an IRA, his required minimum distribution was just 2.29% at the end of the year, based on his 43.6-year life expectancy. These changes mostly go into effect immediately, with a few exceptions.

As I’ve noted before, this change is in some ways a pretty brilliant revenue-raiser. The constituency that benefits from “stretch IRAs” generally does not know that it will benefit, and a $15 billion revenue-raiser is eventually going to get tapped for some other government spending. However, many people will need to rethink their bequest plans, given this new reality.

The Confusing: Will Congress Eventually go Further to Help People Address the Risks of Running out of Money in Retirement? One of the most controversial parts of this bill is a "safe harbor" to make it easier for retirement plan sponsors to include annuities in their plans by giving them some fiduciary relief from the prospect of the product underwriter having financial problems in the future. Consumer advocates have been worried about a potential proliferation of lifetime income products, while industry supporters have been celebrating.

Both sides think this provision does a lot more than it really does. It’s a necessary provision to assuage fears among retirement plan sponsors, but it probably will not open the floodgates for annuity products. To me, it raises a more serious question: Will a future Congress be more interested in ensuring that near-retirees can access institutionally priced insurance to guard against living an usually long time? Except for people who wish to live on a small percentage of their asset base, have a very large Social Security benefit relative to their needs, or have a very strong bequest motive, most people probably could use some lifetime income guarantee--perhaps a guaranteed minimum withdrawal benefit, or a deferred income annuity.

Congress could--and should--take the lead in setting policy here to encourage plan sponsors to offer transparent, easy-to-understand, and competitively priced lifetime income options. As it stands, Congress has cleared a few small hurdles out of the way with the safe harbor (and a few other technical fixes) for offering lifetime income in retirement plans, but has not set policy to ensure that the defined contribution system helps people convert savings into reliable retirement income that will last for life.