Big Changes to Your Retirement Plans: The Good, Bad, and Ugly

  • Small business employees, new parents and working retirees would benefit
  • Retirees could find it easier to create lifelong retirement income using 401(k) dollars
  • Heirs, however, are likely to pay more in taxes to make the cost impact neutral

The House recently passed a bill that contains some of the most significant changes for qualified retirement plans since 2006. The Senate is working to pass a similar bill that will mirror most of the House bill.

The new provisions provide benefits to those working on a full or part-time basis, as well as those nearing retirement.

However, in order to offset the revenue loss to the Treasury from the additional tax advantages contained in the new bill, certain rule changes have been drafted that upend current estate planning by eliminating tax advantages for inheritances and assets held in trust.

The following are some of the more important changes contained in the bill.

Employers can now offer annuities

Employers will now be able to add annuities to the list of approved investment choices for their employees. An annuity offers individuals an opportunity to convert the assets in their retirement into a stream of lifetime income, similar to defined-benefit pensions.

According to the Vanguard Group, only 9% of employers currently offer annuities as an approved investment selection for employees’ retirement plans.

Employers who select annuity providers would be insulated from liability, so employees who opt for this choice would have to conduct due diligence on their own.

Age cap for contributions changed

Under current law, those saving for retirement were prohibited from making any further contributions to their traditional IRA accounts, once they reached the age of of 70 1/2 years.

The new bill repeals the age cap, permitting those with taxable income to continue adding to their existing retirement savings accounts.

401(k) eligibility for part-timers

Most 401k plans require that an employee work 1,000 hours during a 12-month period as a condition of participating in the employer’s plan.

The proposed provisions provide a new standard for part-time employees. Those part-time employees who work a minimum of 500 hours in three consecutive 12-month periods would be allowed to participate.

Under the new rules however, the employer is not obligated to make matching contributions to the part-time employee and the employer could continue to impose an age requirement for enrollment in the plan to age 21.

Advantages for small businesses

Many who work for small businesses with relatively few workers have never had the benefit of participating in employer-sponsored retirement plan. It is estimated that approximately 42% of employees in the private sector don’t have access to a sponsored plan.

The new bill will make it easier for two or more employers to band together for the purpose of offering the tax advantages of a 401(k) retirement plan by increasing the tax incentives tenfold. The tax credit for new plans has been raised from the current cap of $500 to $5,000, and $5,500 for employer plans that enroll workers automatically.

The thrust of the proposed legislation is to make it much easier for getting small employers to pool together to provide plans for their employees.

For example, the new provisions eliminate the prior requirement that there be a “commonality of interest” between those businesses looking join together.

Additionally, the new rules allow small employers to establish open plans administered by “pooled plan providers” so as to reduce costs associated with plan administration.

RMD provisions

Under current law, individuals must take an annual required minimum distribution (RMD) from their IRAs or 401(k) plans once they turn 70 1/2.. The new rule changes the RMD age to 72.

This offers distinct advantages for those retirees who can afford to forestall withdrawals as their contributions would continue to compound tax-free for an additional 18 months.

Inherited IRAs

The new bill also contains substantial changes for those who receive the assets from a decedent’s IRA account. The new law requires those who inherit IRAs to liquidate the balance in the IRA account within 10 years from the death of the owner who bequeathed the account.

Existing law permits beneficiaries to stretch out an inherited IRA over their lifetimes, which provides the significant benefit of decades of tax-deferred compounding.

Under the proposed bill, after December 31, 2019 IRA beneficiaries, except a surviving spouse and minor children, must exhaust the account balance within 10 years of inheritance and pay any taxes due.

The proposed bill would require accelerate the amount of taxes owed and increase tax liability. The 10-year rule also would eliminate the creditor protection for IRAs held in a trust.

For some, this change enormously complicates estate planning and wealth transfer plans.

529 plans

Individuals with 529 education-savings plan will be able to withdraw a maximum of $10,000 for repayments of certain student loans.

Provision for new parents

Currently, individuals are assessed a penalty for early withdrawals from their qualified retirement savings plan. These tax disincentives are built into the retirement plan structure to dissuade those planning for retirement to use their accounts for spending.

The proposed bill makes an exception for new parents by allowing a penalty-free withdrawal of $5,000 from an IRA or 401(k) plan.

The withdrawal must be made within one year after birth or adoption. Parents would be allowed to recontribute the $5,000 amount indefinitely.

Those planning for retirement, particularly those with complex estate plans, should carefully review the new provisions and incorporate them within their existing retirement savings plans.