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Lesser Known Provisions of the SECURE Act

Brent E Chavez

Lesser Known Provisions of the SECURE Act

What younger investors need to know.

The SECURE Act passed into law in late 2019 and changed several aspects of retirement investing. These modifications included modifying the ability to stretch an Individual Retirement Account (IRA) and changing the age when IRA holders must start taking requirement minimum distributions to 72-years-old.1,2

While those provisions grabbed the headlines, several other smaller parts of the SECURE Act have caught the attention of individuals who are raising families and paying off student loan debt. Here’s a look at a few.

Changes for college students. For those who have graduate funding, the SECURE Act allows students to use a portion of their income to start investing in retirement savings. The SECURE Act also contains a clause to include “aid in the pursuit of graduate or postdoctoral study.” A grant or fellowship would be considered income that the student could invest in a retirement vehicle.3

One other provision of The SECURE Act:  you can use your 529 Savings Plan to pay for up to $10,000 of student debt. Money in a 529 Plan can also be used to pay for costs associated with an apprenticeship.4

Funds for a growing family. Are you having a baby or adopting? Under the SECURE Act, you can withdraw up to $5,000 per individual, tax-free from your IRA to help cover costs associated with a birth or adoption. However, there are stipulations. The money must be withdrawn within the first year of this life change; otherwise, you may be open to the tax penalty.5

Annuities and your retirement plan. This might be the most complicated part of the SECURE Act. It’s now easier for your employer-sponsored retirement plans to have annuities added to their investment portfolio. This was accomplished by reducing the fiduciary responsibilities that a company may incur in the event the annuity provider goes bankrupt. The benefit is that annuities may provide retirees with guaranteed lifetime income. The downside, however, is that annuities are often the incorrect vehicle for investors just starting out or far from retirement age.6

The best course is to make sure that you review any investment decisions or potential early retirement withdrawals with your adviser.

Questions? Please don’t hesitate to contact us. (215) 766-7002, info@aeinvestmentsgroup.com

Citations
1 – Under the SECURE Act, your required minimum distribution (RMD) must be distributed by the end of the 10th calendar year following the year of the Individual Retirement Account (IRA) owner’s death. A surviving spouse of the IRA owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the IRA owner, and child of the IRA owner who has not reached the age of majority may have other minimum distribution requirements.
2 – Under the SECURE Act, in most circumstances, once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA). Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. You may continue to contribute to a Traditional IRA past age 70½ under the SECURE Act as long as you meet the earned-income requirement.
3 – forbes.com/sites/simonmoore/2019/12/23/if-youre-a-graduate-student-the-secure-act-makes-easier-to-save-for-retirementheres-how/#207d85d322ef [12/23/2019]. A 529 plan is a college savings play that allows individuals to save for college on a tax-advantages basis. State tax treatment of 529 plans is only one factor to consider prior to committing to a savings plan. Also consider the fees and expenses associated with the particular plan. Whether a state tax deduction is available will depend on your state of residence. State tax laws and treatment may vary. State tax laws may be different than federal tax laws. Earnings on non-qualified distributions will be subject to income tax and a 10% federal penalty tax.
4 – forbes.com/sites/simonmoore/2019/12/21/who-benefit-from-the-recent-changes-to-us-savings-programs/#4b86e86f6432 [12/21/2019]
5 – congress.gov/bill/116th-congress/house-bill/1994/text#toc-HCF4CC8DCF6E14B28968474EB935AB36D [05/23/2019]
6 – marketwatch.com/story/will-the-secure-act-make-your-retirement-more-secure-2020-01-16 [01/16/2020]. The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contact. Withdrawals and income payments are taxes as ordinary income. If a withdrawals is made prior to age 59 ½, a 10% federal income tax penalty may apply (unless an exception applies).

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

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The SECURE Act

Brent E Chavez

The SECURE Act

Long-established retirement account rules change.

The Setting Every Community Up for Retirement Enhancement (SECURE) Act is now law. With it, comes some of the biggest changes to retirement savings law in recent years. While the new rules don’t appear to amount to a massive upheaval, the SECURE Act will require a change in strategy for many Americans. For others, it may reveal new opportunities.

Limits on Stretch IRAs. The legislation “modifies” the required minimum distribution rules in regard to defined contribution plans and Individual Retirement Account (IRA) balances upon the death of the account owner. Under the new rules, distributions to non-spouse beneficiaries are generally required to be distributed by the end of the 10th calendar year following the year of the account owner’s death.1

It’s important to highlight that the new rule does not require the non-spouse beneficiary to take withdrawals during the 10-year period. But all the money must be withdrawn by the end of the 10th calendar year following the inheritance.

A surviving spouse of the IRA owner, disabled or chronically ill individuals, individuals who are not more than 10 years younger than the IRA owner, and child of the IRA owner who has not reached the age of majority may have other minimum distribution requirements. 

Let’s say that a person has a hypothetical $1 million IRA. Under the new law, your non-spouse beneficiary may want to consider taking at least $100,000 a year for 10 years regardless of their age. For example, say you are leaving your IRA to a 50-year-old child. They must take all the money from the IRA by the time they reach age 61. Prior to the rule change, a 50-year-old child could “stretch” the money over their expected lifetime, or roughly 30 more years.

IRA Contributions and Distributions. Another major change is the removal of the age limit for traditional IRA contributions. Before the SECURE Act, you were required to stop making contributions at age 70½. Now, you can continue to make contributions as long as you meet the earned-income requirement.2

Also, as part of the Act, you are mandated to begin taking required minimum distributions (RMDs) from a traditional IRA at age 72, an increase from the prior 70½. Allowing money to remain in a tax-deferred account for an additional 18 months (before needing to take an RMD) may alter some previous projections of your retirement income.2

The SECURE Act’s rule change for RMDs only affects Americans turning 70½ in 2020. For these taxpayers, RMDs will become mandatory at age 72. If you meet this criterion, your first RMD won’t be necessary until April 1 of the year after you reach 72.2

Multiple Employer Retirement Plans for Small Business. In terms of wide-ranging potential, the SECURE Act may offer its biggest change in the realm of multi-employer retirement plans. Previously, multiple employer plans were only open to employers within the same field or sharing some other “common characteristics.” Now, small businesses have the opportunity to buy into larger plans alongside other small businesses, without the prior limitations. This opens small businesses to a much wider field of options.1

Another big change for small business employer plans comes for part-time employees. Before the SECURE Act, these retirement plans were not offered to employees who worked fewer than 1,000 hours in a year. Now, the door is open for employees who have either worked 1,000 hours in the space of one full year or to those who have worked at least 500 hours per year for three consecutive years.2

While the SECURE Act represents some of the most significant changes we have seen to the laws governing financial saving for retirement, it’s important to remember that these changes have been anticipated for a while now. If you have questions or concerns, reach out to your trusted financial professional.

Have questions? Please contact us at (215) 766-7002 or info@aeinvestmentsgroup.com.

Learn more about Brent E Chavez, the Services We Provide, or Why Choose AE?

Citations
1 -waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/SECURE%20Act%20section%20by%20section.pdf  [12/25/19]
2 – marketwatch.com/story/with-president-trumps-signature-the-secure-act-is-passed-here-are-the-most-important-things-to-know-2019-12-21 [12/25/19]

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

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How do Income Riders Really Work?

Brent E Chavez

Hello everyone. This is Brent Chavez of Aequitas Equitas Investment Group. I’m coming to you from beautiful and historic Bedminster, PA. I just want to talk a little bit today about something that is very frustrating to me as an adviser, and has frustrated many investors and many people that have been in my office with these investments… and that is an income rider that is found on variable annuities and fixed indexed annuities.

They position these riders as if the individual is going to get a guaranteed return of six, seven, sometimes even eight percent. And the problem is that the average investor doesn’t realize what this guarantee actually means. What are they getting?

Well, I just recently came across an advertisement for a Transamerica variable annuity. It looks to the inexperienced eye, that you’re going to get 7.2% return guaranteed for 10 years. And in the advertisement it says: “Double your withdrawal base. For those looking for retirement income, Transamerica Retirement Income Max, available with the Transamerica variable annuity, delivers. Designed to be straightforward and flexible retirement income that can double your withdraw base in just 10 years.” Then big bold letters, it says: “More confidence, 7.2% compounding growth.” And again, if you don’t know what you’re looking at, it looks like man, they’re guaranteeing to double my money over the next 10 years.
But what really is that? What does that mean to you as the investor?

Well, you need to understand, it’s just a very expensive rider that the insurance company puts on to your principal that you initially invest with the company. And so, you end up having a cash value in your policy, and then you have a hypothetical amount in your policy – I like to call that your Monopoly money, because it’s not real. You could never withdraw that complete value no matter if you’ve been in the policy for 10, 20, or 30 years. It’s just really hypothetical numbers, not your real cash value. And so, the company rolls up this hypothetical number in your account over a 10-year period, and they guarantee they’re going to do it, in this case, at a 7.2% rate of return or doubling your money. But the reality of it is, your real cash value, most likely, will be much less. So if you say at the end of the 10 years, this contract is a 10 year contract, you want to walk away, you’re going to go to insurance company and you’re not going to be able to take out that guaranteed 7.2%… you will be able to take out your cash value instead. When you really dig in and look at what that means for individuals – again, it gets positioned that you can live on this guaranteed income no matter what happens in the market, you’re going to be able to have this guaranteed lifetime payment.

So, at first blush this may seem good to the investor, that they’re going to have this guaranteed payment, no matter what happens. But when you dig in and look at the math of what is actually happening… it’s not that great. So, if you have $100,000 for example, that rider is going to cost you a minimum of $1,350 a year. If you want to have it set up so that you have a joint life set up on this contract, well it’s going to be 1.45%. So, $100,000, you’re looking at $1350 a year for single life. You’re looking at $1450 for this rider on a joint life contract. Then, when you add in the fact that you again are going to pay, within the advertisement for this Transamerica annuity, you’re going to pay anywhere from .20 to 1.9% M&E fee on top of the 1.35 to 1.45, you’re going to pay an average investment fee for having deep investments, which are going to be mutual funds, within your annuity with their average investment cost being about 1%. So, you can have 1.45%, plus another 1% for your investment and you can have a 1.90, on top of that, the M&E fee. Also, there is a $50 policy fee a year. And so, you’re looking at 4.35%, to have this product.

So, you can imagine the returns that you’re going to need to get to be able to overcome all these costs that you have coming up out of the investment money. And then on top of it, with inside this advertisement it says that, that 1.35 or 1.45, is based on your hypothetical pile of money, your funny money pile. So that’s most likely going to be higher than your real cash value. And they mentioned that with inside the ad that your real money, your real cash value can be substantially less than your income rider pile of money. And so, you could be, as a percentage of your asset, paying a substantially higher amount than 1.35 or 1.45, and contractually they can increase that 1.35 or 1.45 an additional .75 during the life of you having this investment with them. So, you could have 1.35 to start and then they come in and add .75… so now your income rider is a 2.1, we get into a bear market, your value of your portfolio goes down by 30%. And so, you could see you could be at 2.5 or 3%, just with this one rider.

Then say everything goes great. You get through the 10-year period and your money income value is doubled – you gave them $125,000; you have $250,000 sitting in this variable annuity. Well, now here comes the second part of the payout to you. So now, at that point, if you’re age 64 and you want to start this income for life, you get a 4% payout. If you’re 69 you get a 5.25% payout. If you are 74, you get a 5.4% payout. And on and on, up until 80, which is the max, and that is a 5.75 withdrawal rate. And, your joint life withdrawal percentages are lower – so you pay more for the rider and you get to withdraw less. But we’ll just use the example of that first one or two withdrawal percentages.

So, you have a benefit base of $250,000, you gave them $125,000. So, we’ll just say for argument’s sake, your cash value is $200,000 – and I’m probably being liberal by saying you’ll have $200,000 in this type of investment after 10 years, because that would mean you’d have to net a 4.8% return. And again, you could have up to 4.3% just in fees on this product. So, I think it’s very liberal to say you could have $200,000 in this particular investment.

So, you have $250,000 – and by the way, that income rider you’re paying is on the $250,000 not the $200,000 you have in cash value – and they start a payout on that $250,000 at 4% single life… that would be $10,000 that they would pay you a year.

Okay, so now let’s do some math. So, if you were to take that 4% payout, or $10,000, how long could, if you took that money, if you took your $200,000, stuck it under the mattress and just paid yourself that guaranteed income rate? Well, $200,000, again, divided by the $10,000 that they’re going to be willing to pay you, is a 20-year payout. So, you could go take your money, stick it under your mattress and pay yourself, and not pay 1.35% to do it, 20 years. Now if you can just add a 4% return over 20 years, guess what? You could pay yourself that income, that same guaranteed amount for 20 years, and still have $200,000 under your mattress.

Well, let’s look at if you were 69 and you started to take a withdrawal payment out. Well, you could take out of that $250,000 benefit base, you could take $13,125 out. And so again, if you were to just have $200,000 in your account and do the math and you divided by that $13,125, they will pay annually to you, you could pay yourself that money for the next 19 years. So, you’re 69, you add the 19 years that you can pay yourself, that takes you to 88. Again, if you could just get a 5.25% return over the next 19 years with that same $200,000… you could make those same payments to yourself and have the $200,000 for yourself.

So, we see where we’re going here. And that’s if you don’t take any additional monies out of this policy. You have to remember when you do start this income payment, if you withdraw anything, this $200,000 that you have in cash value, when you need some of that, if you take any of that principal out, that’s going to lower that benefit base that they pay to you.

And, in fact, inside this advertisement they have that if you take out too much additional money out of your cash value or your real money pile, and this contract goes to zero because of that, you would then end this contract, your income would stop and the contract would come to an end. So, that’s another loophole that you have got to consider, another potential problem. What if you need a large sum of money? Well, at the very least, it’s going to affect the annual or monthly payout that they give you on this money.

So, we can see very quickly why this is something that you have to look at very closely. Maybe as an individual investor you want to feel warm and fuzzy about having a guaranteed income payment and making sure that you know you can always count on that. But, the reality of this is, and research is showing, that most people in retirement aren’t even spending what they have.

BlackRock had done some research. In Forbes magazine, March of 2018 there was an article titled: “Are retirees spending too little?” It said there: “Despite all the talk of a retirement crisis, BlackRock, the world’s largest asset manager, says it’s research shows that many retirees aren’t spending enough of their money. In fact, BlackRock says most current retirees still have 80% of their pre-retirement savings after almost two decades in retirement.”

And you can look and see all over the internet multitude of articles written about this matter that retirees aren’t spending their retirement money. In fact, they don’t even want to take RMD’s a lot of times. So, if they don’t even want to take RMD’s, do we really want to pay for a ridiculously high-priced rider to guarantee you some income payout for life? Again, that would be up to you, but I think there’s better ways to do this and much less costly ways to make sure that you have the right amount income or guarantee income that you would like to have.

And so again, you can see, this is something that a lot of people get caught up in and we just don’t want you as an investor to be fooled by what can seem to be guarantees of your principal and returns on your principal, when in fact they aren’t. This problem isn’t just in the variable annuity world, these withdrawal guarantee riders; we see them in the fixed indexed annuity world too, they’re just as bad. They will make it seem as if you’re going to get some guaranteed return on your principal, but actually it’s the funny money pile as I like to call it – a hypothetical pile of money, Monopoly money, and that the payouts are going to come from your actual cash value, which in most cases, are going to be substantially lower in the payout period. And again, they’re going to come with very expensive riders on the fixed indexed annuity side. With a fixed indexed annuity, the difference there is your principal base is guaranteed each year; where with a variable annuity, your principal has no guarantees. So that could add some nuances to how your money grows, how much money you have as a cash value base. But that’s again going to be individual or specific to the various contracts from the various companies.

So, we can see a very frustrating process, it can be very misleading, very tricky to understand what you have. But before you make that decision, please make sure you understand exactly what you’re getting, how you’re going to get paid out and then just think about the math. At the end, when you want to take this money out, really what does that mean to you? How long would your money last if you stuck it in a mattress? And in most of these contracts we see, whether it’s a fixed indexed annuity or a variable annuity, you could stick your lump sum under your mattress and get a payout from 16 to 22, 23 years without having to get a penny in return on your investment.

So again, I don’t think that it’s prudent to spend 1.35 or 1% or whatever the various charges are in the various products – they guarantee something that actuarily has been worked out in favor of the insurance companies – I don’t think that is a prudent thing to do with your hard-earned dollars when you factor in what just a 1% difference in return or cost can do to your retirement funds.

Well that’s it for today. In our future podcast, we’ll be looking at some differences between variable annuities and fixed indexed annuities, the pros and cons of both. In the meantime, if you have any questions feel free to reach out to me. We look forward to speaking with you again. This is Brent Chavez, coming to you from Aequitas Equitas Investment Group in Bedminster, PA.

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