Mike Barry – We’ve found broadly that there’s a large group of American workers that are not in retirement savings plans. The kind of vision of the policymakers at this point is we need to get everybody who’s got a job into a plan that defaults them into saving for retirement. And then if they don’t want to save for retirement, they can opt out. But we want to kind of set the default for everybody who’s getting a paycheck to saving for retirement. There have been different approaches to this. The mandatory approach is a proposal Congressman Neal is sponsoring right now, which is to require everybody that doesn’t have a retirement plan to adopt some kind of automatic enrollment. He’s got a bill to that effect. When the Obama administration came in, this was a kind of a headline retirement policy initiative was the auto IRA. To require nationwide if you didn’t have a retirement plan, you had to set up an IRA that people would be defaulted into saving into. This is the vision of covering the uncovered. The Republicans have opposed that, and at least in the way the current political situation lays, that’s not going to be advancing. We’ll see if maybe Neal can get some traction with his proposal. But the idea behind SECURE was to put things in that everybody would agree to. The idea behind a provider provided plan is one of the reasons that small employers, one of the things that’s stopping them from adopting these plans is they’re expensive. They’re expensive to set up, they’re expensive to administer. The theory is that a big provider provided multiple employer plan will provide economies of scale that it will allow them to deliver a retirement benefit kind of cheap where they don’t have to worry about filing the 5500, they don’t have to worry about running an ADP test. All they have to do is kind of hand out the literature and set up some kind of payroll withholding system that gets the money out of employees’ pockets and to the multiple employer plan provider.
Ben Jones – What I’m hearing you say is that the hope is that MEPs kind of expand coverage and access by reducing the barriers that smaller employers may have had to starting plan.
Mike Barry – Yes, although the idea should be to reduce the cost. And also, I think this is actually underestimated, the management attention that’s required to run one of these things.
Ben Jones – Open MEPs represent an opportunity for more employers than ever to offer retirement plans by leveraging economies of scale. The SECURE Act has another solution for small businesses looking to offer retirement plans in the form of newly expanded credits. It has increased a startup retirement plan credit from $500 to $5,000 and introduced a new credit for including auto enrollment provisions of $500 a year for three years. If you work with employers, you will want to bring these to the attention of your clients to potentially take advantage of these credits.
Emily Larsen – The next component of SECURE we’re discussing is lifetime income, which is getting a lot of publicity right now from insurance companies. The legislation requires providers to translate the participants’ account balance into a lifetime income. There are still a lot of details to come on how calculations will be administered, however, this should really help participants better grasp how much their income balance can produce over time and see how changing interest rates affect the cost of retirement income. Many plan participants also don’t have easy access to annuity options in their plan, and the SECURE Act expands the payout options by adding Safe Harbor for in-plan annuities.
Ben Jones – Why did the sponsors of this legislation feel that putting a lifetime income calculation on statements would be beneficial to participants? Because I think it cuts both ways, right? There’s participants that it might motivate to save, but there’s others that it will actually discourage from participating.
Mike Barry – I’m not sure I buy that it’s going to discourage people. I mean people may get discouraged, and I think people’s capacity to save more is overestimated. But it will send a necessary signal to people about how much income they can expect to get out of this pile of money that they’re accumulating. To me that’s useful information.
Ben Jones – It helps eliminate the wealth effect, where people see a big nest egg and think they have a lot of money. So let’s jump into the other half of this, which is the bill, allows for a Safe Harbor for in-plan annuities. Let’s walk through that.
Mike Barry – This is kind of dogged 401k plans for a while. The most obvious solution on hand right now for the payout challenge, we feel like we have the tools that we need to get people to save, but once they retire and they have to start taking money out, I think we are not very confident about the tools that we have. One of the major concerns is that most plans that aren’t sold by insurance companies don’t include annuity options. The annuity is a lifetime income solution. In fact, annuities will generally produce more lifetime income than any payout strategy. You won’t get a legacy off of it and net payments to you and your heirs may be less, but if your main concern is retirement income, a life annuity is probably the best solution for you. Sponsors have not wanted to put annuities in 401k plans out of concern that they would distribute an annuity to a retiring participant and 10 years later the annuity company would go bankrupt and the participant would come back and sue the sponsor, claiming that the sponsor picked an irresponsibly managed annuity company. The regulatory fix that SECURE adopts is they more or less defer to the state insurance regulators on the viability of a carrier. And more or less if the carrier is in good standing with the state insurance regulators, then the employer is no longer on the hook for determining the financial viability of the carrier that it selects to provide annuities in the 401k plan.
Ben Jones – There’s also the thought out there that employers will be able to use their economies of scale to drive down the cost of annuities in kind of this group or pooled environment. Do you see that being a significant benefit for employers who do take this on?
Mike Barry – Yeah, that’s part of the idea. Obviously, the employer has to start out with scale. Right now, if you leave a 401k plan you can buy an annuity. There’s nothing stopping you. But the retail annuity market, there are transparency problems. Seems like there’s a lot of carrying costs on that product. All of those kind of things could be engineered at scale in a way that would save participants money and make the annuity deal more attractive. That is certainly part of what is hoped for. This is kind of why I say that the mandatory lifetime income disclosure is more important than the annuity Safe Harbor, because it may create demand. Right now the biggest problem with getting annuities adopted in 401k plans is that participants don’t seem to like them very much.
Ben Jones – No one likes to give up the kind of flexibility of being able to access those dollars should they have a health scare or some other financial crisis.
Mike Barry – Yeah, the broad issue is labeled uncertainty. That’s one element of uncertainty is you might need this money. But the other element of uncertainty is you might die too soon and not get the value out of your annuity. My sense is that we still haven’t done enough work on the issue of payout to figure out what is the right solution to it. I don’t think we understand enough about participants’ spending patterns and what participants want from retirement income. And also, what’s a participants’ priority between leaving a legacy and having retirement income. I think it’s more complex than we think, and I think it varies a lot. For instance, if somebody doesn’t have any kids, maybe they don’t care about leaving a legacy at all. How do you get people in that context to make good choices for themselves?
Ben Jones – Retirement is personal and an individualized decision. You need to ask participants what they want in order to determine how to choose the best tools for their retirement income needs. For example, are they looking to leave a legacy, do they have a viable plan B for income like an old pension or rental property? What’s the quality of life that they’re expecting in retirement? Unfortunately, there’s no one size fits all solution. But as an advisor, you’re in a great position to help people optimize their options to achieve their objectives.
Emily Larsen – Another important piece of the SECURE Act is that the mandatory distribution age has been pushed back from 70 and a half to 72. This means that if participants don’t need to access their retirement accounts for cash flow needs, they can let those funds grow tax-deferred for an extra one and a half years before being required to start taking distributions. To pay for the change in RMD age, the SECURE Act also eliminates the current rules that allow non-spouse IRA beneficiaries to stretch RMDs from an inherited retirement account over their own lifetime and replaces it with a 10-year pay down period.
Mike Barry – The idea is that we want this rather than to be an estate planning tool, we want it to be a retirement income tool. So that’s why the exception for a spouse, for instance, and not a blanket exception for even children or designated beneficiaries. That was a pay for. I personally think short of a complete re-thinking of our tax policy here, that argument makes sense and it’s relatively easy to implement in a defined contribution context or an IRA context. The age 72 delay in the mandatory distribution annuity commencement date, as it’s called; I think that’s going to wind up in the articles in Money Magazine and the Wall Street Journal. I’ve at least had a couple of people that have no particular connection with retirement policy come up and say they heard this is going to happen and they were interested in it. That allows — I feel like that’s just kind of adapting to way we live nowadays, which is people are living longer and a lot of people are working long.
Ben Jones – These new RMD rules apply to people born July 1st, 1949 or later. They do not apply to retirement accounts inherited by a non-spouse beneficiary as a result of a death occurring on or before December 31st, 2019. Surviving spouse who inherits a retirement account of a deceased spouse will still be permitted to roll over the account into their own name and delay taking RMDs based on their life expectancy until they reach age 72. Distributions over the lifetime of a non-spouse beneficiary will also still be allowed if the beneficiary is a minor, disabled, chronically ill, or not more than 10 years younger than the deceased account owner.
Emily Larsen – Now, while this next item is not about retirement, we want to quickly talk about how the SECURE Act affects 529 plans. Under the SECURE Act up to $10,000 in student loan repayments can now be made using 529 plans. 529 plans have also been expanded so they can pay for registered apprenticeship programs as well as fees and supplies needed for participant. And importantly, these changes will be retroactive to expenses made after December 31st, 2018.
Ben Jones – This next component is a pretty exciting development for defined contribution plan design. SECURE includes an increased cap on automatic escalation contributions in a 401k. The higher cap is a long-awaited update to the original provision from the 2006 Pension Protection Act. I asked Mike for his thoughts on the change.
Mike Barry – I have to say I don’t think if you thought about it hard you could come up with a good reason for having a cap. Understand, this is a cap on escalating people’s contributions that they can opt out of whenever they want to. I guess the concern would be we don’t want somebody by oversight to get in trouble and not be able to pay the rent or something like that. So the cap was 10%. You start out at I think 3% is the place that you default someone in at, and then you ramp it up to 6%, typically. And then if you really want to ramp it up you can ramp it up to 10% the old law, and they increased that to 15%. There are many people who feel that the 3% and 6% savings rates, that’s not enough for an adequate retirement income and we need to be able to do higher, and that’s what lifting this cap does.
Ben Jones – I would just say I’m in the camp that you really do need to save double digits in order to fund retirement in a DC plan, and I think that obviously is painting everything with a broad brush and people have different situations. But in general, the average person probably does need to save double digits, and this goes a long way into making that possible.
Mike Barry – Yeah, there’s a lot of data in support of that. It’s conceivable that a majority of people in our business agree with you.
Ben Jones – One of the key goals of the SECURE Act is to make retirement savings the default for more people, and that includes part-time workers. Under SECURE, if you work more than 500 hours but less than 1,000 hours a year for three years, you now can be picked up in a plan. You won’t be getting matching contributions or counted for non-discrimination rules, but you will be in a plan for the purposes of contributions with any default contribution rate applying.
Mike Barry – When you go and look at who it is that’s not being covered by these plans, this is certainly a meaningful cohort of people. The people that aren’t getting in these plans are low paid people, are casual workers, are service industry workers, and a meaningful number of those are going to format out, profile out as full-time part-time.
Ben Jones – I think a lot of sense the nature of work is changing, right? We hear about the gig economy and a lot more people are choosing to have more flexibility in their work, and this is a nice way for them to still be able to participate in workforce retirement plans.
Mike Barry – This proposal sits right next to the problems with the gig economy. And also, frankly, the whole auto-IRA movement. The whole objective here is just getting more people in these plans.
Emily Larsen – The final provision we’re going to talk about is permanent non-discrimination testing relief for closed defined contribution benefit groups. Yowza. This one is a bit complicated, so we thought we’d let Mike give us the rundown and his thoughts on how SECURE is changing things.
Mike Barry – Something happens to your plan where you in effect freeze or take away benefits from some people but protect other people. Those other people are people, maybe they’ve got 10 years of service at the time of the change or maybe it’s everybody at the time of the change. Or maybe it’s more strict than that. But it’s a closed group. And at the time you make that decision to close that group and say this set of benefits is only going to this group over here, you pass what are a very complicated set of non-discrimination rules that apply. That group starts out non-discriminatory. There’s low paid people in it and high paid people in it. Over time typically in an organization some low paid people are going to get promoted, some low paid people are going to leave. The high paid people are stickier. After a while, that group starts to be discriminatory. The fix is not that we’re going to ignore any discrimination that’s taking place in this group, but that rather we’re going to allow the sponsor to apply the non-discrimination rules, what’s called a benefit spaces. So they look at the benefits that their employees are getting from the DC plan, projecting the value of contributions in those plans and turning them into an age 65 benefit rather than looking at those plans on a contribution basis, just how many dollars were going in each year. When you do that, typically your defined contribution plan will fix whatever non-discrimination problems you have left in this, for instance, defined benefit plan closed group that you have that’s aging into a more and more discriminatory profile. When you start projecting the value of defined contribution plan benefits it solves most of those problems.
Ben Jones – As you can tell, easy and accessibility are running themes in the SECURE Act, including opening up multiple employer plans, making lifetime income more transparent, allowing Safe Harbor for in-plan annuities, or providing more options for part-time workers to enroll in retirement plans.
Emily Larsen – Hopefully these changes will bring Americans closer to retirement security, or at least put them into a plan where saving becomes the default. We’re going to close out the show today with some thoughts from Mike about where retirement policy goes from here. And of course, we want to thank Mike for giving us some of his time over the holidays to cover the new legislation with us.
Mike Barry – I think there’s some big ideas in SECURE, but a lot is going to depend on how the employer/provider/participant ecology adapts to it. It’s possible we could get more annuities out of this legislation, more people buying annuities. It’s possible that would be a good thing. The same goes for open multiple employer plans. I kind of feel like if this is going to be a disrupter, that it will be some technology company partnering with some more non-mainstream financial services company to deliver some technology based open multiple employer plan. And if you put behind that a powerful marketing organization and maybe some AI and some advanced database stuff — that could change the way we do things. All of a sudden you could put everybody’s plan on a phone, more than it already is. I don’t see that yet. So it’s sort of — in a half sense it all remains to be seen. Could I just note, DOL I believe is set. They’re working on a proposal to put annuities into target-date funds also, and that’s going to add to this whole dialogue around retirement income in an interesting way. Frankly, the kind of controversial thing is this Neal proposal to have some kind of automatic plan that everybody’s got to adopt. So if you don’t already have a plan, you’d have to adopt this plan. Neal has a proposal that’s kind of a very skinny 401k. It would still be a qualified ERISA plan, so it wouldn’t be an IRA. But the skinniest version would have a much lower maximum contribution rate and then just anybody could participate in it and it would have a default provision to put you into that plan. Again, this all goes back to getting people into these plans.
Ben Jones – Thank you for listening to Better Conversations. Better Outcomes. This podcast is presented by BMO Global Asset Management. To access the resources discussed in today’s show, please visit us at www.bmogam.com/betterconversations.
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