Back in May of 2019, the House of Representatives did something nearly unheard of in our polarized politics: It overwhelmingly passed a major tax and retirement savings bill on a bipartisan basis.
With an almost unanimous vote, the House sent the “Setting Every Community Up for Retirement Enhancement Act of 2019,” better known as the “SECURE Act,” to the Senate. Since then, it’s been held up by a few senators over several concerns, the most overblown of which is preserving what is known as “Stretch IRAs.”
The SECURE Act would be a giant leap forward in the generational campaign to move us from a defined benefit to a defined contribution retirement system. The most important thing the bill does is make it easier for small employers to pool together in order to form joint 401(k) plans known as “MEPs,” multiple employer pensions. Just like the Trump Administration has made it easier for small employers to combine resources and offer better health insurance coverage, improved MEPs will do the same for 401(k)s.
Today, it’s often prohibitively difficult for smaller employers to offer a retirement plan, but if they could band together and overcome the challenges by sharing costs, suddenly 401(k) plans are available to many more workers. One small business might not be able to afford a $1000 annual fee to run a 401(k) plan, but 100 small businesses might be able to afford a $10,000 annual fee if they pass the hat.
Industry estimates say that MEPs will lead to 700,000 new workers and their families having access to 401(k) type retirement plans. That’s a powerful boost for workers and is the main reason House Ways and Means Committee ranking member Rep. Kevin Brady is a big supporter of the SECURE Act.
That’s not all the bill does, though.
The SECURE Act builds on the success of the 2006 Pension Protection Act by allowing 401(k) plans to auto-escalate worker savings up to 15% of salary, increasing tax benefits for starting a retirement plan, and permitting small business owners to start a new 401(k) plan when they are doing their taxes. For seniors, the arbitrary age limit on new IRA contributions is repealed. For families with children, penalty-free withdrawals can be made from retirement plans to pay for expenses related to the birth of a child or an adoption. Plus, 529 college savings plans could be used to pay for skilled apprenticeship programs and to repay up to $10,000 in student loans.
Most significantly, the maximum age for taking the first distribution from an IRA or 401(k) is increased from 70.5 to 72, a change that helps nearly all retirees and represents a tax cut for millions of seniors.
In order to keep the SECURE Act budget and revenue-neutral (and it’s important for conservatives to know that the bill is, despite some headlines to the contrary, tax revenue-neutral), it has one major pay-for: large modifications to a type of tax loophole that has come to be known as the “Stretch IRA.”
A Stretch IRA is not a type of IRA. Rather, it’s a strategy on how an IRA might be used to pass down inherited assets to future generations instead of for retirement.
Suppose you inherit an IRA from a parent at age 35. The IRS tables say they expect you to live until age 85, another five decades. If structured properly, you can “stretch” the distributions from this inherited IRA over 50 years, rather than taking out the money all at once. The first year you take out 1/50th of the funds, the second year 1/49th, and so on. Meanwhile, the bulk of the money left in the inherited IRA remains available to grow tax-deferred. This strategy can easily turn a $100,000 inherited IRA into over $300,000 of distributions smartly stretched out over time.
The SECURE Act does not get rid of the Stretch IRA, despite what some financial publications have implied. Surviving spouses, minor children, disabled inheritors, and those with chronic illnesses, as well as those who are less than a decade younger than the original IRA owner all get to keep the stretch strategy as it is today. For the rest of us, the stretch is limited to 10 years.
Sources close to Capitol Hill staff who have seen the government numbers tell me that the overwhelming majority of inherited IRAs are today depleted in fewer than five years, half the stretch window ordinarily permitted under the bill. As a result, the SECURE Act’s clipping of the Stretch IRA would affect very few families. True Stretch IRAs today are largely used by wealthy inheritors with expensive financial planners. A small pullback of this benefit in order to pay for the grab bag of middle-class and small employer benefits listed above is a no-brainer for conservatives.
That hasn’t stopped some journalists and editors from writing downright hysterical headlines to describe this modest policy change.
The Wall Street Journal asks, “Planning on Leaving an IRA to the Grandkids? Not So Fast.” Too, Forbes writes of “Three New Retirement Rules That May Change Retirement As We Know It.” With all due respect to the media’s need for clicks and shares, it’s time to calm down, look at the facts, and weigh the tradeoffs.
Nothing in life is free. If we’re going to get all the good things the SECURE Act provides, such as small business 401(k) pooling, greater retirement savings for older Americans, relief for younger families with children, an expansion of 529 plans, and a lot more, of course, something had to give. The SECURE Act as a whole is a big net winner for the overwhelming majority of Americans. The sooner Congress passes it, the better.
Ryan Ellis (@RyanLEllis) is president of the Center for a Free Economy.
