How the SECURE Act Fits into Your Retirement Plan

The new SECURE Act helps make it easier for people to save more for retirement. While you don’t need to be an expert on this retirement legislation, learning about its key features can help you take advantage of it.

Here are some highlights.

Required minimum distributions (RMDs) from traditional IRAs, SEP accounts and 401(k)s are now not mandatory until age 72. Previously, they began the year you turned 70½. RMDs count as taxable income. With the later starting date, retirees can have all their retirement-account money grow tax-deferred a bit longer. People who turned 70½ in 2019 or earlier (meaning those born before July 1, 1949) are not eligible for the later start date. However, be advised that special coronavirus stimulus legislation called the CARES Act recently passed allows everyone to skip their RMDs for 2020. (For more on that, please see A Hidden Benefit of the Coronavirus Stimulus Bill: You Can Wait to Take Your RMD.)

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In addition to having more time to let your money grow tax deferred, you now have unlimited time to add to your IRAs. While previously anyone over age 70½ was barred from pumping money into their IRAs, the SECURE Act eliminates all age restrictions for contributions. If you have earned income, you can now make IRA contributions past age 70½ — even if you’re 72 or older and already taking RMDs.

The so-called “stretch IRA” is mostly dead. A young beneficiary used to be able to stretch out IRA distributions and taxes for decades. Now, most beneficiaries must fully liquidate the account within 10 years of the original account holder’s date of death. "Eligible beneficiaries” are exempt: the account holder’s spouse, heirs who are disabled or chronically ill, and heirs who are within 10 years of the age of the decedent can still stretch out distributions.

Heirs who must spend down an IRA in 10 years still have an attractive option. They can purchase a 10-year immediate-income annuity to evenly spread their tax liability over 10 years. The money in the IRA is converted to a period-certain annuity guaranteed to pay out its full value over 10 years. Even distributions can help reduce the total amount of income tax over 10 years. In contrast, larger distributions in a particular year can put one in a higher tax bracket. It’s a set-and-forget option. Once the 10-year immediate-income annuity is set up, they never have to think about making manual withdrawals again. Also, all investment risk is transferred to the issuing insurance company, and the company guarantees a set payment amount for the 10-year term.

Options in creating retirement income

While the SECURE Act stands for Setting Every Community Up for Retirement Enhancement, one thing it doesn’t do is bolster Social Security. Payouts likely will be less generous in the future as the population ages and there are fewer working people to fund the system. You’ll probably have to fund more of your retirement independently.

Lifetime income annuities are a key tool in securing a lifetime income — your own private pension — that’s not vulnerable to changing demographics or political considerations. They’re underused despite the fact that top economists like Roger Ibbotson and Jason Scott strongly recommend them.

Income annuities convert some of your savings into a guaranteed stream of income. In some special circumstances, like the IRA situation mentioned above, the payments last a certain number of years. However, lifetime annuities are the most popular choice.

• Immediate lifetime annuities start paying right away.
• Deferred income annuities provide monthly payments starting at a future date you choose. If you can afford to defer taking income, you get larger payments and the advantage of more tax deferral.

You can buy either a standard income annuity with set payments or one that guarantees a growing income based on an annual cost-of-living adjustment, such as 2.50% or 3.00%. The inflation-protected type offers lower payments at the start than a comparable level-pay annuity.

While most retirement plans anticipate an average lifespan, many people live far longer. A healthy 65-year-old man has a 50% chance of living beyond age 85 and a 25% chance of living beyond 92. A healthy 65-year-old woman has a 50% chance of living beyond 88 and a 25% chance of living past 94.

A lifetime income annuity insures against the risk of living longer than expected. That’s why they’re also called longevity annuities. The 50% of people who die earlier than average subsidize the half who live longer than average. This risk-pooling is what makes life annuities so valuable.

Using stocks and bonds and savings instead

You can self-insure against longevity risk by investing in stocks, bonds and savings. But there’s a cost. You’ll need to save 25% to 40% more than with an annuity because you won’t have the advantage of risk-pooling, a Wharton Financial Institutions Center study concluded.

Since you’re counting on an insurance company to keep its promise of providing lifetime income, be sure to choose a financially strong insurer. State guaranty associations provide an additional level of protection for annuity buyers, but if you choose a strong company, it’s extremely unlikely you’ll ever need to rely on the guaranty fund.

Qualified retirement plans, including IRAs and 401(k) plans, are your first line of defense for retirement savings. Annuities, however, offer a valuable supplement to defer more of your taxable (nonqualified) money from taxes and secure a lifetime income. While most people purchase annuities with their taxable funds, various types of fixed annuities can be good choices within an IRA. But that’s another whole topic.