Investor’s column: Here is what you need to know about potential tweaks to retirement system
New retirement vehicles are important parts of the Tax Reform 2.0 being proposed by the House Ways and Means Committee.
If it can be separated from the 2.0 tax reform, it has significant support in the Senate. It would be the most significant change to 401K plans since 2006.
Here is what you need to know. Remember these are broad brush strokes and subject to change.
USA accounts
These are new family-friendly retirement savings vehicles. These accounts will provide tax incentives to families to save while also allowing withdrawals for critical life events.
According to one of its sponsors the committee is “creating a new Universal Savings Account to offer a fully flexible savings tool for families.”
Expanded 529 Education Accounts will allow families to use these accounts to pay for an expanded menu of educational cost that may include home schooling, apprenticeship fees for learning a trade and even the repayment of student debt.
New baby savings
Families will be able to access their retirement accounts penalty free for new child care either through birth or adoption.
Repeal of the age limit on IRA contributions
This is one of my favorite changes. Currently, if you are over 70 ½, you cannot make deductible contributions to a traditional IRA.
Congress is considering removing this age cap which would allow contributions of up to $6500 each year in either a traditional or Roth IRA.
New disclosures on 401Ks
Currently, plan sponsors are required to only send out quarterly and annual account statements.
Under the proposed legislation plan sponsors would be required to send out monthly statements that would show an estimate of what the annual income would be if it were generated with an annuity. It would be up to the employer to decide what type of annuity to offer. Fixed or variable are the two options.
I sense the very strong hand of the insurance industry in the push for annuities in more 401K accounts. I have no axe to grind with the insurance industry as annuities and life insurance have been a part (although small) of my business for many years.
Buyers beware here. When used correctly, annuities can be a great enhancement to one’s retirement or investment plan. They can be a disaster if used incorrectly.
One of the drawbacks of annuities is the lower returns compared to the potential for outsized gains in the stock or bond market. This is very important particularly for the younger investors with many years before retirement. Most of us need the outsized growth potential that the stock and bond markets offer in order to meet our retirement objectives.
The second drawback is the higher cost of annuities as well as possible surrender charges.
What my real concern regarding annuities in 401K accounts is the “lifetime income” that all annuities can offer. This is called annuitization.
It is based on one’s age and the amount accumulated. The insurer offers the participant a lifetime income. This is typically this highest payout available. The drawback to this, and it is a very big, very important one, is after ones death all payments stop. There is no asset available to leave to ones heirs.
There are other types of annuitization but when one continues to hear the “lifetime income” phrase over and over again be aware that it typically means giving a lump sum in return for lifetime income. If one were to retire at 65 and pass away at say 67 all payments would cease and there would be nothing to pass on to ones heirs. The insurance company keeps it.
On the other hand, I am in the camp that suggest, if one can, to have ones guaranteed income (ie Social Security and the income from a lifetime annuity) cover ones fixed expenses. Only annuitize a portion of one’s retirement account to cover those fixed expenses. Not all of it.
These proposed tweaks to our retirement system will be welcomed. But, always buyer beware when annuities, particularly “lifetime” annuities are tossed around.
One last thought: Those in my profession can only use the word “guaranteed” when discussing direct obligations of the U.S. Government. That would be bills, notes and bonds. The only other time I can use the word “guaranteed” is with insurance products. So that lifetime income is guaranteed.
Michael T. Doll, an investment adviser with the Longboat Key Financial Group, can be reached at 941-896-2473 or michaeltdoll@longboatkeyfinancial.com.