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News outlets recently flooded social media with headlines about the rise of “401(k) millionaires” in the wake of an analysis by Fidelity Investments which touted the increased number of its 401(k) plans with at least a $1 million balance. It is difficult to decipher whether this development is a sign of individuals taking increased responsibility for funding their retirement, the product of a strong investment market or some other combination of factors. While it appears to show that more people are saving significant funds for retirement, some are questioning whether the government should be doing more to encourage retirement savings.
In March, the Senate introduced a bipartisan bill titled the “Retirement Enhancement and Savings Act of 2018” (RESA, S. 2526), an updated version of a similar bill from 2016. While the likelihood of passing any important bill during the upcoming election cycle is uncertain, there are aspects of this bill that should be attractive to those on either side of the aisle. Coupled with the House of Representative’s Ways and Means Committee’s release of “Tax Reform 2.0”, it appears that savings for retirement and other life events are on Congress’s radar.
In my last article on beneficiary designations, I raised one potentially controversial provision of RESA around shortening the time period in which an account holder’s beneficiaries must withdraw funds from an inherited retirement account. There are some additional RESA items, however, that may be more widely acceptable.
Under current law, an individual cannot make a contribution to a traditional IRA after reaching age 70.5. RESA would remove that limitation and allow individuals of any age to make deductible additions to their IRA, assuming they otherwise qualify. With life expectancies increasing and individuals working well into their seventies, often due to inadequate retirement planning at an earlier age, encouraging continued contributions to a retirement plan makes sense. RESA does not, however, include any change in the provision that requires such individuals to begin making withdrawals from their retirement accounts after reaching age 70.5. If one of the purposes of the proposed change is to recognize that individuals are working longer to save for retirement, some wonder whether it makes sense to also acknowledge that these individuals working beyond traditional retirement age might not yet want to begin withdrawing from their retirement savings.
Another notable provision of RESA would give smaller employers the flexibility to band together to form multiple employer retirement plans (MEPs). Factors such as the cost of setting up a plan and the ongoing compliance and maintenance of a plan are barriers or perceived barriers to entry for many employers who would like to sponsor a retirement plan. MEPs could significantly expand the number of employees covered by an employer sponsored retirement plan as each employer can have different plan designs and its own account within the pooled MEP. A version of MEPs already exists, but is limited to those employers who share a characteristic such as membership in the same trade group or some degree of common ownership that is not sufficient for them to be treated as traditional “multiemployer” plans. RESA would significantly expand the number of employers that could utilize a MEP, share administrative and compliance costs and benefit a greater number of employees working for smaller employers whose retirement planning options are limited. While there are some complexities to MEPs, such as determining what type of data must be tracked among all participating employers versus data counted on an employer by employer level, the potential benefits may outweigh the costs. Employers who have avoided instituting their own plans due to concerns about ongoing investment decisions, tax filing requirements, potential audits and the cost of initiating the plan, now may have retirement offerings that are within reach. In turn, broader access to employer-based retirement plans would be a welcome benefit to those employees who work for smaller employers which previously lacked these resources.
While RESA is the most fleshed-out proposal on the table, there are other indications that retirement accounts and similar savings devices may get a facelift. For some, there is tension between saving to start a family in the near future and the long-off goals of retirement. Just when some individuals begin moving into a position of more responsibility and more pay, they are also thinking about saving for a house, saving for college or providing for children. Such individuals are understandably concerned about earmarking and locking up money for retirement when there are more immediate concerns at hand.
While lacking in details, House of Representatives Ways and Means Chair Kevin Brady (R-Texas) released Tax Reform 2.0 in late July which sought to address some of these concerns. This bullet-point “listening framework” is a follow up to the Republican-sponsored tax bill passed in late 2017. At least part of Tax Reform 2.0 is focused on expanding ways for individuals to save in a tax-advantaged manner while allowing increased flexibility in the ways those funds are used.
One proposal included in Tax Reform 2.0 is a “baby-savings” option. This proposal would permit families to make penalty-free withdrawals from a retirement account to pay for expenses related to the birth or adoption of a child. The individual could later replenish the amount withdrawn from the account. Another provision would expand the breadth of tuition-savings 529 plans, permitting parents to use the saved funds for their children’s home schooling and apprentice fees if a child decides to learn a trade rather than attend a traditional college or university.
A more sweeping concept in Tax Reform 2.0 calls for “universal savings accounts”. While retirement accounts, tuition-savings devices and health-insurance savings accounts offer tax advantages, they all come at a cost relative to the flexibility of accessing those funds. Unlike these types of accounts, universal savings accounts would allow for deposit of after-tax money into accounts that grow tax free and permit withdraws to be made on a tax-free and penalty-free basis. While the proposal makes these accounts available to anyone, it is likely that the benefits or use of such accounts would be phased out by income level, a cap on the amount that may be contributed and other criteria. Similar plans have been instituted in other countries such as Canada and the U.K. While Republicans are generally fans of such plans, others are critical of the concept. One objection is that such accounts would merely result in those wealthy enough to save money in taxable accounts moving those funds into nontaxable accounts. As a result, tax revenues might decrease. Critics also fear that such accounts would make it easier for individuals to abandon retirement planning all together in order to use saved funds to take care of emergency items such as a new HVAC system or on luxury items such as vacations.
With concerns about the solvency of the social security system and healthcare costs associated with retirement, there is significant interest in encouraging Americans to save more. To many, the current retirement savings system is complex and has a language all its own: industry specific acronyms and terms such as SEPs, Roth-IRAs, 401k’s, profit sharing plans, defined benefit plans, Keough plans, 403b plans, SIMPLE IRAs, RMDs, RBDs, 10% penalties on early withdrawals, eligible rollover distributions, employer matches, vesting schedules, and qualified beneficiaries are not easy to understand and make retirement planning difficult to navigate. While it is important to consider the potential political and economic implications of revamping tax-advantaged accounts, a push for a greater level of simplicity in savings vehicles and encouraging broader access to employer-sponsored retirement are factors that could allow more Americans to work toward long-term financial security.
Reprinted with permission from the August 27, 2018 issue of The Legal Intelligencer.
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