What should you know about the SECURE Act?

If you are preparing for retirement, are currently retired, or own a small business chances are you’ve probably heard something about the SECURE Act.  So what is it?  Simply put, the SECURE Act is a law that makes it easier for small business owners to offer attractive retirement savings opportunities to a population of workers largely underserved by retirement savings options. In this week’s blog post, we explore a high-level overview of the SECURE Act and its implications for businesses owners and employees alike. 

Figure 1: U.S. total retirement market assets

Sources: Investment Company Institute, Federal Reserve Board, Department of Labor, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division

The SECURE Act: a brief overview

For years Congress has been exploring ways to make it easier for Americans to save for retirement, particularly at a time when Social Security is expected to go broke.  Last May, the House passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act with the hope of helping more people save for retirement.  Around the same time, the Senate introduced their own bill, the Retirement Enhancement and Savings Act of 2019.  And after some negotiations between the two chambers of Congress, various features from both bills were ultimately amended into an appropriations bill and signed into law on December 20, 2019.  So, what exactly does this law achieve? 

Well, while a host of individual changes were adopted by the SECURE Act, the new law arguably accomplishes three key ends:

  • It creates incentives for more small business owners to offer 401(k) plans;
  • Opens up savings opportunities for a larger portion of the U.S. workforce and;
  • Notably alters required minimum distribution (RMD) rules for traditional IRAs

Impact on small business owners

At its core, the SECURE Act incentivizes small businesses to establish tax advantaged retirement plans (like a 401(k)) for their employees.  This is important because for some small business owners, establishing and administering a 401(k) plan presents high costs and onerous regulatory tasks, particularly if there are few employees eligible to participate in the plan.  So why are 401(k) plans a key part of the SECURE Act? 

With a maximum contribution limit of $19,500 for 2020, a 401(k) plan remains one of the most advantageous ways for employees to save pre-tax dollars in collaborative way with their employers.  While it’s true that Simplified Employee Pension (SEP) plans allow up to $52,000 in annual contributions, employees (other than owners) typically cannot contribute to a SEP and this limits the plan’s use as a retirement savings vehicle among small business owners with employees.  Given the legislation’s goal to incentivize individual retirement savings, a focus on greater adoption of 401(k) plans across a wider swath of companies makes more sense.  

While 401(k) plans remain an attractive option, how do business owners get past the cost and administrative burdens of providing a savings benefits to their employees?  Enter the Multiple Employment Plan (MEP).  In its simplest form, an MEP allows firms to pool together 401(k) resources and share in the administrative burdens with other business owners of running a retirement plan.  Under prior laws, MEPs (now called Pooled Employer Plans) were mostly limited to firms in the same industry or geographic location. 

The SECURE Act loosens some of these restrictions, enabling unrelated small businesses from different industries and from different places around the U.S. to expand retirement offerings to their employees.  The benefits of such an arrangement include 1) reduced fiduciary responsibility for small business owners, 2) transfers the administrative burden of approving loans and hardship withdrawals away from the business owner to the MEP and 3) increases purchasing power and reduces costs of certain investment vehicles.  What’s more, the legislation provides a tax credit to firms of between $500 and $5,000 to help defray costs of setting up a 401(k) plan.  Taken together, the new law creates more incentives for small business owners to offer an important savings tool to their employees. 

…there are some 20 million small businesses in the U.S. that employ fewer than 20 employees – a key group underserved by retirement savings plans.

Impact on workers

Another benefit of the SECURE Act is that could provide more workers with more options to save for retirement.  According to data from the Small Business Administration, approximately 47.5% of the U.S. workforce is employed by firms with less than 500 workers.  In fact, there are some 20 million small businesses in the U.S. that employ fewer than 20 employees – a key group underserved by retirement savings plans.  Assuming that more small businesses owners adopt 401(k) plans, workers could benefit in a couple of ways. 

First, the SECURE Act provides tax credits to plan administrators that automatically enroll eligible employees in a company’s 401(k) plan.  This would reduce administrative burden on an employee to enroll in their savings plan and, more importantly, get employees (particularly younger workers) saving for retirement sooner and generating more wealth.  Second, the new law eliminates the 1,000-hour rule which expands 401(k) participation to more part-time workers.  Under the new law, an employee who has worked at least 500 hours a year for three years is now eligible to participate in an employer’s 401(k) plan.

Taken together, these benefits could allow savers, once excluded from qualified plans, to increase their savings rates by between 10% and 37% as earnings are put to work on a pre-tax basis.  What’s more, in cases where employers offer dollar-for-dollar matching contributions, some participants could effectively see a 100% return on their savings simply by being able to participate in a 401(k) plan.  As we pointed out in a recent post, having more money to put to work early on in the savings process has an exponential effect on wealth creation over time. 

Finally, there are a few added benefits that employees should be aware of, beginning with the ability to select an annuity as a savings vehicle.  That is, the SECURE Act reduces some of a business owner’s liability related to offering annuities in 401(k) plans and increases the portability of an annuity from one retirement plan to another.  Additionally, employees can now contribute as much as 15% (up from 10%) of their pre-tax earnings to their 401(k) (maximum $19,500 annually).  And, for those workers concerned about the solvency of their employer’s retirement plan (particular to startup firms), certain provisions in the law provide for retirement accounts to automatically roll into an IRA should an employer’s plan become insolvent, thus offering better protection to worker’s savings. 

Figure 2: Retirement assets by type

Sources: Investment Company Institute and Federal Reserve Board

Too good to be true?

While the SECURE Act will in many ways benefit employers and employees, someone has to pay for these benefits.  Between 2020 and 2029, it is estimated that the SECURE Act will cost taxpayers approximately $15 billion.  To defray these costs, the new law closes the loophole on the stretch feature available in traditional IRAs. 

What this means is that for those individuals who leave behind IRA savings after death, non-marriage beneficiaries will now have only 10 years to liquidate an inherited IRA.  This compares to previous laws of the land that allowed a beneficiary to “stretch” minimum required distributions (RMDs) out over their lifetime.  The idea here is to expedite the collection of taxes that typically occurs when withdrawals are made from traditional IRAs.  What’s more, the new rules change the RMD date from 70 ½ for traditional IRAs to 72, giving some participants who have yet to retire extra time to accumulate savings in their retirement accounts. 

Some key takeaways

Time will tell whether more small business owners ultimately will choose to sponsor 401(k) plans (or other qualified plans) as a result of the SECURE Act.  With that said, the more businesses that expand retirement benefits to employees, the greater the potential that more people that get to participate in an extremely important tax advantaged savings account.  If you’re a small business owner, there are now more opportunities to attract, retain and reward talent to your firm over the long-term.  Indeed, lower costs and risk sharing available through PEPs coupled with tax credits that help defray startup costs simply make it that much easier to provide an important benefit to your employees. 

For households, increased access to qualified retirement plans could help close the gap on generating a substantial nest egg.  Access to a 401(k) plan, particularly one where employers offer dollar-for-dollar matching and automatic enrollment could help build greater wealth and at a faster pace compared.  While one downside to the SECURE Act is the elimination of the stretch feature related to inherited IRAs, individuals using IRAs to save for retirement will have a couple more years to see their savings grow before RMDs kick in.  Either way, if your employer offers it and you haven’t yet enrolled, the SECURE Act serves as a friendly reminder of how valuable a retirement savings vehicle a 401(k) can be. 

About the Author

Peter Donisanu
Peter Donisanu is Chief Financial Strategist and President at Franklin Madison Advisors, Inc. Franklin Madison Advisors is a fee-only fiduciary financial planning and investment management firm based out of Pittsburgh, Pennsylvania and serving clients nationally. We exist to serve a generation that has been underwhelmed by traditional paths to financial security and independence.