What Congress’ Retirement System Overhaul Means to You

Last week, Congress passed the Secure Act--short for Setting Every Community Up for Retirement Enhancement. The Act was designed to help citizens save more for retirement. Considering the millions of Americans that are under the risk of outliving the funds to sustain themselves through retirement, the Secure Act aims to help counter this growing trend.

It’s a mixed bag, however--one that will force retirees and their beneficiaries to navigate a more complicated field of choices than they had expected, and some of which can be significantly damaging if they proceed without caution.

Legitimizing the Annuity Sharks

Not all annuities are “bad,” but even the best of them may not be ideal as compared with other investment types. But will the average investor have the stamina to carefully analyze long and often complex disclosures and structural descriptions that, by design, were meant to obscure fees, costs, and conditionals?

The insurance companies lobbied hard for inclusion into the Secure Act and, not surprisingly, they won. Congress let the sharks in, so to speak. And as a retiree, you now take full responsibility for the potentially favorable or dismal consequences of your choices, especially once you hit the “annuitize” button and place all of your money under the insurance company’s ownership.

Despite overwhelming support from Congress, many consumer advocates voiced sharp criticism over this inclusion. According to the Wall Street Journal, Barbara Roper, director of Consumer Federation of America, said “given the prevalence of high cost, low-quality annuities, we don’t start with the thought that this is a great idea.”

Such a criticism is understandable, considering that fees for the largest 401(k) investments are a fraction of those for annuities. According to BrightScope Inc (research firm), 401(k) fees fell from 0.34% in 2009 to 0.25% in 2016. Annuity fees, on the other hand, remain between 2.18% and 3.63%, according to Morningstar.

Higher fees for variable annuities have been at the center of controversy for some time, having seen waves of lawsuits over the years. For those who don’t know about this annuity type, variable annuities allow you to benefit from a rising market while shielding investors from negative returns during a falling market, as in the case of a bear market or recession. Hence, they demand higher fees.

What many investors fail to calculate, however, are the effects of “caps” on their returns. The variable market upside is capped, but so is the downside. So, if an annuity contract caps positive returns at, say, an annual 5%, but the market appreciated 20%, then the investor loses a significant portion of that return. On the other hand, if the market tanks -20%, the investor loses nothing. Add in the annual fees and other potential costs (such as those paid for extra benefits called “riders”), and the 5% return ends up significantly lower over the entire lifespan of the annuity. For the guaranteed safety of “income for life,” your returns are significantly diluted while the annuity provider ends up with a higher profit.

Ending the Stretch IRA

Building a legacy in the form of a sizeable retirement fund and leaving it to children is something that many retirees have been doing for decades. Their children can, in turn, continue building that legacy, one that can last them their entire lifetime, or one they can also gift to their children. The capacity to build such a legacy has now been abolished, thanks to Congress.

Non-spousal beneficiaries now have ten years to take all withdrawals from a retirement legacy. And depending on the age of the beneficiary and the size of the inherited account, beneficiaries may end up paying a large portion of their legacy in federal taxes. Less money for them, and more money to the government, which, based on its Trillion-dollar budget deficit--driven by perpetual borrowing and spending--always finds a “use” for money that once rightfully belonged to retirees and their families.

Not Without a Few Key Benefits

Despite the major drawbacks, Congress’ legislative overhaul doesn’t come without a few key benefits: The age limit for mandatory distributions has been pushed back to age 72, allowing pre-retirees to save more money for retirement. If you’re a parent with a 529 education savings plan, you can take tax-free withdrawals to repay some of your student loans--a real plus for those who are burdened with student loan debt. In addition, parents can make penalty-free withdrawals up to $5,000 a year from a retirement account within the year that a new child is born or adopted.

The Bottom Line

As we said earlier, the new legislation is truly a mixed bag. Retirees are neither saddled with a major disadvantage nor are they presented with any choices leading to a major advantage. Instead, retirees have to navigate their options carefully, reading the fine print--literally and figuratively--to avoid any of the hidden pitfalls hidden behind the complexities of structure and language that accompany various retirement plans.

There are simpler and less risky routes, however. Simply holding an index fund and allocating a portion of your wealth to gold and silver presents a much less complex way to diversify a good portion of your assets. Historically, such an approach has also proven to provide much bigger returns in the long run. Plus, your money remains yours, managed by you, accessible only to you and at your time of choosing. There is a benefit to saying “no” to guaranteed income. The benefit is that you can pursue other avenues in which you may reap even greater returns while maintaining ownership of your money.

We’re not saying that you should avoid 401(k)’s altogether. We do, however, warn you against the illusory benefits touted by insurance companies (annuity providers). But perhaps you should diversify your retirement plan the way you diversify assets in a portfolio. This way, you’re not stuck with just one major solution, particularly if such a solution turns out to be much less than optimal.