Over Christmas week, Congress passed—and President Trump signed—the biggest changes to American retirement savings in two decades. The SECURE Act purports to “set every community up for retirement.” The new law does improve the country’s mishmash of retirement options, but mostly around the edges. It also highlights the shortcomings and contradictions in American retirement policy, and at a modest price: the Congressional Budget Office estimates that the whole bill will cost the federal government only about $1.5 billion a year, mostly in lost tax revenues.
The new law seeks to make it easier to save and invest more for retirement—and nods to the country’s changing work environment, too—by making small fixes. Unless you work for a state or local government, you likely will rely on two income sources in old age: Social Security plus withdrawals from a retirement plan sponsored by your employer, such as a 401(k), or one set up by a financial institution, such as an IRA. These accounts are “tax-favored”—that is, contributions are made on pre-tax income, lowering your overall income-tax bill, and then taxed on withdrawal. In your retirement account, you can generally pick investments from a range of low-cost mutual-fund options, from higher-risk stocks to (theoretically) lower-risk bonds.
The SECURE Act adjusts existing law in ways that will affect Americans of all ages. First, it repeals a provision that prohibits people from contributing money to their IRAs after they reach age 70½. “As Americans live longer, an increasing number continue employment beyond traditional retirement age,” an earlier version of the text notes—and those workers should be able to enjoy the tax benefits of continued contributions. The law also increases the age at which “retirees” must begin withdrawing money from their tax-favored retirement accounts, from 70½, first set in the 1960s, to 72. To ensure that older retirees don’t use this new flexibility to pass down more money to their heirs tax-free, Congress now requires those who inherit an IRA from a parent or almost anyone else other than a spouse to close the account—and thus pay the taxes due —within ten years. These are good changes, as they encourage people who can work to keep working by offering a bigger tax shelter for a portion of their income.
For younger people, the SECURE Act introduces new and bigger “nudges,” in economic parlance, to get them to save. Smaller employers will get a three-year, $500-a-year credit for starting new 401(k) and IRA plans that offer automatic enrollment for their workers. For academic workers, the new law allows graduate students and post-doctoral candidates to take IRA tax deductions against money they save from stipend and fellowship income. Part-timers get a new benefit, too: employers can no longer exclude them from retirement plans.
The law also acknowledges the high cost of starting a family, which often takes precedence over retirement savings for younger people. Generally, anyone who withdraws money from a retirement account before he or she has reached the age of 59½ must not only pay all income taxes due but also a 10 percent penalty, unless he or she is withdrawing the money for a specific purpose such as a first-time home purchase, onerous medical expenses, or a list of “hardships.” The SECURE Act removes the penalty for taking $5,000 out for a new child and $10,000 to repay an adult child’s student loans. At the same time, the law makes it harder for workers to withdraw money from an employer-sponsored retirement fund for frivolous purposes, prohibiting plans from offering withdrawal loans via credit cards and other convenient means. Finally, the law nods to many people’s desire to convert their savings into a guaranteed annual income, or “annuity,” once they’ve retired. To encourage employers to offer annuity options, Congress will now protect them from lawsuits should the insurance company become unable to meet its guarantee. Overall, these changes are good, too, but marginal.
More aggressive action is necessary: the grim truth is that the average Gen Xer, now well into middle age, has only $66,000 tucked away. One-third of middle-aged retirement-account holders have taken an early withdrawal, often not because they’re ignorant of the penalty but because they need the money. And though it makes sense for Congress to encourage people to work longer by letting them contribute to retirement accounts well into their seventies, the more pressing problem is early retirement. Most retirees, for example, begin claiming Social Security benefits before the legal retirement age of 66, with the average person claiming benefits just before age 65, even though waiting means receiving significantly higher benefits. Many “retirees” who start claiming Social Security as early as age 62 aren’t ignorant of the penalties, either; they, too, need the money. Clearly, people must save and invest much more.
To encourage that, Congress should, first, motivate savings and investment with a stronger push to match lower-income and middle-income workers’ contributions with tax credits—meaning that they get the money back, even if they don’t pay federal income taxes, because of low-income or multiple-child tax credits. Currently, families earning under $65,000 can get a 10 percent to 50 percent government-matching contribution to their retirement-plan contributions; why not increase these credits for lower-income workers? Second, for people earning below $150,000 who desire a modest but guaranteed income in retirement, why not devise a new type of long-term government savings bond, one that starts paying out, say, 4 percent of accumulated savings per year, starting on a fixed retirement date, decades in the future? Such a bond would give people what they want from a guaranteed annual income, beyond what Social Security offers, but without forcing them to take the risk of an annuity—namely, that the company offering the annuity fails to deliver on this promise, not guaranteed by the government as a bank account is, in 20 or 30 years. Third, cut the complexity by allowing people a low but consistent lifetime limit of early withdrawals without penalty from their retirement accounts—say, $20,000—for any reason, rather than forcing them to meet the criteria of eligible “hardships.”
The SECURE Act is a constructive step forward but only a modest one. Congress has left much to do for future lawmakers. In a presidential election year, some candidate might find it fruitful to seize on the nation’s retirement-savings malaise as an issue—and an opportunity to promote policies that could help middle- and lower-income earners.