The US House of Representatives passed comprehensive reforms on May 23rd to the US retirement ecosystem by a vote of 417-3. While the bill–known as The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) – has yet to become law, a nearly identical version is making its way through the Senate, where it is expected to pass.
The SECURE Act is arguably the most significant change to the US retirement landscape since the Pension Protection Act of 2006 introduced target date funds as qualified default alternatives.
The SECURE Act features several important changes:
- Relaxes rules on forming multi-employer plans (“Open MEPs”). Current rules governing MEPs require commonality among employers to band together to form a multi-employer plan (and take advantage of lower pricing). The SECURE Act seeks to ease this process by relaxing the commonality requirement. The expectation is that this will stimulate more small businesses to offer plans while lowering costs for a broader swath of the defined contribution (DC) industry.
- Addresses fiduciary concerns over annuities in defined contribution plans. The availability of annuities in DC plans has been hindered in part by employer concerns over picking the right insurer to provide annuities in the plan. The proposed law seeks to address these concerns by clarifying the contexts in which a sponsor can be held liable for the selection of an annuities provider. The proposal also addresses portability concerns by allowing employees who take another job or retire to move the annuity to another 401(k) plan or to an IRA without charges and fees.
- Inclusion of lifetime income disclosures. The SECURE Act calls for employers to provide employees with a calculation of how much lifetime income they could receive from their retirement accounts at least once every 12 months. It will likely fall to record keepers to provide this calculation on participant statements. The method for calculating lifetime income has not been determined.
- Increases required minimum distribution (RMD) ages in defined contribution plans. The new rules increase the age by which participants must begin making withdrawals from their retirement plans from 70.5 to 72. The effect would be to provide additional time for growth in a tax privileged account.
- Requires employers provide 401(k) benefits to long-term, part-time workers. This change will increase the number of participants and the amount of assets flowing into the DC system.
- Provides a tax credit to employers to start or enhance plans. The credits are for new plans as well as plans that adopt automatic enrollment. The Act would remove age limitations for IRA contributions. The current law forbids IRA contributions beyond the age of 70.5, while the proposed bill removes this restriction entirely.
- Changes inheritance provisions. The SECURE Act requires most inheritors of 401(k) and IRA accounts to withdraw the entirety of the funds in these accounts over 10 years as opposed to over their own life expectancy. This will force assets out of tax-privileged accounts faster and help fund many of the other provisions in the bill.
- Allows for new penalty-free withdrawals and expands usage of 529 plans. 529 savings plan participants would be able to withdraw $10,000 for student loans. 401(k) participants would be able to withdraw $5,000 after a birth or adoption without penalty. While the quantity of new withdrawals could be high, the overall impact on assets is expected to be low.
We expect the proposed legislation to push more assets to 401(k) plans, while simultaneously increasing the need for advice within those plans. As a result, there will be more retirement planning decisions made by consumers that require advice as well as the continued growth of financial wellness offers. The proposed changes are intended to benefit employers and workers alike. The impact on individual financial services institutions, however, will be varied:
- Annuities manufacturers. Increased availability of annuities on retirement plan menus will have a marginally positive impact in the near term. Today, about 9 percent of 401(k) plans have annuities as an option, but take-up rates within plans are low due to product complexity and well-documented behavioral finance challenges associated with annuities sales. As a result, while addressing employer liability concerns is a helpful step, we do not believe there will be a material shift in 401(k) allocations until annuities become regular components of default options or managed accounts. Should this occur, insurers who own record keepers and other group annuities writers will be the primary beneficiaries.
- Asset managers. Retail focused managers with strong penetration across IRAs stand to benefit from the removal of age caps. The increase in the RMD age to 72 should keep assets in plan longer and therefore stands to benefit managers with strong DC franchises. At the same time, if there is a significant shift in allocations to guaranteed income products, these same managers could be net losers.
- Small plan record keepers. The SECURE Act is likely a double-edged sword for these firms. The rise of Open MEPs could be a game changer in two respects over the next decade. First, Open MEPs should stimulate an overall increase in the number of plans and bring more employees into the DC system (today, roughly half of all workers have access to a DC plan). Congress has published a forecast that Open MEPs could provide 401(k) access to 700,000 participants over a decade, though many more may benefit from higher-quality, “at scale” plans. At the same time, if a significant number of employers opt for an Open MEP structure with lower expenses, it could reduce the overall number of small business plans. For small business record keepers that support Open MEPs, this will be a net benefit. For those that do not serve Open MEPs, this evolution could result in a shrinking market. On a more unambiguously positive note, the increase in RMD ages should keep assets in plan longer and benefit providers that price on a percentage of assets under administration (AUA) basis vs. a per-capita basis. Small plan record keepers are also likely to benefit from an increase in the number of small employers that open a plan due to the new tax incentives and the addition of participants who are part-time workers. Finally, insurance-owned small plan record keepers are particularly well positioned to benefit from attempts to increase in-plan annuities as they will likely be the product manufacturers for the plans they record-keep.
- Large plan record keepers. The SECURE Act should have a modestly positive impact for these firms. Pricing in the large plan market is typically on a per capita vs. AUA basis, so the inclusion of certain part-time workers provides some benefit. The delay in RMDs, however, should have minimal impact given the prevalence of per-capita pricing. The inclusion of lifetime income statements adds modest operational complexity, and record keepers will have a difficult time passing through the cost of providing these estimates. Finally, large plan record keepers are likely evaluating whether to enter the Open MEP market where they can leverage their scale.
- Wealth managers. Wealth managers for whom IRAs are a major economic driver should benefit from the elimination of age restrictions on contributions. The law gives one benefit by removing the cap on contributions but removes another by requiring liquidation of IRAs in ten years. The requirement that inheritors liquidate accounts within ten years could be a drag on asset balances over the long-term and result in flows from tax-advantaged to taxable accounts. Insurance broker-dealers and independent marketing organizations, however, could be net losers should we see growth of in-plan annuities that comes at the expense of the individual annuities market. Again, for this to occur, in plan take-up rates will need to climb for in-plan annuities.
- Banks. Much like wealth managers, banks may be positioned to benefit from the proposed legislation. Banks sit on large IRA accounts and have established fixed annuity offers that will benefit from the rule’s proposed changes.
The new retirement bill has numerous benefits for savers and retirees. It also strengthens the role of 401(k)s in providing financial security to millions of Americans by offering incentives and making it easier for small employers to set up plans. The implications of the law – should a version pass in the Senate – will vary across the retirement ecosystem, but winners will move quickly to capture gains from the bill’s expansion of the DC landscape.