Solving the income equation during retirement has long been an issue, and has only been exacerbated by problems with Social Security and rising inflation. To that end, policymakers and pundits have increasingly turned to annuities as a way to solve Americans’ income needs. Under that guise, the recently passed second installment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act provides an annuity muscle for investors and builds upon the previous version of the bill.
With new rules governing a wide variety of annuity topics, including Qualified Longevity Annuity Contract (QLAC) adoption and cost-of-living adjustments (COLA) for in-plan annuities, the SECURE Act 2.0 has a lot to offer annuity investors. With the passage of the bill, there are now plenty of new planning opportunities and this could help drive annuity adoption.
Be sure to check the Retirement Channel to learn more about investing strategies to build up your nest egg.
Building on SECURE 1.0
The original SECURE Act was a landmark bill that included several major provisions covering everything from required minimum distribution (RMD) rules to benefits for part-time workers. This included a hefty dose of rules designed to remove hurdles and get annuities/lifetime income options into retirement plans. The latest version of the SECURE Act takes those early provisions one step further and adds some new rules designed to help on the annuity front and making saving easier for many investors.
Two of the biggest rules for annuities involve QLACs and COLA for life annuities.
Under the original rules, creating and governing QLACs—written in 2014—investors were limited in two ways. First, they were only able to place 25% or $125,000 of their 401k/403b or IRA plans into a QLAC annuity. The 25% limit was applied separately to separate employer plans, but in aggregate when it came to IRAs. With the limits, using a QLAC to generate long-term deferred income wasn’t necessarily advantageous for many investors. The SECURE 2.0 Act removes the 25% limit and boosts the maximum from $125,000 to $200,000. Moreover, the limit will be indexed to inflation starting next year.
Second, the new law makes it easier for investors to get lifetime income that increases with COLAs. The first SECURE Act allowed for annuities to be placed within qualified workplace and individual retirement accounts. Those annuity payments were allowed to be considered for RMDs with a caveat. Under the rules, annuity payments were split into two parts and some investors would actually see their RMD calculations be higher. The SECURE 2.0 Act allows for investors with annuities that have COLAs of 5% or lower to include both parts to satisfy the RMD.
Big Wins for Annuities
So, why do these changes matter? It turns out they are a big deal when it comes to generating lifetime income from a 401k or IRA plan.
QLACs are a so-called deferred income annuity, in that they are designed to start payments for investors at a later date. This is critical as older investors often feel the pinch of low savings rates. They also allow investors to buy a lot of income later for not that much upfront cost.
The win for the annuity variety is that it allows investors to defer taxes further inside deferred retirement plans. 401ks and other qualified plans, as well as IRAs, can’t defer taxes forever and investors are required to pay RMDs each year after they hit age 73, which was also extended under the SECURE Act 2.0.
However, when an investor buys a QLAC, the amount purchased is removed from the RMD calculation. This allows investors to save on taxes today and push more of their savings into the future with tax deferral. The best part is that this deferral tends to reduce overall long-term tax costs.
With investors now being able to purchase an additional $75,000 in QLACs for their 401ks/IRAs, the tax savings could be significant. For investors with smaller qualified nest eggs, the removal of the 25% cap allows them to potentially use a qualified plan and potentially remove RMDs altogether. Ultimately, it opens up a lot of planning possibilities.
As for the COLAs, this removes a major hurdle for investors. By allowing annuities with payment adjustments, investors have the potential to add lifetime income options to their qualified savings that grow over time. After this year’s big inflationary push, this fact is important. And with investors now not being penalized on the RMD front, this is a huge win.
Opportunities for Investors
The first SECURE Act set the stage for annuities in qualified retirement plans. The new law expands on the goals of lifetime and makes it easier for Americans to spend their savings. With it being easier to add QLACs and annuities to a portfolio, the planning options have grown. Ultimately, investors have more tools to use for their golden years.
Don’t forget to explore our recently launched model portfolios here.
