by Jonathan Goudy / News, Retirement Planning
We conclude our review of the recommendations in the Bipartisan Policy Center’s (“BPC’s”) report on the future of retirement security (the “Report”).
II. Promote Personal Savings for Short-Term Needs and to Preserve Retirement Savings for Older Age
- The Report indicates that 57% of individuals are not financially prepared for an unexpected shock to their financials, requiring early withdrawals from retirement plans or reliance on payday lenders.
- Minimize leakage from retirement plans from early withdrawals by harmonizing the early withdrawal penalties between IRAs and 401(k) Plans.
- Simplify the process for transferring accounts from plan to plan, to avoid cash-outs. Make it easier for employers to allow savings and enrollments in multiple savings plans.
III. Facilitate Lifetime-Income Options to Reduce the Risk of Outliving Savings
- Longevity risk presents one of the largest threats to retirement security.
- Unlike Defined Benefit (“DB”) plans that provide retirement payments for life, Defined Contribution (“DC”) plans, such as 401(k) plans, provide no such guarantees. IRA and 401(k) plan balances are subject to market risks and can be significantly depleted in short order, such as occurred in 2008.
- Tools addressing longevity risk are available in the marketplace, including insurance products (annuities) that guarantee payments for life, as well as non-guaranteed options that generate a sustainable regular payment that keeps up with inflation.
- In 2014, the IRS allowed the use of Qualifying Longevity Annuity Contracts (“QLACs”) in DC plans. Up to 25% of plan assets may be used to purchase a longevity annuity that begins monthly payments as late as age 85 and continues for lifetime of a participant and a surviving spouse, thereby decreasing longevity risk.
- The Report encourages
- Safe harbors to encourage employers to include lifetime income alternatives in DC plans, by limiting fiduciary liabilities.
- Enabling more DC plans to offer automatic installment purchases (laddering) of lifetime income products. This reduces the risk of buying an annuity contract at the wrong time, such as when interest rates and annuity payments are low.
- Encourage sponsors of DC plans through safe harbors to educate participants about the benefits of using plan assets to defer claiming social security as long as possible. The 5-8% annual increase in monthly payments for deferring claiming from 62 to 70 present a significant return and hedge against longevity risk.
IV. Facilitate the Use of Home Equity for Retirement Consumption
- Home Equity is a valuable retirement asset, which can be accessed through downsizing, home equity lines of credit (“HELOCs”) or reverse mortgages. Owners must be incentivized to retain their equity for use in retirement, rather than using it to support pre-retirement consumption.
- The Report recommends that tax deductions be removed from mortgage interest on HELOCs, second home mortgages or refinancing transactions, thereby encouraging homeowners to retain their home equity for retirement security.
- The Report encourages more use of reverse mortgages.
V. Improve Financial Capability Among All Americans
- Incorporate personal finance into K-12 and university curriculums.
- Better communicate the advantages of claiming social security later.
VI. Strengthen Social Security’s Finances and Modernize the Program
- The Social Security Trust Fund is expected to run out of funds in 2035, so this is the most exhausting area of investigation and recommendation in the Report.
- Matching proposals of increases of benefits for the lower paid with increased lifetime payments by the higher paid.
- Establish a minimum benefit to keep all recipients out of poverty in retirement.
- Index the retirement age to longevity, increasing full retirement age from 67 to 69 over many years.
- Limit spousal benefits for higher earning couples.
- Raise the maximum taxable earnings level from the current $118,500 to $195,000 in 2020 and index to wage growth thereafter.
- Increase the payroll-tax rate by 1 percentage point by 2026, to 13.4%.
- Increase taxes on benefits for high earners.
- Improve the Disability Insurance Program before it is depleted at the end of 2016.
Modern employers were unable to afford the traditional DB Pension Plans offering guaranteed lifetime income payments, so DC Plans, such as 401(k) Plans, were implemented in the 1980s. The responsibility was transferred from employer to employee, but employee education and motivation as to the required level of funding to support retirement have been woefully inadequate. When Social Security was implemented in 1935, the retirement age was 65 and the average life expectancy in the United States was 61, versus 79.3 today. Social Security was designed as a safety net, not a retirement plan. The Report provides thoughtful recommendations on fixes for the funding issues, as well as the disbursement issues (annuities). The discussion on repairing social security is one of many, but has some excellent ideas. One need not accept all of the Report’s recommendations, but one must accept that the issues must be addressed in short order.
Remember, it’s not what you make that matters…it’s what you keep!
The general information herein is not intended to be, nor should it be treated as tax, legal, or accounting advice, nor can it be used for the purposes of avoiding tax penalties. Please seek advice from an independent tax advisor before acting on any information presented.