Anticipating Policy Changes in Retirement - American Financial Management Group | Philadelphia Financial Planner

Anticipating Policy Changes in Retirement

At the close of 2019, Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act, providing a significant update to rules governing retirement accounts in America. Part of the law changed the distribution rules for inherited IRAs. Our clients learned that the “stretch” distribution option (allowing a person who inherited an IRA to extend the required distributions over their entire life) was replaced with a requirement that, for most non-spouses, the inherited account be emptied within ten years. The result caused a scrambling start to 2020 (when the SECURE Act went into effect), as we worked with clients and estate lawyers to redesign estate plans.

Responding to changes in federal financial policy is part of every financial planner’s job: retirement income plans must account for “unknowns,” or risks to your retirement. Public Policy Risk is an unknown with potentially the broadest range of outcomes. 

The most common concern our clients have with public policy in retirement planning is taxes. Humorist Will Rogers once said, “The only difference between death and taxes is that death doesn’t get worse every time Congress meets.” Taxes strike fear and resentment in the hearts of many. Even the Beatles felt compelled to lament the inescapable reach of the Taxman in their classic song. [While this version only has one Beatle, George Harrison, the addition of Eric Clapton on back up guitar isn’t the worst trade-off.] But there are other public policy issues to consider besides tax rate changes.  

Social Security and Medicare are two key pillars of most retirement plans. These government programs have provided an important safety net for generations of retired Americans. However, given the shifting whims of Congress, there is always the possibility of changes to these central programs. Moreover, both programs have long-term issues with solvency, and potential fixes could impact everyone. Let me be clear: the worst-case scenario regarding solvency would result in reduced benefits and NOT benefit elimination (contrary to some rumors you may hear elsewhere.)

Policies issued from state and local governments also can have unexpected impacts on retirement. As you reach retirement age, an important decision to make is determining where you will live. Like many people, you may want to remain in the home where you raised your family. But what happens if there is a spike in your property tax? Do you have the resources to cover that expense?

Or consider another scenario: a change in your neighborhood brings about a jump in your home’s value. An increase could come from restrictions on new construction; or tax breaks from your local government to lure in a major company could create a rush of people moving to the area. Neither of these policy decisions directly affects your tax rate, but you still pay more tax.

How can you protect yourself from the mutable impulses of our political leaders? It comes down to awareness and flexibility. Staying aware of possible changes will give you more time to plan, and remaining flexible will enable you to avoid becoming trapped by earlier decisions that no longer make sense.  

AWARENESS

Every year we review beneficiary forms with our clients. This may seem needlessly frequent, but a lot can happen in 12 months. With all of the activity surrounding births, deaths, marriages, and divorces, it is easy to forget about updating forms. Beyond personal events, state decisions involving taxation, inheritance, or civil and bankruptcy court cases all can be cause to reevaluate retirement plans. Top that off with public policy changes such as the SECURE Act, and you can see why the annual review of your documents is essential.  

Awareness of history is also useful. Assuming there will be a revision to Social Security (and math suggests this is vital), it is reasonable to believe that there will be some adjustment to benefits. Does this mean you will need to make significant adjustments to your plan? No one can say for sure, but when Social Security was overhauled in 1983 (pictured above), people who were already collecting were mostly unaffected by the changes. Whether this remains true in the next iteration of Social Security is unknown, but we must stay aware to be sure. 

FLEXIBILITY

Scrutinizing your retirement plan during the annual review is a good time to determine how much flexibility is built into it. Some people prefer to base their retirement plan around annuities because they offer a steady income and few worries about stock market fluctuations. Annuities lock money into accounts with the promise of a guaranteed payout during retirement. However, by investing all of your money in annuities, you lose the flexibility to adjust to changes that may arise. If the property tax rate in your town increases to the point that you need to move, would you have the liquidity to do so? By investing your money into an annuity, you have traded access to a pool of cash for smaller payouts over a great length of time.

We frequently talk to clients about diversification, and not just for investments. Tax diversification among your accounts can be invaluable. With a traditional retirement account like an IRA or 401(k), the money you contribute is not taxed, but everything you take out is taxed. Roth accounts operate in reverse, where you pay tax when the money is put into the account, but you owe nothing when you take it out. Taxable funds like individual or joint investment accounts are taxed as transactions happen (buying, selling, or getting dividends), so when you take the money out, you do not owe additional tax. Having all three types gives you options for when you need to withdraw money, since it might be more advantageous to take from one account over another, depending on your income that year (or expected future income.)

Awareness & Flexibility: Together Again

Planning for policy risk involves a practical bit of prophesy, by weighing current risk factors and anticipating future changes. One of the most common and challenging decisions a client may face is whether to do a Roth conversion. A critical factor in determining the value of conversion is evaluating current versus future tax rates. If you expect your income tax rate to be higher in the future, then a Roth conversion may make sense. Granted, tax rate expectation is the primary, but not only, consideration. There are other reasons to do or not do a conversion, regardless of the income tax probability.

One concern that clients often raise about converting to a Roth IRA is, “What if Congress changes the rules?” Legislators understand that taking benefits away from voters usually is not a good strategy for getting re-elected. As a result, we frequently see existing recipients exempted from changes that Congress enacts. But to speculate on potential Congressional modifications to the Roth account option, we could imagine rule changes that include not allowing new accounts to be opened, or not permitting new contributions and/or conversions. Regardless, we do not believe that any changes would involve having to pay tax on amounts that have already been taxed.

Of course, there is no guarantee that Congress would exempt existing Roth accounts from any future SECURE Act-style adjustments in public policy. That is why flexibility is such an important part of diversification. Having multiple account types lessens your tax strategy’s dependence on a particular set of laws.  

The Roth Conversion decision is just one example of how public policy changes can impact your retirement income plan. Changes in laws and regulations come from every level of government. Since they can have both positive and negative impacts on your retirement plan, working with someone who helps you stay both aware and flexible can be invaluable to keeping your #2ndHalfPlan on track.

Please reach out to us if you have questions about how public policy risk, and other risks, can impact your retirement dreams.  

This information is not intended to be a substitute for individualized tax advice. Please consult your tax advisor regarding your specific situation. 

Kevin-gaines

Kevin focuses on helping people with retirement income planning. He is concerned that too many people become overwhelmed as they shift from building their retirement savings to using their retirement savings to support their desired lifestyle. By engaging in a robust planning process, he aims to lessen the financial fears we all have after we end our careers. Learn more about Kevin

Let's Talk

The true value of planning emerges in the discussion and collaboration of our knowledge applied to your unique circumstances. We bring our areas of expertise to your areas of curiosity, ambition and worry.

Let’s get this conversation started.