Yowser! No posts for six months, and then for the first time ever I pen one on a subject I have never written – taxation – and now another new subject – pension legislation! I can’t blame you if this is too much excitement to bear, but stick with it folks!
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 is a rare unicorn on Capitol Hill – a bipartisan bill that seems likely to be passed.
Also… who dreams up these crazy names right?
The SECURE Act was passed by the House Ways and Means Committee by a unanimous vote in April and looks set to come before Congress in May. If passed it could provide a raft of new changes to make it easier for businesses and individuals to save for retirement.
But what specifically could it mean for those individuals pursuing financial independence?
Save Early
A key pillar for those seeking financial independence is to start saving early and let the compound effect of investment returns do their work over the long term. In this respect the Act would allow graduate and postgraduate students to count stipends and non-tuition fellowship payments in income for the purpose of making IRA contributions. Retirement savings may not be top of mind for students, but a dollar invested for 40 years will result in a retirement pot that is more than 2½ times the size of a dollar invested for 20 years; even at a modest return of 5% a year.
Another section of the Act provides more support for part-time workers to participate in 401(k) plans. These workers are predominantly women, and currently they can be excluded from contributing to their retirement plans. This change could allow some women to start saving earlier and benefit from the power of compounding.
Destroy Your Debt
The second pillar of financial independence is to destroy your debt. Becoming financially independent requires adopting a high savings rate and carrying expensive debt is like trying to fill a leaky bathtub. With student loans by far and away the most prevalent debt of the pre-retirement generation the Act would allow the repayment of a student loan from a 529 account. This could provide welcome flexibility for those with college savings and starting on their savings journey.
There is another retirement bill being discussed in the Senate called the Retirement Enhanced and Saving Act (RESA) of 2019. I know! Those crazy cats on the Hill introducing two bills! Connected with the RESA bill is another bill (keeping up?) that gives employers more flexibility in paying their employees’ student loan payments.
Currently employees can pay matching contributions to your 401(k) plan but the new bill permits them to instead divert those contributions to paying down a student loan. Student load burden is often cited as a barrier to young people making 401(k) contributions and this change allows them to enjoy the benefits of the employer match. Depending on your debt cost relative to an expected rate of return in your 401(k) this could be very attractive, especially as student loan repayments are after-tax.
Retirement Flexibility
The third pillar of financial independence is retirement flexibility. For those seeking early retirement and a life of financial independence the break from working to retirement is fungible. Many retirees are seeking to do some work in ‘retirement’. To this end the Act would allow the payment of IRA contributions beyond age 70½, thus allowing maximum tax efficiency throughout life.
Tax Efficiency
Finally, the fourth pillar is tax efficiency. Accumulating assets in a tax efficient way is only one part of the strategy, with the other more complex part concerned with spending-down those assets while making use of all available tax advantages. Over your life you may accumulate assets in tax deferred accounts like 401(k) plans, Roth accounts and post-tax brokerage accounts.
The goal is to juggle the spending from these accounts to ensure a smooth income stream whilst minimizing your tax liability. Currently the required minimum distribution (RMD) rules from the IRS insist that you take payments from your tax deferred accounts from age 70½. This restriction can throw a monkey wrench into your plans as you might be forced to take a distribution that pushes you into a higher tax bracket. Financial independence enthusiasts have therefore developed many arcane gyrations to optimize their accounts. This could include partial Roth conversions, filling the 0% capital gains tax bracket and harvesting capital gains when income is low to ensure a ‘free’ step-up in basis.
The Act provides more flexibility on the timing of some of these strategies since the proposed RMD age will be lengthened to age 72. This gives another 18 months of leeway to ensure your accounts are suitably arranged for optimal spendown. Breaking news is that the Senate with their parallel bill are talking about moving RMDs out to age 75!
It’s tempting to think that this gives you a lot more flexibility in the spendown phase, and yes, I admit it does. But the reason for pushing out the RMD age is that people are living longer. The IRS should still get their money, even with an older RMD age but not if financial independence enthusiasts have their way!
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I think I can eek a free year of retirement out of this bill. I’m living on cash and Roth converting. Extending the Roth conversion period reduces the tax burden quite a bit. My goal is to RMD a 600K TIRA set to about 3% return as a low volatility quasi inflation adjusted annuity, add my SS which is also inflation adjusted and tax advantaged to yield a very stable 6K/mo income and a very predictable $4200 tax bill on the ordinary income. SS + RMD will fill about 60% of the tax bracket so I will have 10-15 years of possible bracket creep before I step up in bracket. My income will be filled out by post tax money. If the RMD and SS provide 6K/mo and I need 10K per month I simply sell small amounts of post tax portfolio to make up the difference pretty much cap gain free. The Roth money provides self insurance in case of disaster and otherwise won’t be touched unelkss I want to buy a car oe something. Extending the Roth funding to age 72 reduces my tax burden by 97K by placing me in a bit lower bracket so it’s like getting a 97K tax windfall. I think its a good deal. Efficiently learning how to spend down and control taxes is probably more important than the accumulating strategy and optimizing the spend down is a lot more complicated, but correctly engineered you can say 100% bye bye to things like side gigs with plenty of money rolling in.
I have arrived at your conclusion that the spendown period is an under-looked and over-complex period that really need some work. There is fantastic work out there in the FIRE community on tax optimizing your spendown and I’m working my way through it. I feel like I got this blog up and running on the accumulation phase. I then pretty much ran out of interesting things to say, but now I am going to turn my attention to the spendown phase.
Thanks for visiting! Just like old times!