Legislative Risk in Qualified Retirement Plans and How to Minimize It with Tax-Free Options
By Steve Gaito
McDowell County
Planning for retirement is a major financial concern for many Americans, and qualified retirement plans such as 401(k)s, IRAs, and pensions have long been considered safe and reliable vehicles for securing a future income stream. These plans, however, are not immune to one significant and often overlooked threat: legislative risk. This refers to the potential for future changes in tax laws or government regulations to impact the benefits of these retirement plans.
As Christians, we are called to be wise stewards of the blessings and resources God has given us (Luke 16:10). Part of that stewardship involves understanding the risks and challenges in our financial planning so that we can make decisions that align with our long-term goals and, ultimately, our faith.
In this article, we will explore the nature of legislative risk in qualified retirement plans and discuss how tax-free alternatives can help safeguard your financial future.
Understanding Legislative Risk
What is a Legislative Risk?
Legislative risk refers to the possibility that future government actions, including changes to tax laws, regulations, or other legal frameworks, may negatively affect your retirement savings. In the case of qualified retirement plans, such as 401(k)s or IRAs, this risk is particularly relevant because these plans are governed by complex tax rules and regulations that can change at any time.
Congress may, for example, raise taxes on retirement withdrawals, reduce the amount of tax-deferred contributions you can make, or even alter the age at which required minimum distributions (RMDs) must begin. The uncertainty of these future changes makes it difficult for retirees to accurately predict their tax burden or income in retirement.
Examples of Legislative Risk
Over the years, we’ve seen examples of legislative changes that have affected retirement planning. The most notable recent example is the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, which made significant changes to retirement laws, including:
- Elimination of the Stretch IRA: Before the SECURE Act, beneficiaries of inherited IRAs could “stretch” required distributions over their lifetime, minimizing their tax burden. The new law requires most beneficiaries to empty the account within 10 years, increasing the tax burden significantly for heirs.
- RMD Age Increase: The SECURE Act raised the age for required minimum distributions (RMDs) from 70½ to 72. This may seem like a minor change, but future legislative adjustments could increase the RMD age further, or worse, lower it, forcing retirees to take taxable distributions earlier than planned.
- Cap on Contributions: Historically, the government has adjusted the limits on retirement contributions, making it harder for some individuals to contribute as much as they need. These caps could be lowered again if the government seeks new revenue streams.
- Potential Tax Rate Increases: With the national debt continuing to rise, future tax increases are highly likely. Retirees relying on tax-deferred accounts like 401(k)s and IRAs could find themselves facing higher tax rates on their withdrawals, significantly reducing their income.
Minimizing Legislative Risk with Tax-Free Options
As Christians, we are reminded that while we may not be able to control every aspect of our lives, we can seek wisdom in making prudent decisions (Proverbs 21:5). In the case of retirement planning, this wisdom includes considering strategies that can reduce legislative risk and provide more certainty in your financial future. One of the best ways to do this is by exploring tax-free retirement options.
- Roth IRAs
Roth IRAs are an excellent tool for minimizing legislative risk. While contributions to a Roth IRA are made with after-tax dollars, the account grows tax-free, and withdrawals in retirement are also tax-free, provided certain conditions are met.
By converting some or all of your traditional IRA or 401(k) funds to a Roth IRA, you lock in your current tax rate and eliminate future tax uncertainty. Even if tax rates increase or legislative changes occur, your Roth IRA withdrawals will remain untouched by those changes.
However, it’s important to note that Roth conversions themselves are taxable events, meaning you will pay taxes upfront when you convert. It’s crucial to consult with a financial advisor to ensure this strategy fits your situation, and you may want to spread out conversions over several years to minimize the tax impact.
- Life Insurance
Permanent life insurance, such as Indexed Universal Life (IUL) policies, offers another tax-free option that can help protect against legislative risk. These policies allow you to build cash value over time, which grows tax-deferred, and when structured properly, you can access this cash value tax-free through loans and withdrawals.
This approach not only provides tax-free income in retirement but also offers death benefits to your heirs, helping to avoid the high tax costs that may come with inherited IRAs or other qualified plans.
In addition, IUL policies protect from market downturns, as the cash value grows based on the performance of an index (like the S&P 500) but is not directly invested in the market. This adds a layer of financial security for retirees.
- Municipal Bonds
For those seeking low-risk, tax-free income, municipal bonds can be an attractive option. The interest earned on municipal bonds is generally exempt from federal taxes, and in some cases, state and local taxes as well. By investing in a diversified portfolio of municipal bonds, retirees can enjoy a steady stream of tax-free income.
However, it’s essential to understand that municipal bonds typically provide lower returns than other investment options, so they should be considered as part of a balanced retirement portfolio.
Additional Considerations
While tax-free options provide excellent protection against legislative risk, it’s essential to approach retirement planning with a holistic mindset. Here are some additional factors to consider:
- Diversification: Having a diverse range of assets—including tax-deferred, tax-free, and taxable accounts—can help mitigate risk. If future tax laws change, having multiple types of accounts can provide flexibility and allow you to manage your tax burden in retirement more effectively.
- Stay Informed: Keeping up to date on changes in tax laws and retirement regulations is crucial. Consulting with a financial advisor who is knowledgeable about legislative risks and tax-efficient strategies can help you adapt your plan as laws evolve.
- Charitable Giving: As Christians, charitable giving is an integral part of our financial stewardship. Qualified charitable distributions (QCDs) from IRAs can satisfy RMDs and reduce your taxable income, providing a way to give to causes you care about while minimizing your tax burden.
Conclusion
Legislative risk is a reality that cannot be ignored when planning for retirement. To see how you can best avoid or minimize legislative risk, schedule a free initial consultation. We love creating plans that help our clients get more out of their retirement with less risk.
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Steve is the owner of Faith-Based Health Care and Retirement Resource Management. He is a National Speaker on the topic of Social Security optimization, quoted in national publications like Money Magazine, US News and World Reports, and Fox Business. Steve loves to educate and teach on financial topics like taxation of retirement accounts, long term care, healthcare, and efficient savings plans for small businesses. He has provided financial planning for missionaries through the International Mission Board. You can find Steve at 68 South Main St. in Marion, NC by calling 828-559-0299, email steve@faithbasedhc.com or visit his website at www.faithbasedhc.com.
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