How the SECURE Act Affects Your Retirement & Estate Planning

In late December 2019, President Donald Trump signed into law the Setting Every Community Up for Retirement Enhancement Act (SECURE Act).

Many of the changes volleyed around Capitol Hill for years, and proponents tout them as the most comprehensive retirement changes since the 2006 Pension Protection Act. Given its bipartisan support, the changes aren’t exactly revolutionary. Most changes are incremental, tweaking the existing retirement account rules.

And being a bipartisan bill, it also includes a clever way to raise tax revenue without raising tax rates. Everyone in Washington gets to clap themselves on the back after such maneuvers.

As you plan your retirement, make sure you understand the new rules and adjust your estate planning based on the new rules on inherited IRAs.

Inherited IRAs: Drain in 10

Before the SECURE Act, people who inherited an individual retirement account (IRA) could spread out the withdrawals over their entire lifetime. They still had to take required minimum distributions (RMDs) based on their age, life expectancy, and the amount available in the account. But heirs could spread their withdrawals out over their entire remaining life expectancy.

The days of these “stretch IRAs” are over. The most significant change of the SECURE Act was to require account owners to empty all inherited retirement accounts within 10 years – a clause quickly labeled the “drain-in-10” rule. It removes annual RMDs, instead merely requiring that nothing remains in the account 10 years after passing to an heir.

Note that the drain-in-10 rule applies to non-Roth retirement accounts like traditional IRAs, 401(k)s, and SIMPLE IRAs. Roth accounts come with their own separate inheritance rules, which have remained unchanged.

The Purpose of the Drain-in-10 Rule

Why did Congress stop allowing heirs to draw on their inheritance at a slower, more responsible pace?

In a word, revenue. The IRS taxes withdrawals from traditional IRA accounts as regular income. By forcing heirs to withdraw all the money relatively quickly, the IRA distributions drive heirs’ taxable income into higher tax brackets.

Imagine you’re a single person earning a modest $40,000 per year. According to the 2021 federal income tax brackets, you pay 10% for roughly the first $10,000 of that and 12% for the next $30,000. Your last remaining parent dies and leaves you $400,000 from their IRA.

No matter what, you have to pay taxes on withdrawals. But previously, you could spread withdrawals over the rest of your life and enjoy much of that inheritance as retirement income. For example, you could take $15,000 per year from it to supplement your income, paying the higher 22% tax rate on it since it drove your income into the next tax bracket.

Because of the SECURE Act, you now must instead take $40,000 per year on it, plus returns. You pay the higher 22% tax rate on $40,000 rather than $15,000. The money also stops compounding, as it had been as untouched pre-tax funds in an IRA.

It amounts to serious tax revenue too. Estimates from the Congressional Budget Office put the additional tax revenue from this new rule at $15.7 billion over the next 10 years.

And if you fail to take the required minimum distributions, you must pay the IRS a 50% penalty on the amount you fail to take. Thus, if you were required to withdraw $10,000 but don’t, you pay a $5,000 penalty to the IRS.

Irs Tax Revenue Form Magnifying Glass

Exceptions to the Drain-in-10 Rule

The SECURE Act took effect on Jan. 1, 2020, and is not retroactively applied. Any taxpayers who inherited an IRA or 401(k) previously are exempt.

Other exceptions include surviving spouses, heirs no more than 10 years younger than their benefactor – such as siblings – and people with disabilities. Spouses can roll the inherited IRA into their own traditional IRA or spousal IRA.

Nonspouses cannot roll over funds from an inherited IRA into their own. Their only option is to withdraw the money at regular income tax rates.

A fourth exception exists for minors. The drain-in-10 rule only kicks in once the minor children turn 18 and reach the age of majority. As such, children who inherit an IRA have until age 28 to empty the account without facing IRS penalties.

Problems Trusts Create for Heirs

Some benefactors put their money into trusts upon their death, with detailed instructions for how to release the funds in their estate plan. In some cases, the trust pays out funds a little at a time or releases them only after a predetermined number of years.

These restrictive trusts can create a problem for designated beneficiaries (heirs). For example, if a trust only allows the beneficiary to take the RMD, that could mean releasing the entire balance all at once after 10 years – and require the beneficiary to pay massive income taxes on it.

Forcing heirs to take the entire balance of trust funds in no more than 10 years can also defeat the whole purpose: to spread the inheritance out over many years to prevent the heir from blowing the money on sports cars and gadgets and designer clothing.

Ideas to Minimize Taxes

If you’re planning your estate, talk to a financial advisor before you do anything else. The tax rules on inheritances are complicated and made even more so by estate planning rules. If you don’t currently have a financial advisor, you can find one in your area through SmartAsset.

Benefactors who have set up trusts for their heirs to receive an IRA must consider their structure carefully and make sure they don’t force their heirs to take the entire amount all at once.

One option is to use part of the IRA funds to create a life insurance policy through Bestow with your heir as the named beneficiary. You do pay taxes on premium costs, but your heir doesn’t pay taxes on the payout.

You can also look into trustee-to-trustee transfers for IRA inheritances. But these get complicated quickly, so talk to an estate planning attorney or tax specialist through H&R Block.

If you’re on the receiving end of an IRA inheritance, common sense suggests spreading the withdrawals evenly over the 10 years to minimize your tax burden. You can put the money into your own tax-sheltered retirement accounts, whether an employer-sponsored account, like a 401(k) or 403(b), or an IRA.

Alternatively, if you’re near retirement age, you can wait until you retire before taking withdrawals. You avoid pulling money from the inherited IRA while also collecting earned income, so the combination doesn’t drive up your income tax bracket. Even better, you can delay pulling any money from your own retirement accounts, leaving them to compound and minimizing your sequence of returns risk.

Pro tip: If you haven’t set up your will, consider doing so through a company like Trust & Will. They make the whole process simple and are available to answer any questions you might have along the way.

Additional Retirement Account Changes

While the new drain-in-10 change to inherited IRAs stirred up the most controversy and angst among investors, it’s far from the only change created by the SECURE Act.

Make sure you understand all the rule changes, whether you’re planning out your own retirement investments or you’re a small-business owner considering a retirement plan for your employees.

1. No More Age Restriction on Traditional IRA Contributions

Before the SECURE Act, Americans over age 70 1/2 couldn’t contribute to their traditional IRA accounts.

But Americans are living longer, which usually means they need to work longer and save more to afford retirement. The SECURE Act allows Americans of any age to continue adding money to their traditional IRA.

And why not? From the perspective of the IRS, they can allow older Americans to keep contributing, safe in the knowledge the funds can only remain untaxed for a maximum of 10 years after the contributor’s death.

Particularly savvy planners can take advantage of the ceiling removal with backdoor Roth contributions, allowing them more flexibility to shuffle money based on that year’s income. But talk to a financial planner about such complex maneuvering before trying it at home.

2. Higher Age for Required Minimum Distributions

Under the previous rules, IRA owners had to start taking RMDs at age 70 1/2. The SECURE Act raised the minimum starting age for RMDs to age 72. Again, it only makes sense, with Americans living and working longer.

The exception to the RMD age remains in place: Americans who continue working and don’t own more than 5% of the company where they work don’t have to take RMDs. After retiring, they must start taking RMDs if they’re over age 72.

Retirement Planning Old Couple Walking Up Stacks Of Coins

3. Annuities in 401(k) Plans

Almost no employers included annuities as an option in their 401(k) plans before the SECURE Act. The reason was simple: the old laws held employers liable as having fiduciary responsibility for annuities included in their 401(k) plans.

But the insurance industry lobbied hard to change that rule, and their lobbying dollars paid off in the SECURE Act. The onus of responsibility now falls to insurance providers, not employers, which opens the doors for employers to start considering annuities as options in their retirement plans.

Annuities are complex investments that pay out income over time. Before choosing one in your employer-sponsored plan, speak with a financial advisor about the exact implications, risks, and rewards.

4. More Options for Part-Time Employees

Under the previous laws, employers only had to offer participation in their retirement plans to employees who worked at least 1,000 hours per year for them.

The SECURE Act requires employers to allow more part-time employees to opt in. While the previous rule still applies, employers must also allow access to all employees who work at least 500 hours per year for three consecutive years or more.

The requirement protects part-time employees increasingly piecemealing their income and participating in the gig economy. Saving for retirement is hard enough, even with an employer-sponsored plan. Surviving in a job without benefits makes it dramatically harder.

5. Penalty-Free Withdrawals for New Children

Having children is expensive. Really, really expensive.

The SECURE Act allows account holders to withdraw up to $5,000 from their retirement account when they give birth or adopt a child. The withdrawal is subject to regular income taxes, but it is not subject to the standard 10% penalty.

While not an earth-shaking change, it does make retirement accounts more flexible and encourages Americans to contribute money toward them. The new-child exception works similarly to the down payment exception, which allows account holders to withdraw up to $10,000 from their IRA penalty-free to buy a home.

6. Multiple-Employer Retirement Plans

In a bid to help more employers offer retirement plans, the SECURE Act makes it easier for multiple employers to band together to negotiate affordable plans.

The law removes tax penalties previously faced by multiple-employer plans if one employer failed to meet the requirements. The old law penalized all participating employers. The SECURE Act removed this so-called one-bad-apple rule.

The act also removes another restrictive rule: the requirement that employers must share a “common characteristic” to come together to offer their workers a multiple-employer plan. In practice, that typically meant only companies in the same industry formed multiemployer plans. Now, any group of employers can come together to negotiate with plan administrators and provide the best possible plans for employees.

7. Incentives for Auto-Enrollment

A 2019 study by T. Rowe Price found a startling fact. When employees had to opt into employer-sponsored plans voluntarily, only 44% of them did so. When the employer auto-enrolled them, requiring them to opt out rather than in, the participation rate nearly doubled to 86%.

It makes sense. People tend to take the path of least resistance. But it also means one of the easiest ways to increase employee participation is simply to encourage employers to auto-enroll them.

The SECURE Act creates a new tax credit for employers who start auto-enrolling their employees in a company retirement plan. Though it’s only $500, the tax credit applies not only to employers who start a new retirement plan but also to those who start auto-enrollment for their existing plan. Employers can take it for up to three years after they start auto-enrolling employees for a maximum total tax credit of $1,500.

Finally, it raises the ceiling on what percentage of income employers can set as a default employee contribution. The previous default limit was 10%, and the SECURE Act raises it to 15%.

8. Increase in Tax Credit for New Employer-Sponsored Retirement Plans

Under the previous law, employers could take a maximum tax credit of $500 for up to three years when they started offering a retirement plan for employees.

The SECURE Act expands the tax credit. Employers can claim a tax credit of $250 per eligible employee covered, with a maximum tax credit of $5,000. Sweetening the pot, employers can also take the $500 tax credit for auto-enrolling employees on top of the tax credit for creating a new employer-sponsored retirement plan.

While these numbers seem small, they help offset the costs for small businesses who want to offer retirement plans but have little spare money to spend on them.

Final Word

The SECURE Act is 125 pages long and includes additional provisions not listed above. For example, it requires 401(k) plan administrators to offer “lifetime income disclosure statements,” breaking down the income potential of various investments. Insurance companies can use these income potential breakdowns as a marketing device to pitch their annuities by demonstrating with convenient examples just how much better off they think employees will be if they opt for an annuity over “high-risk” equity funds.

For a full explanation of how the SECURE Act impacts your retirement planning, estate planning, and tax planning, speak to your financial advisor. While many of the changes in the act involve simple tweaks, the change in rules for inherited IRA funds, in particular, has complex implications for your estate planning.

When in doubt, invest more money in your tax-sheltered retirement accounts. After all, it’s better to build too much wealth for retirement than not enough.


What Is a SIMPLE IRA and How Is It Different?

Small companies tend not to offer 401(k) plans, given the administrative costs and headaches associated with them. So where does that leave employees and owners of small businesses who want retirement benefits?

There’s a type of employer retirement account specifically for small businesses called the Savings Incentive Match Plan for Employees – or, as less of a mouthful, its acronym: the SIMPLE IRA. Here’s what you need to know about it.


Like both IRAs and 401(k) accounts, SIMPLE IRA accounts provide a tax-deferred way to save and invest for retirement. Contributions are pre-tax, meaning they come off employees’ adjusted gross income. In other words, the income you contribute to a SIMPLE IRA is not subject to income taxes. And, as with IRAs and 401(k)s, the IRS imposes contribution limits each year on SIMPLE IRAs.

Yet despite the name, SIMPLE IRAs share more in common with a 401(k) than a traditional IRA.

How SIMPLE IRAs Differ From Other IRAs

First and foremost, traditional IRA accounts are created and maintained by the employee. The employee owns the account in every way. By contrast, SIMPLE IRA accounts are employer-sponsored accounts, typically created and maintained by the employer. Normally, the employer chooses a brokerage, such as Schwab or Vanguard, to hold employees’ SIMPLE IRA accounts. That isn’t always the case, though; the employer can opt to leave it up to employees to open and maintain their own SIMPLE IRA accounts.

The contribution limits are also higher for SIMPLE IRAs than for traditional and Roth IRAs. For the tax year 2021, the contribution limit for SIMPLE IRAs is $13,500 for taxpayers under 50, and taxpayers over 50 can make an extra catch-up contribution of $3,000, for a total limit of $16,500. Contrast that with $6,000 for traditional and Roth IRAs with a $1,000 catch-up option for taxpayers over 50.

Speaking of Roth IRAs, there is no Roth option for SIMPLE IRAs. That means you can’t opt to pay taxes on the contributions now and take the earnings tax-free in retirement.

Contributing to Both an IRA & a SIMPLE IRA

Modest-income taxpayers can contribute to both a traditional or Roth IRA and a SIMPLE IRA through a broker like TD Ameritrade. The same IRS contribution rules apply to both SIMPLE IRAs and 401(k)s when combined with traditional or Roth IRAs. Above a certain income, your ability to contribute to both an IRA and an employer-sponsored retirement plan phases out, and at a certain level, it disappears entirely; see IRS deduction limits here.

How SIMPLE IRAs Differ From 401(k)s

As an employer-sponsored plan, SIMPLE IRA accounts are a cheaper, more flexible alternative to 401(k)s for small businesses with fewer employees. Employers contribute money, but without the administrative headaches and fees that come with 401(k)s.

One similarity worth noting between SIMPLE IRAs and 401(k)s is the income cap on employer contributions. Employers can only contribute based on the first $280,000 of an employee’s income; after that, all obligation ends on the part of the employer.

However, employee contribution limits for SIMPLE IRAs, as outlined above, differ from those for 401(k)s. Employees can contribute more to 401(k) accounts – up to $19,500 per year for employees under 50 or $26,000 per year for employees over 50.

And the differences don’t end there.

1. Contribution Requirement

With a 401(k), employers are not obligated to contribute any money to their employees’ retirement savings. That’s not so with SIMPLE IRAs. For these accounts, employers are legally required to offer one of two contribution plans for employees:

  • A “nonelective” contribution equaling 2% of the employee’s salary, no strings attached.
  • A matching contribution of up to 3% of the employee’s salary. If the employee doesn’t contribute, the employer doesn’t contribute.

With the latter, the employer can opt to only match 1% of the employee’s contributions for two out of five consecutive years. That’s a particularly useful caveat for startups tight on cash in their early years.

The contribution requirement applies to all employees earning $5,000 or more in each of the last two years who have a “reasonable expectation” of earning over $5,000 this year. For 401(k) accounts, employers typically require one year’s service – the legal minimum – rather than two. Employers must include SIMPLE IRA coverage for part-time employees earning $5,000 or more, not just full-time employees.

Two other exceptions exist: Employers can exclude employees who receive benefits under a collective bargaining agreement and nonresident alien employees who received no U.S. source income.

2. Rollover Restrictions

Unlike with a 401(k), employees must have participated in a SIMPLE IRA account for at least two years in order to roll it over to a different type of retirement account, such as a traditional IRA or 401(k). If they’ve participated for less than two years when they change jobs, they can only roll over funds to another SIMPLE IRA account.

That makes it tricky for employees moving to a new company that doesn’t offer a SIMPLE IRA. After all, forgetting about past employers’ retirement accounts is a classic retirement planning mistake to avoid.

Fortunately, once two years have passed since the first contribution to a SIMPLE IRA, employees can then roll over the funds to a different type of retirement account – with the exception of a Roth IRA since there is no Roth option for SIMPLE IRA accounts.

If you’re trying to roll over funds after changing jobs, read up on the rollover process for SIMPLE IRA accounts.

3. Greater Investment Flexibility

One drawback of 401(k) plans is that employees are stuck with whatever investment options the plan administrator offers. But since employees open SIMPLE IRA accounts directly with a brokerage, they can choose their own investments, such as stocks, bonds, mutual funds, and ETFs. Most brokerages allow employees broad flexibility to choose investments. Employees can even invest in target-date funds in most cases, relieving them of worrying about shifting their asset allocation as they approach retirement.

4. Easier & Cheaper for Both Employees & Employers

Instead of hiring a 401(k) plan administrator, employers can simply open accounts with a brokerage. That means they can avoid both the initial setup fee and, in some cases, ongoing maintenance fees. For example, Charles Schwab charges no monthly or annual fees for SIMPLE IRA accounts. That’s a stark contrast to 401(k) fees, which can be high for both employers and employees.

There is one drawback to keep in mind: Unlike with a 401(k), employers must set up a separate account for each employee – if they take on the responsibility of opening the accounts, that is. Employers can opt to let employees open their own SIMPLE IRA accounts. In that case, all employers have to do is fund the accounts each payroll cycle.

5. Higher Penalties for Early Withdrawal

When you take an early withdrawal or distribution from your retirement account before age 59½, the IRS frowns upon it. It then slaps you with both a 10% penalty and the full income taxes due on the money you withdrew. That applies to IRAs, 401(k)s, 403(b)s, and SIMPLE IRAs.

But SIMPLE IRAs don’t stop there. If you take a distribution before you turn 59½ and within the first two years of participating in your SIMPLE IRA plan, the penalty increases from 10% to 25%.

There are a couple of exceptions to this penalty. You can avoid it if:

  • You incur non-reimbursed medical expenses and use the withdrawal to cover them.
  • You receive the SIMPLE IRA account from someone who died.

6. Company Size Restrictions

Unlike a 401(k), SIMPLE IRA accounts are only for small businesses. Companies must have under 100 employees to qualify as small enough to offer a SIMPLE IRA – specifically, 100 eligible employees who earn $5,000 or more each year. Employees earning under $5,000 per year don’t count toward the cap, nor do independent contractors. Anyone paid via 1099 also doesn’t count toward the employee limit.

Similarly, small-business owners aren’t obligated to pay SIMPLE IRA contribution benefits to independent contractors, unlike part-time employees.

7. No Loans Allowed

While many 401(k) administrators allow employees to borrow money from their 401(k) accounts, the same is not true of SIMPLE IRAs. They share this feature with traditional IRAs. So don’t count on pulling money from your SIMPLE IRA in a pinch without incurring distribution penalties.

Creating a SEP IRA vs. a SIMPLE IRA

For self-employed workers and small companies with only a few employees, a SEP IRA may be a better choice. That’s because the contribution limit for SEP IRAs is a whopping $58,000 per year. Even though self-employed people can contribute $13,500 on the employee side and up to another $13,500 on the employer profit-sharing side for SIMPLE IRAs, the contribution limit for SEP IRAs is still more than double that. Prior year contributions are also allowed in SEP IRAs, unlike with SIMPLE IRAs.

Before deciding between a SEP IRA and a SIMPLE IRA, speak with your tax preparer or another financial advisor.

5 Steps to Create a SIMPLE IRA

Interested in moving forward with a SIMPLE IRA retirement savings plan for your small business? Here are five quick steps to follow.

Step 1: Confirm Eligibility

As long as you have fewer than 100 employees earning $5,000 per year or more, your business qualifies. It’s as simple as that.

Step 2: Pick a Provider

Choose a brokerage firm that offers SIMPLE IRA accounts. Notable examples include TD Ameritrade, T. Rowe Price, Fidelity, Vanguard, Charles Schwab, Edward Jones, and most other big-name brokerage firms.

Make sure you clearly understand the fee structure before committing. For example, Vanguard charges $25 per account per year but waives the fee for high-value accounts. As mentioned above, Schwab doesn’t charge a maintenance fee on SIMPLE IRA accounts.

Step 3: Complete the IRS Forms

The IRS wouldn’t be the IRS if they didn’t make you fill out forms.

While your brokerage provider will have their own forms they require you to fill out, you also need to give a specific form to your employees. Which form you need depends on who’s opening the SIMPLE IRA accounts.

  • IRS Form 5305-SIMPLE. If you open SIMPLE IRA accounts with the brokerage yourself on your employees’ behalf, use this form.
  • IRS Form 5304-SIMPLE. If you have your employees open their own SIMPLE IRA accounts with the brokerage of their choice, use this form.

Employers do not need to file this form with the IRS but should keep copies in case they ever get a call from Uncle Sam.

Step 4: Enroll Your Employees

Typically, your plan provider helps you enroll your employees. They provide the signup and enrollment links, normally handling it all online.

One quirk worth noting, however, is that employers can only set up a SIMPLE IRA during the first three quarters of the year. After October 1st, companies have to wait until the following year if they want to create a SIMPLE IRA.

Step 5: Set Up Contribution Payments

Making payments simply involves setting up direct deposits from payroll for each participating employee. Remember, contributions must be taken out before payroll taxes are processed. Otherwise, it would defeat the entire purpose.

Final Word

For small businesses, offering employees a SIMPLE IRA is a low-cost, low-headache alternative to a 401(k) plan. With no setup fees and potentially no maintenance fees, the only significant costs to employers are the contributions themselves.

Still, SIMPLE IRAs come with their own rules, requirements, and restrictions, so make sure you understand them all before making any commitments to employees.


Indexed Universal Life (IUL) vs. 401(k)

Indexed Universal Life (IUL) vs. 401(k) – SmartAsset

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When creating your personal retirement plan, there are a variety of tools you can use to fund your long-term savings goals. An employer-sponsored 401(k) is one of them while indexed universal life insurance (IUL) is another. A 401(k) allows you to invest money on a tax-deferred basis while also enjoying a tax deduction for contributions. Indexed universal life insurance allows you to secure a death benefit for your loved ones while accumulating cash value that you can borrow against. Understanding the differences and similarities between IUL vs. 401(k) matters for effective retirement planning. Working with a financial advisor can also make a substantial difference in the amount of money you’ll have when you retire.

What Is Indexed Universal Life Insurance?

Indexed universal life insurance is a type of permanent life insurance coverage. When you buy a policy, you’re covered for the rest of your natural life as long as your premiums are paid. When you pass away, the policy pays out a death benefit to your beneficiaries.

During your lifetime, an IUL insurance policy can accumulate cash value. Part of the premiums you pay are allocated to a cash-value account. That account tracks the performance of an underlying stock index, such as the Nasdaq or S&P 500 Composite Price Index. As the index moves up or down, the insurance company credits the cash value portion of your policy each year with interest.

IUL is different from fixed universal life insurance or variable universal life insurance. With fixed universal life insurance your rate of return is guaranteed, making it the least risky of the three. With variable universal life insurance, your cash value account is invested in mutual funds and other securities so you’re exposed to more risk. An indexed universal life insurance policy fits in the middle of the risk spectrum.

Cash value that accumulates inside an IUL insurance policy grows tax-deferred. You can borrow against this cash value if necessary, though any loans left unpaid at the time you pass away are deducted from the death benefit.

What Is a 401(k)?

A 401(k) is a type of qualified retirement plan that allows you to set money aside for retirement on a tax-advantaged basis. Contributions are deducted from your paychecks via a salary deferral. Your employer can also offer a matching contribution. The IRS limits the amount you can and your employer can contribute each year.

With a traditional 401(k), contributions are made using pre-tax dollars. Any money you contribute is automatically deducted from your taxable income from the year. When you begin taking money out of your 401(k) in retirement, you’ll pay ordinary income tax on withdrawals. Any withdrawals made before age 59.5 may be subject to a 10% early withdrawal penalty as well as income tax.

Traditional 401(k) plans allow you to invest in a variety of securities, including mutual funds and exchange-traded funds. Target-date funds are also a popular option. These funds automatically adjust your asset allocation based on your target retirement date.

There’s no death benefit component with a 401(k). This is money you save during your working years that you can tap into in retirement. Unless you’re still working with the same employer, you’re required to begin taking minimum distributions from a 401(k) beginning at age 72. Failing to do so can trigger a tax penalty equivalent to 50% of the amount you were required to withdraw.

IUL vs. 401(k): Which Is Better for Retirement Savings?

Indexed universal life insurance and 401(k) plans can both be used as investment tools for retirement. But there are some important differences to note. With IUL, returns are tied to the performance of an underlying index. If the index performs well, then your policy earns a higher interest rate. If the index underperforms, on the other hand, your returns may shrink. Your insurance company can also cap the rate of return credited to your account each year, regardless of how well the underlying index does. For instance, you may have a cap rate of 3% or 4% annually.

In a 401(k) plan, you have the option to invest in index mutual funds or ETFs but you’re not locked in to just those investments. You can also choose actively managed funds, target-date funds and other securities, based on your time frame for investing, goals and risk tolerance. Your rate of return is still tied to how well those investments perform but there’s no cap. So, if you invest in an index fund that goes up by 20%, you’ll see that reflected in your 401(k) balance.

A 401(k) also affords the advantage of an employer matching contribution. This is essentially free money you can use to grow retirement wealth. With an indexed universal life insurance policy, you’re responsible for paying all of the premium costs.

Another big difference between the two centers on tax treatment and withdrawals. With an indexed universal life insurance policy, you can borrow against the cash value at any time. You’ll pay no capital gains tax on loans and no penalties unless you surrender the policy completely or fail to repay what you borrow. Death benefits pass to your beneficiaries tax-free.

With a 401(k), you generally can’t tap into this money penalty-free before the age of 59.5, even in the case of a hardship withdrawal. You may be able to avoid a tax penalty if you’re withdrawing money for qualified medical expenses but you’d still owe income tax on the distribution. You could take out a 401(k) loan instead but that also has tax implications. If you separate from your employer with an outstanding loan balance and fail to repay the loan in full, the entire amount can be treated as a taxable distribution.

Qualified distributions in retirement are taxable at your regular income tax rate. And if you pass away with a balance in your 401(k), the beneficiary who inherits the money will have to pay taxes on it. Talking with a tax professional or your financial advisor can help you come up with a plan for managing tax liability efficiently both prior to retirement and after.

The Bottom Line

Indexed universal life insurance and a 401(k) plan can both help you build wealth for retirement but they aren’t necessarily interchangeable. If you have a 401(k) at work, this may be the first place to start when creating a retirement savings plan. You can then decide if IUL or another type of life insurance is needed to supplement your workplace savings as well as the money you’re investing an IRA or brokerage account.

Tips for Investing

  • When using a 401(k) to invest for retirement, pay close attention to fees. This includes the fees charged by the plan itself as well as the fees associated with individual investments. If a mutual fund has a higher expense ratio, for instance, consider whether that cost is justified by a consistently higher rate of return.
  • Consider talking with a financial advisor about how to maximize your 401(k) plan at work and whether indexed universal life insurance is something you need. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to get personalized recommendations for professionals in your local area in just minutes. If you’re ready, get started now.

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Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.

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Should I Move the Money in My 401(k) to Bonds?

Should I Move the Money in My 401(k) to Bonds? – SmartAsset

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An employer-sponsored 401(k) plan may be an important part of your financial plan for retirement. Between tax-deferred growth, tax-deductible contributions and the opportunity to take advantage of employer matching contributions, a 401(k) can be a useful tool for investing long term. Managing those investments wisely means keeping an eye on market movements. When a bear market sets in, you may be tempted to make a flight to safety with bonds or other conservative investments. If you’re asking yourself, “Should I move my 401(k) to bonds?” consider the potential pros and cons of making such a move. Also, consider talking with a financial advisor about what the wisest move in your portfolio would be.

Bonds and the Bear Market

Bear markets are characterized by a 20% or more decline in stock prices. There are different factors that can trigger a bear market, but generally they’re typically preceded by economic uncertainty or a slowdown in economic activity. For example, the most recent sustained bear market lasted from 2007 to 2009 as the U.S. economy experienced a financial crisis and subsequent recession.

During a bear market environment, bonds are typically viewed as safe investments. That’s because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it’s typical to see bond prices increasing and yields falling just before the recession reaches its deepest point. Bond prices also move in relation to interest rates, so if rates fall as they often do in a recession, then bond prices rise.

While bonds and bond funds are not 100% risk-free investments, they can generally offer more stability to investors during periods of market volatility. Shifting more of a portfolio’s allocation to bonds and cash investments may offer a sense of security for investors who are heavily invested in stocks when a period of extended volatility sets in.

Should I Move My 401(k) to Bonds?

Whether it makes sense to move assets in your 401(k) away from mutual funds, target-date funds or exchange-traded funds (ETF) and toward bonds can depend on several factors. Specifically, those include:

  • Years left to retirement (time horizon)
  • Risk tolerance
  • Total 401(k) asset allocation
  • 401(k) balance
  • Where else you’ve invested money
  • How long you expect a stock market downturn to last

First, consider your age. Generally, the younger you are, the more risk you can afford to take with your 401(k) or other investments. That’s because you have a longer window of time to recover from downturns, including bear markets, recessions or even market corrections.

If you’re still in your 20s, 30s or even 40s, a shift toward bonds and away from stocks may be premature. The more time you keep your money in growth investments, such as stocks, the more wealth you may be able to build leading up to retirement. Given that the average bear market since World War II has lasted 14 months, moving assets in your 401(k) to bonds could actually cost you money if stock prices rebound relatively quickly.

On the other hand, if you’re in your 50s or early 60s then you may already have begun the move to bonds in your 401(k). That might be natural as you lean more toward income-producing investments, such as bonds, versus growth-focused ones.

It’s also important to look at the bigger financial picture in terms of where else you have money invested. Diversification matters for managing risk in your portfolio and before switching to bonds in your 401(k), it’s helpful to review what you’ve invested in your IRA or a taxable brokerage account. It’s possible that you may already have bond holdings elsewhere that could help to balance out any losses triggered by a bear market.

There are various rules of thumb you can use to determine your ideal asset allocation. The 60/40 rule, for example, dictates having 60% of your portfolio in stocks and 40% dedicated to bonds. Or you may use the rule of 100 or 120 instead, which advocate subtracting your age from 100 or 120. So, if you’re 30 years old and use the rule of 120, you’d keep 90% of your portfolio in stocks and the rest in bonds or other safer investments.

Consider Bond Funds

Bond mutual funds and bond ETFs could be a more attractive option than traditional bond investments if you’re worried about bear market impacts on your portfolio. With bond ETFs, for example, you can own a collection of bonds in a single basket that trades on an exchange just like a stock. This could allow you to buy in low during periods of volatility and benefit from price appreciation as you ride the market back up. Sinking money into individual bonds during a bear market or recession, on the other hand, can lock you in when it comes to bond prices and yields.

If you’re weighing individual bonds, remember that they aren’t all alike and the way one bond reacts to a bear market may be different than another. Treasury-Inflation Protected Securities or TIPS, for example, might sound good in a bear market since they offer some protection against inflationary impacts but they may not perform as well as U.S. Treasurys. And shorter-term bonds may fare better than long-term bonds.

How to Manage Your 401(k) in a Bear Market

When a bear market sets in, the worst thing you can do is hit the panic button on your 401(k). While it may be disheartening to see your account value decreasing as stock prices drop, that’s not necessarily a reason to overhaul your asset allocation.

Instead, look at which investments are continuing to perform well, if any. And consider how much of a decline you’re seeing in your investments overall. Look closely at how much of your 401(k) you have invested in your own company’s stock, as this could be a potential trouble spot if your company takes a financial hit as the result of a downturn.

Continue making contributions to your 401(k), at least at the minimum level to receive your employer’s full company match. If you can afford to do so, you may also consider increasing your contribution rate. This could allow you to max out your annual contribution limit while purchasing new investments at a discount when the market is down. Rebalance your investments in your 401(k) as needed to stay aligned with your financial goals, risk tolerance and timeline for retiring.

The Bottom Line

Moving 401(k) assets into bonds could make sense if you’re closer to retirement age or you’re generally a more conservative investor overall. But doing so could potentially cost you growth in your portfolio over time. Talking to your 401(k) plan administrator or your financial advisor can help you decide the best way to weather a bear market or economic slowdown while preserving retirement assets.

Tips for Investing

  • It’s helpful to review your 401(k) at least once per year to see how your investments are performing and whether you’re still on track to reach your retirement goals. If you notice that you’re getting overweighted in a particular asset class or stock market sector, for example, you may need to rebalance to get back on track. You should also review the fees you’re paying for your 401(k), including individual expense ratios for each mutual fund or ETF you own.
  • Consider talking to a professional financial advisor about the best strategies to implement when investing in bear markets and bull markets as well. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors online. It takes just a few minutes to get your personalized advisor recommendations. If you’re ready, get started now.

Photo credit: ©, © Kavaleuskaya, ©

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She’s worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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