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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Major legislation seeks to address retirement savings crisis

It is no secret that Americans are not saving enough for retirement. According to the Boston College Center for Retirement Research, the US faces a $7 trillion deficit in retirement assets and progress toward improvement has been slow. Nearly half of working adults do not have access to an employer retirement plan and many who do are not contributing sufficiently. A new law signed by the President on December 29 includes some of the most significant and beneficial enhancements to retirement savings options in a generation.

In 2019 Congress adopted the Setting Every Community Up for Retirement Enhancement or SECURE Act which made several changes to the rules around retirement planning. The omnibus spending bill passed in December inluded a major rework known as SECURE 2.0 that goes far beyond the original act in improving access to and participation in employer retirement plans. The bill was aggressively lobbied for by the financial industry, but in a felicitous confluence of interests, individual investors and taxpayers will also benefit from the changes.

Interestingly, a central theme in the Secure 2.0 Act has been dubbed “Rothification”, an increased emphasis on directing retirement investment into Roth accounts funded with after-tax contributions. Congress likes the approach since it front loads tax revenue, while savers benefit over the long-term thanks to tax-free returns. The package contains over 90 separate provisions, but here are a few highlights.

Retirement plans. Beginning in 2025, all new 401(k) or 403(b) plans with over 10 employees will include automatic enrollment with a minimum employee deferral of 3%. Contributions increase by at least 1% annually to between 10% and 15%. Definitive research has demonstrated that default choices impact behavior and that automatic enrollment significantly improves participation. Employees may opt out, and existing plans are currently grandfathered.

Employer plans that include a Roth option will now be able to make matching and nonelective contributions to the employee’s Roth account. Currently, employer contributions must be pretax. Roth employer matches would be reported as income to the participant. In addition, Simple and SEP plans may now also accept after-tax Roth contributions.

The act shortens the waiting period for part-time workers to participate in their employer plan. Employees who work 500 or more hours for 2 consecutive years are eligible to sign up in 2025.

Several incentives are created or expanded to encourage small companies to establish 401(k) plans. An enhanced tax credit to cover startup and administrative expenses as well as a per-employee credit of up to $1,000 is available to employers with less than 50 workers that establish company plans. The act also creates a new bare bones “Starter 401(k)” plan in 2024 that does not require employer contributions or year-end testing but allows employees to contribute up to $6,000 indexed for inflation.

Required minimum distributions. The first SECURE act of 2019 raised the age at which required distributions must begin from 70 ½ to 72. SECURE 2.0 again raises the age for starting RMDs in 2 steps. Individuals born between 1951 and 1959 must begin distributions in the year in which they reach 73. This means that if you turn 72 in 2023 you can hold off until 2024 for your first RMD. For birth dates during or after 1960, the RMD age rises to 75.

Failure to take required distributions on time has resulted in an onerous 50% penalty excise tax. The new law reduces the penalty for missed RMDs to 25% and allows for a reduction to 10% if the error is corrected timely, generally within 2 years.

In addition, the required distribution from Roth 401(k) and 403(b) plans is eliminated starting in 2024 to comport with rules applicable to Roth IRA accounts. Plan participants already subject to Roth RMDs may discontinue distributions in 2024.

Catch-up contributions. Individuals age 50 and over have been able to make additional catch-up contributions to their retirement plans since 2001 at levels periodically adjusted by Congress. SECURE 2.0 indexes future limits for inflation automatically in $100 increments.

The act includes a special plus-up for workers nearing retirement age. Beginning in 2025, individuals turning 60, 61, 63, or 63 during the year may increase their catch-up contribution to 150% of the regular limit or $10,000, which ever is greater. The current limit is $7,500 for 2023.

In an additional wrinkle, employees with income over $145,000 (indexed for inflation) who make catch-up contributions after 2023 must classify them as after-tax Roth contributions included in income. 

Catch-up contributions for ages 60-63 in SIMPLE IRA accounts are subject to a special limit of 150% of the standard amount or $5,000, whichever is greater.

Additional provisions. Certain exemptions from the 10% early withdrawal penalty are included or expanded, including limited distributions for natural disasters, domestic abuse, and terminal illness. Long term care premiums are also exempted from penalty up to $2,500 annually. All are still subject to income tax.

SECURE 2.0 also introduces a new lower income “direct saver’s” provision starting in 2027, matching up to 50% or $2,000 of retirement contributions subject to an income phase-out. In addition, employers will be able to match qualified student loan payments with a direct employer contribution into the individual’s retirement plan.

On balance the legislation provides many incentives for employers to establish or enhance their plans and for savers to step their contributions. It won’t solve the savings crisis, but it’s a big step forward.

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