It’s no secret that Americans aren’t saving enough for retirement. According to the Boston College Center for Retirement Research, the United States 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 pension plan and many of them do not contribute enough. A new law signed by the president on Dec. 29 includes some of the biggest and most beneficial improvements to retirement savings options in a generation.
In 2019, Congress passed the Setting Every Community Up for Retirement Enhancement or SECURE Act, which made several changes to retirement planning rules. The omnibus spending bill passed in December included a major overhaul known as SECURE 2.0 that goes far beyond the original law by improving access to and participation in employer pension plans. The bill has been aggressively lobbied by the financial industry, but in a happy confluence of interests, individual investors and taxpayers will also benefit from the changes.
Interestingly, a central theme of the Secure 2.0 Act has been dubbed “Rothification,” an increased emphasis on directing retirement investments into Roth accounts funded by after-tax contributions. Congress likes the approach because it takes tax revenue, while savers benefit in the long run through tax-exempt returns. The package contains over 90 distinct layouts, but here are some highlights.
Retirement plans. Starting in 2025, all new 401(k) or 403(b) plans with more than 10 employees will include automatic enrollment with a minimum 3% employee rollover. Contributions increase by at least 1% per year to reach between 10% and 15%. Definitive research has shown that default choices impact behavior and auto-registration significantly improves engagement. Employees can opt out and existing plans are currently grandfathered.
Employer plans that include a Roth option will now be able to make matching, non-optional contributions to the employee’s Roth account. Currently, employer contributions must be pre-tax. Roth employer correspondence would be reported as income for the participant. In addition, Simple and SEP plans can now also accept Roth contributions after tax.
The law shortens the waiting period for part-time workers to participate in their employer’s plan. Employees who work 500 hours or more for 2 consecutive years can enroll in 2025.
Several incentives are being created or expanded to encourage small businesses to establish 401(k) plans. An enhanced tax credit to cover start-up and administrative expenses as well as a per-employee credit of up to $1,000 is available to employers with fewer than 50 workers who set up company plans. The law also creates a simple new “Starter 401(k)” plan in 2024 that does not require employer contributions or year-end tests, but allows employees to contribute up to $6,000 indexed. on inflation.
Minimum distributions required. The first SECURE law of 2019 raised the age at which required distributions must begin from 70½ to 72. SECURE 2.0 again increases the age to start RMDs in 2 steps. People born between 1951 and 1959 must begin distributions the year they turn 73. This means that if you turn 72 in 2023, you can wait until 2024 for your first RMD. For dates of birth during or after 1960, the RMD age increases to 75 years.
Failure to take the required distributions on time resulted in a onerous 50% excise tax. The new law reduces the penalty for missed RMDs to 25% and allows a reduction to 10% if the error is corrected in a timely manner, usually within 2 years.
In addition, the required distribution of Roth 401(k) and 403(b) plans is eliminated starting in 2024 to comply with the rules applicable to Roth IRA accounts. Plan participants already subject to Roth RMDs can discontinue distributions in 2024.
Catch-up contributions. Since 2001, people age 50 and older have been able to make additional catch-up contributions to their retirement plan at levels periodically adjusted by Congress. SECURE 2.0 automatically indexes future inflation limits in $100 increments.
The law provides for a special increase for workers close to retirement age. Starting in 2025, people who turn 60, 61, 63 or 63 during the year can increase their catch-up contribution to 150% of the regular limit or $10,000, whichever is greater. The current limit is $7,500 for 2023.
In an added wrinkle, employees with income over $145,000 (indexed to 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. Some exemptions from the 10% early withdrawal penalty are included or extended, including limited distributions for natural disasters, domestic violence and terminal illnesses. Long-term care premiums are also penalty-exempt up to $2,500 per year. All remain subject to income tax.
SECURE 2.0 also introduces a new low-income “direct saver” provision starting in 2027, matching up to 50% or $2,000 of pension contributions subject to income phase-out. In addition, employers will be able to match eligible student loan repayments with a direct employer contribution to the individual’s retirement plan.
Overall, the legislation provides many incentives for employers to establish or improve their plans and for savers to spread their contributions. It won’t solve the savings crisis, but it’s a big step forward.
Christopher A. Hopkins is a Certified Financial Analyst and co-founder of Apogee Wealth Partners in Chattanooga.