The SECURE Act, passed in late 2019, changed the rules for saving and withdrawing money from retirement accounts. Also, it was the first major legislative change to tax laws in more than ten years.
An update to this legislation is getting a lot of attention from Congress. Congress passed the bipartisan Secure Act 2.0 earlier this year; two Senate committees introduced different legislation in June. An updated final pension plan could be approved in 2022 after November's midterm elections.
One of the reasons the issue is getting so much attention from politicians in Washington is the lack of retirement preparedness. According to one study, by 2050, there will be a $137 trillion retirement income gap. If the projections hold, retirees in six major economies (including the United States) will outlive their savings by an average of 8 to 20 years. These proposed changes are beneficial in helping people meet their savings and retirement goals. Understanding current laws and their evolution can help you prepare your retirement savings strategy for the future.
The original SECURE Act is now in effect.
The 2019 legislation added significant new improvements to existing retirement savings rules, including:
Access to penalty-free withdrawals of up to $5,000 per year from a savings plan to help offset the expenses of having or adopting a child.
Allowing 529 college savings account holders to use the money in their plan to pay off up to $10,000 per year in eligible student debt.
Eliminating an age limit for traditional IRA contributions. They can now happen at any age, provided the person has received compensation.
Eliminating the ability for unmarried beneficiaries to "stretch out" distributions from an inherited IRA (Individual Retirement Account) over their lifetime. In these circumstances, the full amount of the inherited IRA must be distributed within ten (10) years of its receipt. (Individuals who inherited an Individual Retirement Account before the SECURE Act took effect are protected and can continue to stretch out their RMDs.)
Raising the required minimum distribution (RMD) age from 70½ to 72 years. Delaying your RMD gives you more time to adjust to your job and tax situation, retire a bit later, and potentially be in a lower tax bracket when distributions are required for tax purposes.
The main provisions of the SECURE 2.0 Act and other proposals
Note that the legislation currently being discussed in Congress is only at the proposal stage. Although the changes described below have not yet been implemented, it may be useful to know what might change and consider the potential impact on your retirement savings and income strategies.
Updates on RMD
A proposal in a single package would allow RMDs to be deferred until age 73, beginning in 2022. Thus, the date required to start distributions would shift to age 74 in 2029 and to age 75 in 2032. Other proposals contain variations of this program.
These proposed changes are helpful in helping people meet their savings goals and provide more flexibility in retirement.
In addition, under current legislation, non-compliance with the requirements of RMD results in an excise tax equal to 50% of the amount of the expected distribution for the year. The new proposals would reduce the penalty to 10% or 25% if the person promptly corrected the failure to take a timely RMD.
Extending RMD dates to later ages and reducing the penalty for not taking the required minimum distributions on time are ways to give people more power to determine how and when to withdraw their tax-deferred savings. These changes could also have a tax impact on individuals.
An increase in catch-up contributions
Catch-up contributions help people age 50 and older to allocate additional dollars over the standard maximum contributions to retirement plans (such as 401(k) and IRAs). Under the new proposals, another type of "catch-up contribution" would be created for people aged 62 to 64 (in one plan) or 60 to 63 (in another plan). At that point, people could add $10,000 to a 401(k) or 403(b) plan. This maximum would be indexed to inflation in future years.
Another significant proposed change to the basic requirements of the catch-up contribution scheme is to subject them to Roth tax treatment. This means that the contributions would be paid after tax so as not to reduce the current income of the participants. However, any distributions attributable to these catch-up contributions may qualify for tax-free withdrawals (provided the individual meets the holding period requirements).
The ability to put more income to work in a subsidized retirement savings plan increases retirement savings and reduces current taxable income. As a result, some people can avoid moving to a higher tax bracket by deferring more of their salary and taking advantage of higher upgrade contributions.
Retirement plan contributions for those with student loan debt
Several bills under consideration include a clause that would allow employers to contribute to workplace savings plans (such as 401(k)) for employees who are still repaying student loans. It is not uncommon for young workers in debt to forgo pension plan contributions to continue paying off college loans. Under the proposed law, employers can make contributions on behalf of employees facing this dilemma, even if these employees are not contributing to the pension plan.
This creates a great opportunity for employers to provide an incentive to attract and retain employees. This can effectively bolster a retirement savings plan for young workers burdened with college loans.
Roth employer contributions
Under current law, there is no provision for employer contributions to match after-tax employee contributions to the Roth 401(k) plan. A proposal under consideration would enable (but not require) employers to make matching contributions to Roth 401(k) plans.
Under applicable law, Roth 401(k)s are subject to RMDs.
Early withdrawals without penalty
The previous version of the SECURE Act waived the 10% penalty on early withdrawals from workplace savings plans to cover birth or adoption expenses as long as those expenses were reimbursed to the plan. However, it did not set a timeline for repayment. The new proposals would require a period of three years from the date of withdrawal to fully repay the plan and avoid penalties.
Other proposals involving penalty-free withdrawals from a workplace savings plan include:
"Hardship" withdrawals for people who have experienced domestic violence: Similar to the birth/adoption provisions, the 10% early withdrawal fine would be waived, provided the retirement account is paid off in full within three years of withdrawal.
Distributions to be expected for terminally ill participants: Up to $22,000 can be distributed through penalty-free retirement plans or IRAs to those affected by a declared disaster. In addition, the tax return of these distributions can be spread over three taxation years.
Distributions to pay premiums on specific types of long-term care contracts: For this purpose, up to $2,500 per year can be withdrawn.
Emergency Accounts
Giving employees access to emergency funds would be authorized under a Senate provision. Employers can automatically enroll workers in emergency savings accounts accessed at least once a month. Workers will be allowed to keep up to 3% of their gross pay in this account, up to $2,500. Any excess contributions will be directed to the individual's 401(k) through the employer.
Automatic enrollment in 401(k) plans.
Employers currently have the option of initiating "automatic enrollment" of employees in a company-sponsored retirement plan, which means that employees automatically join the plan unless they opt-out.
The new proposals would require employers to provide self-enrollment and automatic growth capabilities for newly established 401(k) and 403(b) plans. According to the law, the automatically deferred amount would start at 3% or 6% of the compensation. Under one proposal, employees who transfer at least 3% of their annual income to the plan would automatically increase their contributions by 1% each year until they contribute at least 10% of their salary unless they opt out of this feature.
Auto-enrollment can be useful for supporting retirement savings as long as people have enough cash to cover day-to-day expenses.
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