As has been widely publicized lately, there is a looming retirement savings crisis in America. Only 40% of Americans have any savings at all in retirement accounts and the median American worker has nothing saved for retirement. As an attempt to help solve this crisis, the House of Representatives passed the Securing a Strong Retirement Act of 2022 (aka the SECURE 2.0 Act), building upon the Setting Every Community Up for Retirement Enhancement Act (aka the SECURE Act) of 2019. The legislation is currently in committee in the Senate.
What Changes Does the SECURE ACT 2.0 Make?
The first and perhaps the most consequential change this legislation makes is making it mandatory that employers auto-enroll their employees in a retirement savings plan. The default settings are:
- Pre-tax contributions are to be 3% of the employee’s gross income.
- Contribution percentages increase by 1% each year to at least 10% of gross income, but not to exceed 15% of gross income.
- Contributions will be invested in a qualified default investment alternative like a target date fund, a balanced fund or a managed account.
-Participants can change these settings at any time but they must be prompted to do so.
-This only applies to businesses with over 10 employees who have been in business for at least 3 years. There are also exemptions for church and government plans.
The next set of changes the SECURE Act 2.0 makes are around the topic of “catch-up” contributions.
- For those aged between 62 and 64, the catch-up contribution to defined contribution plans like 401ks and 403bs increases to $10,000. The additional catch-up contribution allowed for those between age 50 and 62 remains the same.
- The $1,000 additional catch-up contribution allowed for IRAs for participants aged 50 years and older, will be indexed to inflation starting in 2023. It is currently not indexed to inflation.
- Starting in 2023, all catch-up contributions must be made to Roth IRAs. That means plan participants will pay income taxes on their contributions in the year they’re made, but they won’t pay income taxes on those contributions when they start to withdraw them.
Other changes to the rules around retirement plans include:
- Allowing employees to have their employer’s matching contributions treated as a Roth IRA contribution, meaning said contributions will be included in the employees’ gross taxable income. But, employees won’t pay taxes on those contributions when they withdraw them in retirement.
- Delaying the start date for required minimum distributions (RMDs). Now, participants in defined contribution plans like 401ks must start taking their required minimum distributions starting at age 70 ½. If the SECURE 2.0 Act passes, it will delay the start of RMDs until 73 in 2023 (if you reach age 72 between 1/1/2023 and 12/31/2029), 74 in 2030 (if you reach age 73 between 1/1/2030 and 12/31/2032), and 75 in 2033 (if you reach 74 after 12/31/2032).
- Employers can provide matching contributions to employees for student loan payments, even if those employees aren’t currently contributing to their retirement plan.
- It expands the eligibility for long-term, part-time employees to participate in their employer’s defined contribution plan. Right now, part-time employees become eligible after working for an employer for 3 years. The SECURE 2.0 Act shortens that time period down to 2 years.
- It will create a lost-and-found database for people to locate retirement accounts they had with former employers.
- It offers a tax incentive to small businesses of $1,000 per employee if they offer a retirement plan.
What Problems does the SECURE 2.0 Act Solve?
There are some things about this legislation to applaud. Allowing employers to provide 401k contribution matching for student loan payments can benefit both employer and employee. The employee receives a retirement benefit for paying their student loans, and by providing this matching it could make it easier for the employer to pass non-discrimination tests as long as those paying off their student loans aren’t highly compensated employees.
Creating a database that enables people to locate retirement accounts they had with previous employers could potentially cut down on the number of abandoned accounts and lead to greater retirement savings for individuals. And shortening the time in which part-time employees become eligible for the employer-sponsored retirement benefit and providing small businesses an incentive to offer employees a retirement savings plan could result in increased access to retirement savings accounts.
On the surface, these are all good things. But they don’t solve the structural problems inherent in the 401k industry and some of the provisions laid out in the SECURE 2.0 Act aren’t going to benefit those that need it most.
What the SECURE 2.0 Act Doesn’t Solve
- Auto-enrolling employees with a default contribution rate of 3% their gross income, and then automatically increasing the contribution percentage by 1% per year might sound like a good way to force savings. But it could catch some employees by surprise and they might not be prepared to allocate that much of their monthly or annual budget to their retirement account.
- The lack of retirement savings among mid to low income earners. Increasing the catch-up contribution amount will likely only benefit high earners who can afford to set aside an additional $10,000 a year for their retirement account. Taking away the tax deferral benefit of catch-up contributions by requiring they’re deposited in a Roth IRA, makes it even more difficult for mid to low income earners to afford these additional contributions.
- Delaying RMDs might be a good thing if you’re a high earner and you plan to continue working into your 70’s. That way you don’t have to pay income taxes on both your traditional income and your retirement distributions. However, by delaying these distributions, individuals will be taking larger chunks of money over a shorter period of time and might be subject to higher taxes because of this.
- The structural problems inherent in the 401k system. These types of retirement accounts are expensive to set up and administer, making it difficult for small businesses to offer this benefit (even with a $1,000/employee incentive). The fiduciary risk these plans carry is also a burden many companies, big, medium or small, can’t justify. The lack of portability of 401k plans and the cost of rollovers means that even if individuals find their long-lost retirement accounts, they will be left with the choice of managing and continuing to keep track of separate accounts or engaging in an expensive rollover.
While the SECURE 2.0 Act attempts to solve many facets of the looming retirement crisis in America, it doesn’t do enough to increase access to and the usability of retirement savings accounts for most Americans.
Icon’s payroll IRA is a portable, low-cost (for both plan participants and employers) retirement benefits solution that is easy to set and use. There’s no fiduciary risk to employers and employees always have access to their money.