Congress is expected to pass new legislation later this year (SECURE Act 2.0) and this will have big impacts on savings and distributions from retirement plans as well. We’ll be sure to discuss these in our spring meetings and reflect them in your cash flow modeling and financial plans.
- The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 revised existing rules around retirement saving, including raising the age of required minimum distributions (RMDs) and eliminating age limits for traditional IRA contributions.
- New legislation under consideration in Congress includes extending RMDs to later ages and increasing catch-up contribution amounts.
- There are prospects for the revised package to move through Congress before the end of 2022.
The original SECURE Act now in effect
The 2019 legislation added some important new enhancements to existing rules about retirement saving, including:
- Raising the age of required minimum distributions (RMDs) from 70 ½ to 72. Delaying the RMD gives you more time to adjust to what your work and tax situation might be, retire a little bit later, and, when the taxable distribution is required, potentially be in a lower tax bracket.
- Eliminating an age limit for contributions to traditional IRAs. They can now occur at any age provided the individual has earned compensation.
- Removing the ability of non-spouse beneficiaries to “stretch out” distributions from an inherited IRA over their lifetimes. In these circumstances, the entire value of the inherited IRA must be distributed within ten years of its receipt. (Those who inherited an IRA before the SECURE Act took effect are grandfathered in and may continue to stretch out their RMDs.)
- Allowing 529 college savings plan account holders to use funds in their plan to repay up to $10,000 per year in qualified student loan debt.
- Access to penalty-free withdrawals of up to $5,000 per year from a workplace savings plan (such as a 401(k)) to help offset the costs of having or adopting a child.
Key provisions of the SECURE Act 2.0 and other proposals
Keep in mind that legislation currently under consideration in Congress is only in the proposal stage. While the changes laid out below are not yet enacted into law, it can be beneficial to know what may be changing and consider the potential impact on your own retirement savings and income strategies.
Updates to RMDs
A proposal in one package would allow RMDs to be delayed until age 73 beginning in 2022. Then, the required start date for distributions would shift to age 74 in 2029 and age 75 in 2032. Other proposals contain variations on that timeline.
Additionally, under current law, failure to comply with RMD requirements results in an excise tax equal to 50% of the year’s required distribution amount. New proposals would decrease the penalty to 10% or 25% if the individual promptly corrected the failure to take a timely RMD.
An increase in catch-up contributions
Catch-up contributions allow people age 50 and older to set aside additional dollars over the standard maximum contributions to workplace retirement plans (such as 401(k)s) and IRAs. Under new proposals, another form of “catch-up contribution” would be created for those ages 62 to 64 (under one plan) or 60 to 63 (under another plan). At that point, individuals would be allowed to add $10,000 to a 401(k) or 403(b) plan. This maximum would be indexed for inflation in future years.
Another important proposed change to basic catch-up contribution plan requirements is to subject them to Roth tax treatment. That means contributions would occur on an after-tax basis, so they would not reduce current income for participants. However, all distributions attributable to these catch-up contributions would potentially qualify for tax-free withdrawals (if holding period requirements are met).
“The ability to put more income to work in a tax-advantaged retirement savings plan not only boosts retirement savings,” says Darr, “but also reduces current taxable income.” As a result, some individuals may be able to avoid moving into a higher tax bracket by deferring a larger chunk of their salary and taking advantage of expanded catch-up contributions.
Retirement plan contributions for those with student loan debts
Multiple bills under consideration include a provision that would allow employers to make contributions to workplace savings plans for employees who are still repaying student loans. It isn’t unusual for younger workers carrying student debt to forego retirement plan contributions in order to continue to pay off college loans. Under the proposed legislation, employers would be allowed to make contributions on behalf of employees faced with this dilemma, even if those employees do not make retirement plan contributions.
Roth employer contributions
Under current law, there are no provisions that accommodate employer matching contributions to employees after-tax Roth 401(k) plan contributions. One proposal under consideration would allow, but not require, employers to make such matching contributions to Roth 401(k) plans.
Under current law, Roth 401(k)s are subject to RMDs (which do not apply to Roth IRAs). A proposal in the Senate plan would eliminate required distributions from Roth 401(k)s.
Penalty-free early withdrawals
The previous version of the SECURE Act waived the 10% penalty for early withdrawals from a workplace savings plan to meet birth or adoption expenses, provided those expenses are repaid to the plan. However, it did not put a timeline on when repayment had to occur. New proposals would impose a deadline of three years from the date of withdrawal to repay the plan in full to avoid any penalties.
Additional proposals that provide for penalty free withdrawals from a workplace savings plan include:
- “Hardship” withdrawals for individuals who have been subject to domestic abuse. Similar to the birth/adoption provisions above, the 10% early withdrawal penalty would be waived provided the retirement account is repaid in full within three years of the withdrawal.
- Distributions to terminally ill plan participants. Up to $22,000 could be distributed from retirement plans or IRAs on a penalty-free basis for individuals affected by a declared disaster. In addition, tax reporting of these distributions could be spread out over three tax years.
- Distributions to pay premiums on certain types of long-term care contracts. Up to $2,500 per year could be withdrawn for this purpose.
Giving employees access to emergency funds would be allowed under a Senate provision. Employers could automatically enroll workers in emergency savings accounts that could be accessed at least once a month. Workers would be allowed to set aside up to 3% of their gross salary into this account, up to $2,500. Any surplus contributions would be directed to the individual’s 401(k) plan through the employer.
Auto enrollment in 401(k) plans
Employers currently have an option to initiate “automatic enrollment” of employees into a company-sponsored retirement plan, which means employees automatically participate in the plan unless they choose not to.
New proposals would require employers to provide automatic enrollment and automatic increase features to newly-established 401(k) and 403(b) plans. Depending on the piece of legislation, the amount automatically deferred would start at 3% or 6% of compensation. Under one proposal, employees deferring at least 3% of their income annually into the plan would have contributions automatically increased by 1% each year until they’re contributing at least 10% of their pay, unless they choose to opt out of this feature.
As you can see, the new retirement tax rules can have a important implications to both savings for retirement and taking retirement distributions. There are lots of details to understand. Fortunately, we love all the little details and nuances to keep everything on the right track.
As we know more, we’ll provide updates on our blog as well as newsletter and for our client recommendations