According to the professional services firm, PwC: “A quarter of US adults have no retirement savings and only 36% feel their retirement planning is on track. Even for those who are saving, many will likely come up short. We estimate the median retirement savings account of $120,000 for those approaching retirement (age cohort 55 to 64) will likely provide less than $1,000 per month over a 15-year retirement span. That’s hardly enough, even without factoring in rising life expectancies and increasing healthcare costs.”
There was a time when corporate America played a significant role in financing retirement for their employees. Although traditional defined benefit plans are still common in the public sector, the Department of Labor reports that only about 12 million workers in the private sector have them today, which is less than half the number in 1975, although the workforce has more than doubled. During the same period, the number of active participants in defined contribution plans, such as 401(k)s, which are primarily funded by the employees themselves, has grown from about 11 million active participants in 1975 to over 85 million today. Yet even among full-time workers, less than 60% actively participate in their employer-sponsored plan, even though 75% have access, according to the Bureau of Labor Statistics. A recent Bankrate survey found that 36% of all adults have never had any retirement account at all, even an IRA, which doesn’t require an employer sponsor.
This is the situation members of Congress are trying to address as they write new legislation being referred to as Secure Act 2.0. It was in 2019 that the original Secure Act was passed by Congress. Its most notable elements were (1) the elimination of the Stretch IRA*, which had allowed non-spouse beneficiaries to spread withdrawals from their inherited IRA over their life expectancy, but now have to deplete the account within 10 years, and (2) the postponement of required minimum distributions from IRAs and other retirement plans from age 70½ to age 72, which benefits those who can afford to leave their tax-deferred retirement accounts untouched for longer. There were a few provisions that were designed to increase retirement plan participation, but Secure Act 2.0 goes further.
In creating rules for retirement plans, Congress attempts to balance the desire to make them more attractive for taxpayers in the form of tax breaks, but not sacrifice income tax revenue more than is necessary. In the original Secure Act, requiring retirement account heirs to withdraw money sooner acts to accelerate tax collection, while postponing required distributions for IRA owners postpones tax collection for a little while longer. The provisions included in the proposed legislation tweak the rules to break down barriers that may be preventing more people from saving for retirement, without having a major negative impact on tax collection.
One well-publicized barrier is college debt. It is not surprising that a recent ETrade from Morgan Stanley study found that 63% of investors under age 34 said that education costs or paying down loans are barriers to saving for retirement. Workers who are so burdened with college loan payments that they cannot afford to make contributions to their employer’s 401(k) may be missing out on their employer’s matching contribution. To address that problem, the new legislation would allow for an employees’ college loan payment to substitute for a retirement plan contribution and qualify them for the employer’s match.
Also part of the proposed legislation is a requirement that newly-established plans (but not existing plans) would be required to “auto enroll” employees at a certain contribution rate, such as 3%. The employee would have to opt out if they do not wish to, or can’t afford to, participate. To help address the affordability problem, another provision would allow retirement plan participants to self-certify their need for hardship withdrawals from the plan. Also, the penalty on early withdrawals, up to $1,000 per year, would be waived. Alternatively, the legislation could allow the employee to contribute to an “emergency savings account” up to a certain amount, with the excess above a certain amount flowing into the qualified plan.
Another group of people with a low participation rate are part-time workers. Congress would further loosen the criteria for the participation of part-time workers to require 500 hours in two years rather than 500 hours each year for three consecutive years in the original Secure Act. Also, it would take effect in 2023 rather than 2024.
Increasing Contribution Amounts
Although most people do not max out their retirement plan contributions, for those who are nearing retirement and can afford to contribute more, the annual catch-up for participants in employer-sponsored qualified plans who are in their early 60s could be increased to $10,000 from the current $6,500. In SIMPLE IRA or SIMPLE 401(k) plans the increase is to $5,000. This could be an important benefit for people who were perhaps unable to maximize their contributions when they were younger, due to their lower salaries, or the costs of raising children, but now have extra income they can put away for retirement.
However, all catch-up contributions, available to those at least 50, would have to be Roth contributions, which offer no deduction but are tax-free upon withdrawal. This will prevent taxpayers in high tax brackets, who are more likely to be able to afford the larger contributions, from receiving a large upfront tax deduction for their catch-up contribution. (Taxpayers in lower tax brackets are less likely to make catch-up contributions and do not benefit as much from the deduction.) But while losing the deduction will be disappointing to some participants, it may be a better strategy anyway in the long run, if it turns out that today’s tax rates won’t last. Unlike Traditional IRA and 401(k) withdrawals, Roth withdrawals will not be taxed and don’t even have required withdrawals, allowing wealthier taxpayers to benefit from tax-free investing or longer and perhaps leave a tax-free gift to their heirs.
Required Minimum Distributions
Where the original Secure Act raised the age at which minimum required distributions must begin, from 70½ to 72, Secure 2.0 would raise it further to 75, either gradually starting next year or not until 2032, depending on how the House and the Senate reconcile their respective bills. Although most retirement account owners are not in a position to leave their accounts untouched for longer, for those that can afford to do so, they can enjoy a few more years of tax-deferred growth and postpone taxation. They can also have a few more years to convert their Traditional accounts to Roth accounts.
However, waiting to withdraw from Traditional IRAs may not be the optimal strategy for everyone who can afford to wait. Depending on the situation, withdrawing from retirement accounts before it is required may be a more tax-effective strategy for the owner, as well as for the eventual heirs of the accounts, especially if the accounts are converted to Roth IRAs. There are many factors to consider, including marginal tax rates for both the owner and the future heirs, other income sources, and the possible effect on higher Medicare premiums and Social Security taxation. One factor may be the IRA owner’s plans to make Qualified Charitable Distributions from their IRA, which, in effect, provide a tax deduction for charitable contributions that may otherwise not be available as a result of the higher standard deduction.
Secure 2.0 may also include a reduction in the penalty for failing to take the required distribution from 50%, which is rarely assessed, to 25%, and may waive RMDs altogether for anyone with less than $100,000 in retirement plan assets.
Other Potential Provisions
The proposed legislation contains many other changes, including penalty-free distributions from qualified plans to pay for long term care insurance premiums, easier portability for job changers by standardizing rollover forms, and the modification of RMD rules to increase the availability of life annuities in qualified plans and IRAs.
Possible Changes NOT in 2.0
Some members of Congress are concerned about the exploitation of the tax benefits of retirement accounts by the wealthy. This has become a sensitive issue with the recent publicity surrounding the revelation that some super-rich people have built up retirement accounts worth tens of millions (and even billions) of dollars. To address that issue, the Build Back Better legislation, passed by the House but stalled in the Senate, would prohibit additional plan contributions and require minimum distributions if a high-income individual’s total plan balance exceeds $10 million. (The legislation defines high income as taxable income over $400,000 (single) or $450,000 (joint).) Further, high-income individuals would no longer be able to make Roth conversions. Also included is the elimination of the so-called “Backdoor IRA”, which allows taxpayers whose income is too high to qualify to contribute to a Roth IRA to instead contribute to a non-deductible Traditional IRA then immediately convert the account to a Roth IRA.
Status of Secure Act 2.0
The House passed its version of Secure Act 2.0 legislation in March with an overwhelming bipartisan majority. The Senate has two bills that easily passed out of their respective committees and will be combined to form the Senate’s Secure Act 2.0 legislation. Then the two versions of Secure 2.0 will be reconciled to form a final bill to be voted on in each chamber.
As always, if you have questions on the Secure Act or other topics, reach us any time at (833) 888-0534 x2 or by email.