Historically speaking, retirees have typically relied on three primary tools to help them prepare for retirement: pension plans, Social Security, and defined contribution plans, like 401(k) plans.
That’s no longer the case. Pension plans are virtually non-existent, falling from nearly half of private sector participation in the mid-1980s to less than 15% today.
As for Social Security, while it still provides the vast majority (90%) of income for nearly a quarter of retirees, the trust fund is facing a historic deficit, and without intervention, it will be depleted by the mid-2030s.
LAWMAKERS ARE STEPPING IN
Faced with these obstacles, lawmakers are turning their attention to 401(k) plans, which are available to 68% of private industry workers, yet only 50% utilize them.
This is welcome news. By the end of this decade, the percentage of the U.S. population 65 or older will increase 40%, from 15% to 21%, according to the Census Bureau. Most concerning - nearly two-thirds of adults think they aren’t saving enough for retirement.
A new bill, expected to reach President Joe Biden's desk by the end of the year, could usher in wide-sweeping changes to 401(k) plans. It could include auto-enrolling workers, escalating contributions over time, increasing contribution limits, integrating student loan repayments, delaying mandatory withdrawals, allowing part-time employee participation, and lowing costs for small businesses.
Critics of the bill point out that 401(k) plans tend to favor the wealthy, since, under the current program, an employee in the highest tax bracket saves 37%, while an employee in the lowest tax bracket gains a pre-tax advantage of only 10% on deferred income. Additionally, less than 40% of lower-paid workers have retirement accounts, compared with 80% of middle- and upper-income families.
Nevertheless, lawmakers believe that radical changes to what has now become this country’s primary retirement vehicle are in order. Here’s a look at how 401(k) plans may soon change as part of the SECURE 2.0 bill winding its way through Congress;
SECURE 2.0 would require employers to automatically enroll eligible workers into their 401(k) or 403(b) at a 3% (of salary) rate of savings. As it stands now, most employees must “opt-in” to participate, and then elect their own contribution level.
It’s worth noting that workers would still have the option to “opt-out” of the plan or change their contribution level after enrollment, but studies have shown that automatically enrolling workers into these plans makes a substantial impact on program participation.
Just consider that while over 15% of employers currently offer automatic enrollment, 90% of new hires at these companies wind up participating in retirement plans. This is staggering, especially when compared with just 28% who work for employers who practice voluntary enrollment in their 401(k) and 403(b) plans.
AUTO-ESCALATION OF CONTRIBUTIONS
SECURE 2.0 would automatically increase contribution rates for 401(k) and 403(b) enrollees by 1% each year until their contribution reaches 10% annually.
INCREASE IN CATCH-UP CONTRIBUTIONS
SECURE 2.0 would allow workers between the ages of 62 and 64 to increase their annual catch-up contributions to $10,000, up from $6,500 now. It’s important to note that unlike today’s pre-tax contributions, these newly proposed catch-up contributions would be taxed as Roth contributions, meaning they'd be taxed before being invested for retirement.
STUDENT LOAN PAYOFFS WHILE SAVING FOR RETIREMENT
SECURE 2.0 would allow employers to treat student loan repayments as elective retirement account deferrals, allowing them to provide a matching contribution to an employee’s 401(k). For example, if a company offers a 6% contribution match, dollar-for-dollar, employees who pay $2,500 in student loan debt during the year would see a $150 company match ($2,500 x .06) into their 401(k).
Such a change would allow student loan borrowers, who typically pay off those loans before participating in retirement plans, to participate in these plans at a much younger age, taking full advantage of the compounding effects of retirement savings.
DELAYED MANDATORY WITHDRAWALS
SECURE 2.0 would increase the minimum age enrollees must begin withdrawing money from their retirement accounts from 72 to 75 years of age, allowing three additional years of tax-free growth on their retirement investments.
REDUCED TAX PENALTIES FOR FAILING TO WITHDRAWL
With Americans living longer and retiring later, SECURE 2.0 would reduce the penalties for those who fail to withdraw required minimum distributions from their account after age 75 from 50% to 25%.
PART-TIME WORKER PARTICIPATION
SECURE 2.0 would require companies that offer a 401(k) plan to allow part-time employees who work at least 500 hours a year, for two years, to contribute to a retirement account. These part-time workers would include independent contractors, caregivers, freelancers, and contractors.
TAX CREDITS FOR SMALL BUSINESSES
Finally, SECURE 2.0 would provide several incentives for small businesses that provide greater access to retirement plans for their workers, including;
- A doubling of the tax credit for starting a company retirement plan: For small businesses with up to 100 employees (up from 50 employees), the SECURE Act 2.0 bill would boost the existing tax credit from 50% to 100% of plan start-up costs, capped at $5,000 per employer for each of the first three years—a total of $15,000.
- An expansion of time eligible for the start-up tax credit: The legislation would also extend start-up tax credits to employers based on the year they join existing plans, rather than only offering the credit for the first three years of the plan’s existence.
- New tax credits for employer contributions: Employers would receive a new tax credit—a percentage of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000 (excluding employer contributions as elective deferrals). This additional credit would be limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees on a sliding scale during the first five years.
On March 29 of this year, the U.S. House of Representatives passed SECURE 2.0. The Senate is expected to take up the bill later this Spring. It’s widely anticipated that changes resulting from the passing of this bill will go into effect in 2023.
It's worth noting that many states have passed legislation mandating retirement benefits for private-sector workers, in an effort to address the U.S. retirement savings gap. While the majority of these programs are mandatory, employers in all program states retain the option of offering their own retirement plan. Click here to see an entire list of state mandates and how they might impact your business.
Contact us to learn how their Retirement Specialty Practice Experts at JP Griffin Group, a division of HUB International, can help your organization with retirement benefits.