By Paige Wang
Earlier this year, the House passed the Securing a Strong Retirement Act by an overwhelming majority, while the Senate passed The Enhancing American Retirement Now (EARN) Act and the Retirement Improvement and Savings Enhancement to Supplement Healthy Investments for the Nest Egg (RISE & SHINE) Act. Together, these three bills represent the basis for a newly proposed Secure Act 2.0.
The Secure Act changed the rules around how you can save and withdraw money from your retirement accounts. And it’s widely expected that a newly updated Act will pass into law by the end of 2022—helping more Americans save more money for their retirements.
Understanding these current laws and how they’ll likely change, therefore, can be invaluable in better preparing your current and future retirement savings strategy. To that end, the following are some of the legislation’s key provisions broadly intended to achieve three key goals:
- Expand access to retirement plans and investment options;
- Increase savings and preserve income; and
- Simplify plan administration.
Key Secure Act 2.0 provisions
- Mandatory automatic enrollment and escalation in retirement plans. Under current law, automatic enrollment and/or escalation (i.e., annual deferral percentage increases) may be used by 401(k) and 403(b) plans, but aren’t mandatory. Secure Act 2.0 would require employers with these plans to automatically enroll new employees (when eligible) in the plan at a pre-tax level between 3% and 10% and with 1% annual step ups until a 10% deferral rate is reached. Exceptions will be made for small businesses with fewer than 10 employees or those that are less than three years old, church plans, and governmental plans.
- Expands 401(k) plan access to more long-term, part-time workers. Currently, employers offering a 401(k) plan must permit plan participation for any employee with at least 500 hours of service a year in three consecutive years. The new provision would reduce the three-year requirement to two years.
- Raising catch-up contribution limits & applying Roth tax treatment. If you’re age 50 or older, you are allowed to make additional catch-up contributions to your retirement accounts. Secure Act 2.0 would keep those existing catch-up limits, but would also permit those aged 62 – 64 to contribute an additional $10,000 to your 401(k) or 403(b) plan (or an additional $5,000 to your SIMPLE IRA plan) annually. The bill would also index the $1,000 IRA catch-up contribution limit to inflation each year. Additionally, all catch-up contributions to employer-sponsored plans would be taxed as Roth contributions—meaning you’d pay income taxes up front. but tax-free upon distribution. While this would serve to reduce your initial tax savings, any catch-up contributions would be tax-free upon distribution.
- Allowing Roth matching contributions. SIMPLE and SEP IRAs are presently not allowed to accept Roth contributions from employees. Under the revised Act, a SIMPLE or SEP IRA would be permitted to be designated as a Roth IRA. Another provision in the bill would allow 401(k) and other plans to give you the option of having any employer-matching contributions put into Roth 401(k) accounts. Matching contributions designated as Roth contributions, however, would not be excludable from your income.
- Change to required minimum distribution (RMD) age. The original Secure Act raised the age at which you must start taking RMDs from your traditional IRA and 401(k) from age 70.5 to 72. Secure Act 2.0 would further raise the RMD age to 75. While this allows more time for your money to grow tax-deferred, your annual withdrawals may need to be larger. The RMD age would initially increase to 73 in 2023, move to age 74 in 2030, and ultimately to age 75 in 2033. Additionally, the penalty for missing RMDs becomes less severe. The current 50% excise tax on any distribution shortfall is one of the harshest penalties in the entire tax code. Under the new Act, this would be reduced to 25%, and if the mistake is corrected in a timely manner, the penalty would be further reduced to 10%.
The 10-year rule
Despite all the positive aspects of the Secure Act 2.0, there’s one proposed change that could make retirement planning a bit more challenging and confusing. Prior law allowed the owner of certain retirement plans to designate a beneficiary who, upon the death of the owner, could take distributions from the plan based on the beneficiary’s life expectancy. In an effort to speed up tax collections, however, the new law eliminates this so-called ‘stretch IRA’ for most non-spouse designated beneficiaries and replaces it with a new 10-year rule—requiring all inherited retirement funds to be withdrawn by the end of the 10th year after the owner’s death.
This means, instead of stretching an inherited IRA for 30 or 40 years and only having to take a small RMDs each year, the new rule will force you to take distributions within 10 years; shortening the amount of time for tax-advantaged growth and increase the size of RMDs. Eligible designated beneficiaries (EBD) such as surviving spouses or chronically ill people will continue to have the option of stretching payments over their own life expectancies. Non-EBDs, however, will need to be more cautious about tax planning if the 10-year rule remains in place. Since Roth IRA beneficiaries aren’t taxed on any withdrawals, this new proposed regulation doesn’t apply to any inherited Roths.
The changes and provisions listed above offer a brief glimpse into a few of the key provisions and proposals contained in the Secure Act 2.0—many more will be contained in the final version and some changes to the above may occur before final passage. We’ll continue to monitor the progress of the Act as it takes its final form. In the meantime, consider what new opportunities may soon be available to enhance your retirement savings and talk to your advisor to assess where you stand today. We can help you review your current strategy, discuss any appropriate changes, and begin planning for any potential opportunities or changes the new legislation will bring.
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