Secure Act 2.0: How new legislation could change the way you save for retirement

With the end of 2022 fast approaching, time is running out for the current Congress to approve new retirement provisions that have generally gained bi-partisan approval. These changes are a follow-up to the SECURE Act, enacted into law in late 2019, which altered the rules around how you can save and withdraw money from your retirement accounts. The 2019 bill represented the first major legislative change to tax laws relating to retirement in more than 10 years.

In 2022, an update to this legislation received serious attention from Congress. The House passed the Secure Act 2.0 earlier this year on a nearly unanimous vote. In June, two Senate committees advanced different pieces of similar legislation. It’s possible that a final, updated plan will gain Senate approval yet in 2022, but the timeframe is tight. The current bills require passage before the current session of Congress adjourns, or lawmakers will have to start over on new legislation in 2023.

“Chances are at this point, with a significant agenda facing this lame duck Congress, any bill passing the Senate will have to be attached to another, priority piece of legislation,” says Kevin MacMillan, head of government relations at U.S. Bank. “If the Senate passes its version of retirement plan legislation, a conference committee of Senate and House members will have to work out the differences between the two bills before anything is finalized and passed into law,” says MacMillan.

The lack of retirement preparedness among Americans has drawn the attention of Washington policymakers. According to one study, by 2050, the U.S. will face a $137 trillion retirement income gap (the difference between what savers should have and what they’ve actually saved). If projections hold, retirees in six major economies (including the U.S.) would outlive their savings by an average of eight to 20 years.¹ “These proposed changes are beneficial to empower individuals to reach savings goals and provide more flexibility upon retirement,” says Sarah Darr, head of financial planning at U.S. Bank Wealth Management.

Understanding current laws and how they may change can help you prepare your retirement savings strategy well into the future.

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 your 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 traditional IRA contributions. 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 retirement 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, including making RMDs first effective at age 75 in 2031.

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.

“Extending RMD dates to later ages and decreasing the penalty for not taking RMDs on time are ways to put more power in the hands of individuals to determine when and how to withdraw their tax-deferred savings,” says Darr. “These changes can also have a tax impact for individuals.”

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).

Additionally, there is a proposal to index IRA catch-up contributions to inflation. Currently, those 50 and older can only direct an additional $1,000 per year (above standard contribution limits) to an IRA.

“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.

“This creates an excellent opportunity for employers to offer an incentive to attract and retain employees,” says Darr. She notes that it could prove to be an effective way to kick-start a retirement savings plan for younger workers who are burdened with college loans.

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.

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.

“Auto enrollment can be beneficial to support retirement savings,” says Darr, “as long as individuals have sufficient cash flow to meet day-to-day expenses.”

Emergency savings provisions

One of the Senate provisions would give employees access to emergency funds. 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.

A separate proposal would allow workers to take penalty-free withdrawals of up to $1,000 from retirement accounts to cover emergency expenses. Such withdrawals would only be allowed once per year and then not again until additional contributions are made to the retirement account.

Watch for further developments

Updated retirement plan legislation made impressive progress on Capitol Hill earlier in the year. Along with full House approval of SECURE Act 2.0, the two Senate bills under consideration have achieved approval at the committee level. Action stalled in the summer, but the Senate Finance Committee advanced final language to its Enhancing American Retirement Now (EARN) Act in November 2022. This appeared to enhance the potential that the bill could be passed by the full Senate, but the likelihood of that occurring before year-end is up in the air.

As you consider what new opportunities may be available to enhance your retirement savings in the future, take the time to assess where you stand today. Your financial professional can help you review your current strategy and discuss whether any changes are appropriate for you. You can also plan for any potential changes should new legislation be enacted.

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