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401(k)s are tax-advantaged savings accounts designed to help Americans save for their retirement. They’re typically one of the best ways to save for retirement.
In late October, a bill proposed in the House of Representatives named Securing a Strong Retirement Account of 2020, detailed potential changes to 401(k) plans that could help people save more for retirement.
How 401(k)s Work
401(k)s are retirement accounts offered by employers as a benefit for employees. Unless you run your own business or are self-employed, you cannot open a 401(k) for yourself.
There are two types of 401(k)s, traditional and Roth. Traditional 401(k)s are more common, allowing you to deduct contributions from your income, and reducing your tax bill. When you withdraw money from a Traditional 401(k), you pay income taxes on the amount withdrawn.
With a Roth 401(k), you pay taxes as normal when making contributions but pay no taxes on withdrawals of earnings or contributions.
With both types of 401(k), there are restrictions on when you can withdraw money. The intent of the account is to use them to save for retirement. With some exceptions, you can’t make withdrawals without paying a hefty penalty until you turn 59.
Proposed Changes to 401(k)s
Here are some of the changes the Securing a Strong Retirement Account of 2020 proposes.
Automatic Enrollment
Under current law, employers have the option to automatically enroll new employees in their 401(k) or another retirement plan. Employees have the option to opt out after enrollment. Employers can also elect to automatically increase employee contributions each year, up to a limit.
The idea behind automatic enrollment is that it will increase participation. Historically, it’s been shown to be effective.
Under the Securing a Strong Retirement Account of 2020, employers would be required to automatically enroll all new employees in their retirement plan with a contribution equal to between 3% and 10% of their pay. The bill would also require employers to increase employee contributions by 1% each year until they reach 10% of their pay.
Matching for Student Loan Payments
One of the biggest obstacles for many people who want to save for retirement is student debt.
Under current law, many employers choose to match some of the contributions their employees make to their 401(k)s. For example, an employer may offer a 100% match on the first 4% of an employee’s salary that they contribute. For someone that makes $50,000 and contributes $2,500 per year, this means $2,000 in matching contributions.
Under the proposed law, employers could choose to make 401(k) matching contributions based on employees’ payments toward student debt. This could give workers with student loans a head start on saving for their retirement.
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Required Minimum Distributions Start Later
Retirement accounts like 401(k)s and Individual Retirement Accounts (IRAs) include a rule for required minimum distributions (RMDs). Currently, RMDs kick in when the account holder is between the ages of 70 and 72.
There is a complex formula to determine how much savers must withdraw from their retirement accounts each year to satisfy RMD requirements. In some cases, the withdrawal requirements are large, which can lead to big tax bills.
Under the Securing a Strong Retirement Account of 2020, the age that RMDs begin would increase to 75. This would add flexibility to older retirees’ withdrawal strategies. The bill would also exempt savers with less than $100,000 in their retirement accounts on December 31st of the year before they turn 75 from making RMDs.
Increased Savers Credit
The saver’s credit is a tax incentive aimed at low-income individuals and families. It offers a tax credit to those who make contributions to IRAs and 401(k)s.
Under current law, savers can get a credit equal to 10%, 20%, or 50% of the contributions they make, up to a limit of $1,000 in tax credit.
Credit based on Adjusted Gross Income
| Single and Married, filing separately | Head of Household | Married, filing jointly | |
|---|---|---|---|
| 50% | Up to $19,750 | Up to $29,265 | Up to $39,500 |
| 20% | $19,751 – $21,500 | $29,266 – $32,250 | $39,501 – $42,000 |
| 10% | $21,501 – $33,000 | $32,251 – $49,500 | $42,001 – $66,000 |
| 0% | More than $33,000 | More than $49,500 | More than $66,000 |
The proposed bill would increase the saver’s credit, allowing taxpayers to get a credit of up to $1,500 based on their contributions. It would also simplify the calculation by implementing a single credit rate of 50%.
Increased Catch-up Contribution Limits
When saving for retirement, one of the most powerful tools you have is time. The earlier you invest, the longer you give your investments to gain value. However, it can be difficult for many young people to save substantial amounts.
Under current law, both IRAs and 401(k)s offer older savers the chance to make catch-up contributions. These contributions can be made on top of the typical contribution limits ($19,500 for 401(k)s and $6,000 for IRAs).
Currently, those who are 50 or older can make catch-up contributions of up to $6,500 to a 401(k) and $1,000 to an IRA.
Under the new law, catch-up contribution limits for 401(k)s would increase to $10,000 when the worker turns 60. The catch-up limit for IRAs will not increase immediately, but would instead be indexed to increase with inflation starting in 2022.
Other Changes
There are some other, smaller changes included in the bill that could have an impact on retirement accounts.
- Increased credits for small employers establishing plans, helping encourage more businesses to offer retirement plans.
- Reduced barriers that help reduce plan costs for small businesses.
- Allowing employers to offer financial incentives to employees for participating in plans.
- Creating an online registry to help people find retirement plans managed by previous employers.
What to Watch For
The Securing a Strong Retirement Account of 2020 is a bill currently in the House of Representatives. The law hasn’t been passed, so none of these changes are in effect. In order for these changes to happen, the bill must pass through the House and Senate before being signed into law by the President.
Given the gridlock in our government, it’s understandable to feel like the bill has no chance of becoming law. One point in its favor is that there was bipartisan work on producing the bill, spearheaded by Democrat Richard Neal of Massachusetts and Republican Kevin Brady of Texas.
Given the cooperation between the two parties in creating this bill, there is a good chance that some version of this bill will pass through the split chambers of Congress and reach the President’s desk. Both parties have an interest in retirement reform and while this exact version of the law may not be the one that ultimately passes, it may serve as the basis of further negotiations.
The odds of these changes going into effect for 2021 are relatively low given that there are less than two months until the new year. If this or a similar law passes, expect the first changes to occur in 2022.
Summary
The Securing a Strong Retirement Account of 2020 is a proposed law that will make changes to Americans’ 401(k)s and IRAs. These changes will primarily make it easier to save for retirement and encourage more savings.
Given that the median American in their 60s has just over $170,000 in retirement savings (enough to provide just $6,800 in income each year according to the 4% rule), anything that helps people save more is a good thing. That leaves many hopeful that this bill, or a similar one, will pass.