Introduction:
The major provisions of the Secure Act 2.0, summarized here by CI Private Wealth, include changes to rules governing required minimum distributions (RMDs), increased access to 401(k) plans for part-time workers, larger catch-up contributions for older workers, changes to qualified charitable distributions, employer matching contributions to 401(k) plans for student loan payments, mandatory automatic enrollment into 401(k) plans, and employer matching contributions for Roth 401(k) accounts.
There are merits to some aspects of these proposals. However, changes to pension rules currently in Secure Act 2.0 do not provide major benefits to people who are struggling to save for retirement.
Larger improvements to retirement savings for more households could be achieved at lower cost to the government by expanding Individuals Retirement Accounts (IRAs) instead of expanding firm-based retirement plans.
Discussion of Specific Proposals:
Modifications to RMD rules:
Changes:
The Secure Act 2.0 has a proposal to delay required minimum distributions from retirement accounts. The current RMD age is 72. The proposal increases the RMD age to 73 in 2023, 74 in 2024, and 75 in 2031. The Secure Act 2.0 also reduces the penalty for not making a RMD from 50 percent to 25 percent.
Comments:
These proposals are unlikely to benefit people with relatively modest income who must withdraw more than the RMD from their retirement account to fund current needs in retirement. This change will NOT reduce the number of households who might outlive their retirement savings.
It is unlikely that workers currently saving for retirement consider the RMD when makings savings decisions because tax savings from contributions to retirement accounts are already large. These changes to RMD rules will not incentivize increased retirement savings for current workers.
RMD requirements only pertain to traditional retirement plans. Roth accounts do not have RMD requirements. These changes could discourage some workers from contributing to Roth accounts or converting traditional retirement assets to Roth assets.
Many investment firms will automatically limit retirement plan disbursements to the RMD amount and will automatically increase the rate of spending of non-retirement assets for individuals who have not reached the RMD age. This approach will increase fees to the firm managing the 401(k) plan but may be detrimental to the investor. The major beneficiary of this proposal is pension fund managers who will receive more fee income because of the slower disbursements from retirement accounts.
The increase in the RMD age will increase distributions and tax payments once the RMD age is reached because the retirement plan balance is larger, and the expected future life span is shorter. The increased RMD age delays disbursements and taxes but could increase total lifetime tax payments for some households. The increased RMD age could increase early depletion of Series I Savings bonds, (an asset outside of retirement accounts) leaving investors less prepared for an increase in inflation later in life.
Increased Access to 401(k) plans for part-time workers:
Changes:
The Secure Act 2.0 reduces the waiting time for part-time workers to make contribution to 401(k) plans. The current waiting period is three years. The proposed waiting period is two years.
Comments:
Many small firms with a large percentage of part-time workers do not offer 401(k) plans.
This proposal will not help part-time workers without a continuous employment history. Many part-time workers are seasonal and do not have continuous employment at a firm.
This reduced waiting period does not affect vesting requirements. Part-time workers are subject to the waiting period and the vesting requirement. A part-time worker at a firm with a 401(k) plan that has a three-year vesting requirement would have to work at the same firm for five years to fully vest.
401(k) plans at firms with a high proportion of part-time workers tend to have high fees. Many part-time workers would be better off contributing to a low-fee IRA instead of a high-fee 401(k).
It would be easier and more effective to motivate retirement savings for part-time workers by increasing incentives for contributions to IRAs. This approach benefits all workers as soon as they are employed, workers at firms that do not offer 401(k) plans, and workers with multiple jobs.
Larger catch-up contributions for older workers:
Changes:
The Secure Act 2.0 increases catch-up contribution to firm-sponsored retirement plans for people aged 62-64 from the current level of $6,500 to $10,000. The current catch-up contribution remains the same for people between age of 50 and 61. The proposal indexes the current catch-up contribution for IRAs to inflation and provides for a more modest increase in catch-up contributions for Simple Plans.
Comments:
The Secure Act 2.0 increases the disparity between allowable catch-up contributions for employer-based retirement plans and IRAs. The goal of pension reform should be reducing all disparities between employer-based retirement plans and IRAs including disparities in catch-up contributions because the people most in need to additional retirement assets currently do not have access to employer-based plans.
Many low-income and middle-income workers nearing retirement are better off reducing debt than increasing contributions to 401(k) plans. Go here for a post documenting the advantages of debt reduction prior to retirement.
Changes to Qualified Charitable Distribution Requirements:
Changes:
The Secure Act 2.0 increases potential charitable distributions from retirement plans and associated tax benefits. The charitable distribution is also indexed to inflation.
Comment:
This is a useful change for well-heeled savers, charities and people benefiting from charities. However, this provision does nothing for people with limited retirement resources who may out-live their retirement wealth.
Student Loan Matching:
Changes:
The Secure Act clarifies the tax code to make clear employers are allowed to contribute matching funds to retirement plans for workers making student loan payments, even if the worker does not make contributions to the plan.
Comments:
This proposal does not benefit workers at firms that do not offer a retirement plan or workers at firms with a retirement plan that do not match employee contributions. As a result, this provision will disproportionately benefit workers with better jobs and will do little to reduce student loan debt burdens for people most affected by student debt.
Mandatory Automatic Enrollment:
Changes:
The Secure Act 2.0 requires employers with an employer-based retirement plan to automatically enroll new employees who are qualified for enrollment into the plan. The initial automatic enrollment is set at 3.0 percent of income. The automatic enrollment is increased by 1.0 percent per year up to 10 percent of income.
Comments:
The government sanctioned automatic enrollment provision implies that the government believes that contributions to firm-sponsored retirement plan are the best use of funds. This argument may not be correct in many circumstances including when workers have high debt levels, when the employer does not match contributions, and/or when the plan charges high fees.
The case for automatic enrollment in 401(k) plans is strongest when firms match employee contributions. A modified automatic enrollment provision limited to firms with matching contributions for contributions up to the amount needed to receive the entire match would be superior to the current provision. Automatic enrollment of funds beyond this level is difficult to justify given the existence of other investment options including Roth IRAs and Series I Savings Bonds.
The case for automatic enrollment for newly eligible employees is stronger than the case for automatic increases in contributions. Employers or plan managers could provide advice about desired contribution levels instead of assuming one strategy fits all workers.
Other automatic pension changes including automatic rollover of high-fee 401(k) funds to low-fee IRAs when employees leave a firm and automatic enrollment of workers at firms without a 401(K) plan into IRAs should be considered.
Matching Contributions to Roth Accounts:
Changes:
Starting in 2023, employer-matching contributions could be placed in a Roth account. Current law places employer-matching contributions in a conventional account while the employee contributions are placed in a Roth account.
Comments:
Under current law, employer contributions are not taxed in the year of the contribution. A provision an untaxed employer contribution into a Roth account would result in the contribution never being taxed. Presumably, if the employer contribution is placed in a Roth account it would be fully taxed in the year of the contribution.
The proposal only benefits workers at firms with a 401(k) plan that matches contributions and has a Roth option.
This proposal does not pertain to Roth IRAs because no employer contributions are allowed in any IRA. An expansion of matching contributions to IRAs would better assist households who are having difficulty saving for retirement.
Concluding Remarks:
The Secure Act 2.0 is not yet law. It must be reconciled with Senate provisions that include provisions for expanded access to emergency funds through retirement accounts. A blog post describing these proposals can be found here.
The Secure Act 2.0 is not an effective way to improve retirement security for American workers.
Many of its provisions give larger benefits to investment firms than to workers saving for retirement. The bill provides scant assistance to the workers who are having the most difficult time saving for retirement. A more effective approach involves expanding saving through individual Retirement Accounts instead of firm-sponsored retirement plans.
Authors Note: David Bernstein, an economist and author, has written An Alternative to the Biden Student Debt Plan. This paper is a must read now that the Biden plan is tied up in court. David is an economic consultant taking on new clients. He can be reached here or can be emailed at Bernstein.book1958@gmail.com.