Retirement planning is going to get even more complicated. Last Tuesday, Congress overwhelmingly passed a bill changing the rules governing 401(k) plans. We shall see what comes out of the Senate, but with a vote of 414 to 5, we can anticipate significant changes that continue the trends begun with the 2019 SECURE Act.
Traditionally, the idea behind defined-contribution plans, such as the 401(k), was to make it easier for individuals to save for retirement. By allowing workers to defer income before taxes, saving for retirement makes it easier to save because some of the contrition comes from reduced tax withholding. Because young people raising families and buying homes have a hard time deferring enough of their salaries, those over 50 could (and can) defer extra income in what is called a catch-up provision. After all, we reach our peak earning years after the kids are out of school and we have bought our big-ticket items. Therefore, middle-aged workers usually have more disposable income available to save for retirement. Moreover, the older we are the less time is available for us to reap the full benefit of compounding, so we need to save more. The government does not lose (and may gain) because retirees eventually need to take taxable required minimum distributions (RMD). After death, the government continues to collect taxes from the RMDs of beneficiaries. The SECURE Act changed the mandatory beginning date from 70-1/2 to 72. Over the years, after-tax options such as the ROTH IRA and the ROTH 401(k) became available.
Today, defined contribution plan assets total more than $8 trillion, which makes a very large target for politicians, banks, insurance and investment companies. Thus, we have a new flurry of legislative activity. Just as with the SECURE Act, some changes are positive, while others are designed to pull taxes from the future into the terms of incumbent politicians. The bill in its present form would:
- Incrementally raise the age at which retirees must begin withdrawals to 73 next year, 74 in 2030, and 75 in 2033.
- Increase the annual catch-up contribution from $6,500 to $10,000 starting in 2024 for people ages 62, 63, and 64.
- Automatically enroll employees.
- Expand the saver’s credit.
- Allow employers to give incentives for signing up.
- Permit an employer to make matching contributions on qualified student loan payments.
- Increase the IRA catch-up contribution limit from $5,000 to $10,000 for people aged 62-64.
- Allow 100% of balances to be invested in life annuities.
The downside to the proposals comes in two parts. The first is that catch-up contributions would have to be made after-tax. The purpose of this provision is to pull taxes forward rather than waiting for workers to retire. While the promoters claim that they are allowing people to save more, the reality is that it will cost more to save the same amount. For a couple with a taxable income of more than $83,550 (not counting state income taxes), a before-tax contribution of $10,000 would have an out-of-pocket cost of only $7,800 versus $10,000 under the new rule. People with low incomes will be unable to make these expensive contributions, while many wealthier people will either save less or devote the required ROTH contributions to their grandchildren. For middle-class people over 50, saving enough for retirement will be harder.
Saving less would reduce the second problem, which is that the later you retire, the higher will be the amount you are required to take out of your plan each year. After the required beginning date for withdrawals, the value of your account at the beginning of each year is divided by your life expectancy. The older you are, the shorter your life expectancy and the smaller the divisor.
The proposed bill will benefit some lower-income employees who work for firms with more than ten employees. It will also benefit insurance companies and the government. Generous employers will be able to help employees who are paying off student debt. The bill removes the cap for life annuities, a provision that will be used by those with fewer assets. This will secure a lifetime income for the less well-off, but at the cost of passing assets to their heirs. If you do not want to leave anything to your kids, this is a great option.
I guess that the increased complications will be good for all the financial planners who will need to memorize the rules and explain them to clients. Unfortunately, it fails to help the millions of working-class people who have no access to a retirement plan at all. It ignores the army of laborers who move from one job to the next without working long enough to participate in a plan. The bill does reduce the time required to participate in a plan from three years to two, but many laborers will never be with an employer that long.
Hopefully, the Senate will remember why these plans exist. The purpose is to promote dignified retirements that are free from want for the vast number of citizens who will not benefit from traditional pensions. The bill will help many workers, but in my view, it should be less complicated, less restrictive, and cover far more people. Whatever happens, we will learn the rules and be available to our clients to make the most of it.