It is a little past the first anniversary of the SECURE Act. It was signed into law on December 19, 2019, and what a year it has been. There were many impactful changes, which we will cover so you can better understand your employer’s retirement plan and how best to use it as part of your financial plan.
Contributions
A large part of the SECURE Act focused on how to improve retirement outcomes for plan participants through increased contributions to employer retirement plans. Long-term employees who have worked at least 500 hours in three consecutive 12-month periods are now eligible to make salary-deferral contributions. This may be helpful for those employees who were forced to reduce work hours over the previous year due to COVID-19. Employers are permitted, but not required, to make matching or nonelective contributions to the plan on an employee’s behalf.
There are two inarguable truths regarding savings: first, it is really hard to start, and second, if the money is automatically taken out of our paychecks, we barely notice it is gone. With that in mind, the SECURE Act increased the Qualified Automatic Contribution Arrangement (QACA) for employers’ retirement plans. QACA was a rule established by the Pension Protection Act of 2006 that allows employers to automatically enroll employees into the retirement plan at a 3% of salary deferral rate, but with a 10% cap. While it is great to get started with some savings, 3% won’t likely be enough to build a retirement nest-egg. Now, thanks to the SECURE Act, the cap has been raised to 15%, which depending on what age you start saving and investing, should be enough to build the necessary retirement savings.
While not part of your employer’s retirement plan, there was a change made to traditional IRA contributions as well. Whereas previously you couldn’t contribute to IRAs past a certain age, now “as long as you are working and have earned income” you can contribute at any age. This is great for those who may not have employer plans at work, or those who have maxed out their salary deferral and are looking to save more in a tax-deferred vehicle past the traditional retirement age.
Distributions
Arguably the biggest benefit of employer retirement plans is the tax deferral component, which thanks to the SECURE Act, became a little better. For those participants who turned 70 ½ during 2020, or anyone who turns 70 ½ after 2020, the new Required Minimum Distribution (RMD) age is now 72. This increase also applies to IRAs. The 70 ½ age limit always confused people, so hopefully the new age limit will make it easier for people to avoid missing RMDs, which carries a substantial 50% penalty on the amount not distributed.
While the SECURE Act offered many benefits for employer plan participants, it did make one change that wasn’t very helpful for most. In the past, if you inherited a retirement plan you had the ability to stretch out distributions over your lifetime, limiting ordinary income taxes paid on the distributions. However, you now must have the entire balance withdrawn within 10 years. Failing to meet this 10-year deadline will result in a 50% penalty on the balance still remaining in the account. Imagine an inherited $1,000,000 401(k) where an adult child didn’t understand the distribution rules and the balance remained after 10 years, yikes! Thankfully, these rules do not apply to spouses who will still have the ability to treat the funds as their own, or keep them in an inherited account, whichever is more beneficial.
Finally, while again not pertaining to your employer’s retirement plan, the SECURE Act offered two more new rules regarding distributions. If you have childbirth or adoption expenses, you can take up to a $5,000 penalty-free IRA withdraw; and if you have student loans, you can withdraw up to $10,000 tax-free from a 529 plan.
Normally, I would say, isn’t it amazing, it seems like the year just flew by, and I can’t believe it is the one-year anniversary of the SECURE Act. This time, though, I have to say it feels like an eternity…
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