(Trends Wide Business) — America is on the brink of a retirement crisis. The main savings tool for Americans, your 401k, isn’t helping.
By the end of the decade, about 21% of the nation’s population will be 65 or older, up from 15% in 2016, according to Census Bureau forecasts. Most non-retired adults have some form of retirement savings, but only 36% think their savings are on track.
Now, Congress is seeking to help Americans save by strengthening 401k programs, company-sponsored, tax-deferred retirement accounts to which employees can contribute income and employers can match their contributions.
A new bill, expected to hit President Joe Biden’s desk by the end of the year, could require most employer-sponsored retirement plans to automatically enroll their workers, making it easier for applicants to save. for student loans and for older workers to make catch-up contributions. It will also reduce costs for smaller businesses.
Retirement savings in America was long thought of as a three-legged stool. Americans had pension plans, Social Security benefits, and defined contribution plans like the 401k. Not anymore.
Pension plans are almost extinct. About half of private sector workers were covered by so-called defined benefit plans in the mid-1980s, but by 2021 only 15% of private sector workers had them.
Social Security payments still provide about 90% of income for a quarter of seniors, according to surveys by the Social Security Agency. But the Social Security trust fund faces a 75-year deficit and, without intervention, will run out by the mid-2030s. Lawmakers have faced a decades-long political gridlock over how to fix it.
What remains is the 401k, which 68% of private sector workers have access to, but only 50% use.
“I don’t think it was ever anticipated that this would be the main leg of the stool,” said Jonathan Barber, head of compensation and benefits policy research at Ayco, a unit of Goldman Sachs that provides investment services to hundreds of U.S. companies and more than one million corporate employees.
In fact, the 401k was never designed to be the primary retirement tool for Americans when it was introduced into the US tax code in 1978. “When it works, it works very well,” said Sri Reddy, Senior Vice President of Retirement and revenue solutions for Principal Financial Group.
The 401k naturally appeals to Americans who contribute the most money as a savings vehicle, critics say. Under the current plan, an employee in the highest tax bracket saves 37%. But an employee in the lower tax bracket would get a pre-tax advantage by saving just 10% in deferred income.
Tax breaks for these retirement savings are expected to cost the government almost $200 billion this year, with most of those benefits going to the top 20% of earners, according to the Center on Budget and Policy Priorities.
Fewer than 40% of lower-wage workers have retirement accounts, compared to 80% of middle- and upper-income families, according to Vanguard. First, making a 401k more affordable doesn’t help Americans who don’t have money to save.
Still, Congress believes there is a solution.
In late 2019, President Donald Trump signed into law one of the most important retirement laws of the last 15 years: the bipartisan Setting Every Community Up for Retirement Enhancement Act, or SECURE Act. The bill eliminated maximum age limits on retirement contributions, provided tax credits for small businesses to offer their employees 401k plans, and extended retirement benefits to some long-term but part-time employees.
Last week, Congress almost unanimously passed another bill, SECURE 2.0, which has even broader changes. The Senate is expected to approve its version in the coming weeks.
Here’s a look at how America’s premier retirement savings plan could change soon:
In what would be the biggest change to the 401k program, SECURE 2.0 would require employers to automatically enroll all eligible workers in their 401k plans at a savings rate of 3% of salary. (Many employees currently have to opt in and then choose their contribution level.) The new rule also applies to 403(b), a similar program for employees of certain public and tax-exempt organizations.
The contribution rates of affiliated workers would automatically increase each year by 1% until their contribution reaches 10% per year.
While workers have the option to opt out of the plan or change their contribution level after enrolling, automatically enrolling workers in these plans would make a big difference in the participation of younger, low-wage employees in the program.
A 2012 study cited in the SECURE 2.0 bill found that “[l]he most dramatic increases in enrollment rates are among younger, low-paid employees, and the racial gap in participation rates is nearly eliminated among employees subject to automatic enrollment.
About one in six employers already offer automatic enrollment, and about 90% of new hires who use them participate in retirement plans, compared with only 28% in voluntary enrollment, according to a recent study by Vanguard, the largest provider of mutual funds in the United States.
Early retirees save more
Older workers ages 62 to 64 can increase their catch-up contributions to $10,000 a year, up from $6,500 today. Beginning in 2023, these catch-up contributions would be taxed as Roth contributions, meaning they would be taxed before being invested for retirement, although earnings would be indexed for inflation.
People generally earn more as they get older, Reddy said, and people in their 60s generally earn more than they spend. Giving them the ability to increase their contributions makes a big difference in retirement savings. “If you have people who are motivated and have incremental means, it’s a wonderful way to help them get up to speed for retirement,” she said.
Barber, who heads earnings research at Goldman Sachs financial advisory firm Ayco, worries that this change may be too complex.
Currently, most 401k contributions come from pre-tax employee paychecks, so investors don’t really feel the impact until they’re ready to withdraw their savings. Under the new plan, the catch-up contribution will be increased, but employees must pay taxes before contributing.
For investors, “that could be a shock to some people who don’t understand the financial impact of that, especially if they’ve never had a Roth account,” Barber said.
Pay off student loan debt while you save
About 43.4 million loan applicants in the United States have federal student loan debt, totaling $1.7 billion, and many employees tend to forgo saving for retirement until they pay off their loans in full.
Missing out on those first few years of potential savings puts them at a significant disadvantage. The plan has a solution for that.
Employers may treat student loan payments as optional retirement account deferrals and provide a matching contribution to your 401k. So if you pay off $1,000 in student loan debt, that would be the same as putting $1,000 into a retirement plan, as far as matching goes. If a company matches 6%, that’s an additional $60 in savings.
“Sooner [inviertas]the more those investment gains can be multiplied,” said T. Lake Moore V, McAfee & Taft employee benefits attorney.
Delay mandatory withdrawals and limit tax penalties
Americans retire later and live longer. SECURE 2.0 raises the minimum age at which affiliates must start withdrawing money from their accounts each year from 72 to 75 years old. That allows for an additional three years of tax-free growth in your retirement investments.
(The penalty for those who do not withdraw the required minimum from their account after age 75 would be cut in half, from 50% to 25%.)
Part-time workers can pay
Under the proposed law, companies that offer a 401k plan would be required to allow part-time employees who work at least 500 hours a year for two years (the equivalent of just under 10 hours a week) to contribute to an account. of retirement. That would include part-time workers, temporary employees, freelancers, caregivers, and independent contractors.
The plan would also extend tax credits to small businesses to provide greater access to retirement plans for their workers and create an online database for Americans to locate lost retirement funds.