Retirement Saving Reforms: Details & Analysis
As part of an omnibus spending package last December, Congress enacted several changes to retirement savings accounts that are scheduled to phase in over the next several years. The legislation expands saving opportunities for taxpayers by allowing additional catch-up contributions for workers approaching retirement, adopting automatic enrollment for certain retirement accounts, reforming the saver’s credit, and offering a new type of emergency savings account, among other changes.
The changes improve the current taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
system’s treatment of savings, but policymakers should continue to pursue efforts to further simply retirement options for taxpayers.
The proposals originated under the Senate’s Enhancing American Retirement Now (EARN) Act and the House’s Securing a Strong Retirement Act (Secure 2.0). Both bills were ultimately reconciled and included in the spending bill. Some of the changes will begin taking effect in 2024, and lawmakers have recently circulated a discussion draft of technical corrections to the legislation.
Secure 2.0 Addresses Flaws in Tax Code’s Treatment of Saving and Retirement
To assist taxpayers who may be falling behind in their retirement savings, Secure 2.0 makes several changes to catch-up contributions. Starting in 2023, the $1,000 limit on catch-up contributions into Roth IRAs for taxpayers older than 50 will be indexed to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
, bringing 2023’s maximum allowed contribution to $7,500. Beginning in 2025, taxpayers aged 60 through 63 will also be allowed to make additional catch-up contributions (super catch-ups) to their IRA or 401(k) equal to 50 percent of the ordinary catch-up amount for 2025, and indexed to inflation thereafter.
The prior-law limits on 401(k) contributions ($22,500 in 2023 plus a $7,500 catch-up limit, both indexed to inflation) remain in place, but starting in 2026, taxpayers older than 50 earning more than $145,000 will be required to deposit 401(k) catch-up contributions into a Roth account. This provision was implemented as a “pay-for” for other components of the bill. The change was supposed to have taken effect in 2024, but the IRS delayed the rule to give taxpayers more time to set up their Roth accounts.
Current law requires that taxpayers begin taking minimum distributions from their account at age 72, but Secure 2.0 increases this age from 72 to 73 in 2023, and will increase it to 75 in 2033.
Some workers do not enroll in retirement plans that are available to them. Beginning in 2024, employers may offer a new type of 401(k), the starter 401(k), where workers will be automatically enrolled at a contribution rate between 3 and 10 percent. They may opt out of the plan or increase their contributions up to that maximum amount of 10 percent. Each year the employer must increase their contribution by 1 percent until it reaches the ceiling, which will rise to 15 percent beginning in 2026. However, yearly contributions may not exceed $6,000, while catch-up contributions up to $1,000 are permitted for workers over 50.
Secure 2.0 will also provide relief to taxpayers who may not be able to save as much due to student loan debt. Starting in 2024, employers may make matching contributions to an employee’s retirement account for qualifying student loan payments. Additionally, parents with 529 savings accounts will also be allowed to roll over up to $35,000 into a Roth IRA for their child, if the 529 savings account has been open for at least 15 years.
The other major changes for 2024 provide flexibility for taxpayers who need a cash buffer for emergencies. Normally, taxpayers who withdraw from their retirement accounts early face an additional 10 percent penalty for doing so. Starting in 2024, taxpayers who face an unforeseeable emergency expense will be allowed to withdraw up to $1,000 from their retirement account in one distribution, with the option to repay the distribution within three years to avoid the tax penalty.
Additionally, the bill allows employers to offer pension-linked emergency savings accounts. They may automatically opt their employees into such an account, up to 3 percent of that employee’s salary on a Roth basis. The accounts are not standalone and must be linked to another defined contribution retirement plan. Total contributions are capped at $2,500 or lower as set by the employer. Once the cap is reached, contributions can be directed into another employer-sponsored Roth plan if one is available. The first four withdrawals from the account are not subject to any tax penalty, and employees can roll over their emergency accounts into another plan if they leave their employer.
Secure 2.0 also made changes to the saver’s credit to assist low and middle-income taxpayers who may find it difficult to save. Under current law, single filers earning under $36,500 ($73,000 for joint filers) may be eligible for a nonrefundable credit up to $1,000 if they contributed to their retirement accounts. The size of the credit equals 10 to 50 percent of the taxpayer’s yearly contribution, depending on their income. However, starting in 2027, the credit will change from a tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s.
to a matching contribution deposited directly into the taxpayer’s IRA or 401(k). The match will be 50 percent of the retirement plan contribution, up to $2,000 per individual.
A discussion draft circulated the House last week that would make some technical corrections to Secure 2.0. Due to a drafting error, the original legislation accidentally eliminated catch-up contributions altogether for 2024. Although the IRS announced this summer that it would permit catch-up contributions to continue for 2024 in spite of the error, the proposed corrections would codify the fix in law.
A Better Solution: Universal Savings Accounts
With Secure 2.0, lawmakers recognized and addressed several flaws in the tax code’s treatment of saving and retirement, but there is continued work to be done simplifying and expanding savings and retirement options for taxpayers. While taxpayers certainly have a need for access to savings for many reasons beyond retirement, including for emergencies, adding a separate tax-advantaged account for every saving purpose is hardly an efficient fix. Rather, Congress should aim to create a simple set of rules that encourage saving generally for all taxpayers and for any purpose.
Universal savings accounts (USAs) would accomplish that, reducing the tax code’s penalties for saving without micromanaging behavior or confusing taxpayers in the process. While USAs have existed as an idea in the U.S. for decades, other countries such as the UK and Canada have actually implemented them, finding taxpayers at all income levels use them extensively. When lawmakers consider the next iteration of Secure 2.0, they should keep USAs top of mind.
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