SECURE Act 2.0 – Heading Our Way Soon?

Take-Away: As we await Congress’ return to session this fall and its annual task of establishing a budget for fiscal year 2021-2022, not only will income tax increases be on everyone’s mind, but also possible changes to the rules with regard to retirement plans, plan contributions, and possibly the income tax deduction that is associated with contributions to 401(k) plans.

Background: Earlier this year the House Ways and Means Committee voted out of that committee a proposed bill. The bill’s title is Securing a Strong Retirement Act; it is informally being called SECURE Act 2.0. It is possible that some features of this bill might find its way into Congress’ budget reconciliation process, which like the SECURE Act with its 10-year payout rule change, could result in more tax revenues without Congress arguably raising tax rates.

Tax Benefit of 401(k) Accounts: As a practical matter, there are two direct tax benefits to participants who save with contributions made to a traditional 401(k) account. Those income tax benefits could be impacted if the income tax rates are changed.

#1: If the participant’s income tax rate is the same at the time of the contribution to their 401(k) account and their distribution from their 401(k) account, the value of the retirement savings tax benefit is the value of the non-taxation of the account’s earnings. The value of this tax benefit is not the value of the tax ‘exclusion’; rather, it is the value of the exemption from immediate taxation of the account’s earnings.

#2: When the participant’s tax rate is higher at the time of the contribution than it is at the time of distribution from their 401(k) account, there is a second retirement savings tax benefit equal to the difference between those two income tax rates. If the participant is paying higher income taxes in the year of contribution than the year of their distribution, then a non-Roth contribution shifts income from the higher income tax rate year to the lower income tax year. If the participant is paying lower taxes in the year of contribution than in the year of distribution from the 401(k) account, then a Roth contribution accomplishes the same thing.

If Congress moves to increase tax rates (both income and invested capital gains) future income tax increases will increase, in some cases significantly, the value to affected highly paid individuals of saving ‘inside’ a tax qualified plan, because the income taxes on non-plan savings would have been increased. The increases in income taxes could also increase the value of the tax benefit (#2) although this will depend less on the steepness of the progressivity of the new income tax rates. Being able to shift income from the year of contribution with a tax rate of 37% to the year of distribution at the new lower rate, e.g. 35% is less valuable than being able to shift income from a 39.6% rate (as proposed) to a 35% or 36% income tax rate.

SECURE Act 2.0: The bill voted out of the House Ways and Means Committee and now before the full House of Representatives, would make several changes to existing 401(k) contribution rules, some of which are in the bill, and other changes that were debated as the bill worked its way through and out of the Ways and Means Committee:

Required Beginning Date: The bill would further delay a participant’s required beginning date (RBD). The current RBD is age 72 years. The bill would increase the RBD to age 73 in 2022, age 74 in 2029, and 75 years in 2032.
Suspend Some RMDs: If a retirement account owner’s retirement account has a balance of $100,000 or less, required minimum distributions (RMDs) would be suspended. The $100,000 would be subject to annual adjustments to reflect cost of living.
Saver’s Tax Credit: The current saver’s income tax credit would increase from $1,000 to $1,500, while also making it easier for some individuals to qualify for the tax credit.
Student Loans: If employees are still paying student loans, and thus not financially able to contribute to their employer’s qualified plan, the bill would permit those employees paying their student loans to nonetheless receive a matching contribution. The plan sponsor would match up to a percent of the employee’s salary, and deposit that matching amount into an account in the qualified plan for the employee, even if the employee makes not contribution to the plan.
Some Catch-up Contributions Limited: The bill would change catch-up contributions to 401(k) accounts if the participant is over the age of 50 years. The catch-up contribution would only be to Roth 401(k) accounts. The impact of this change would be to limit the ability of high earners/high tax bracket employees, through catch-up contributions, to shift their taxable income to a lower income tax year. This was considered back in 2017, referred to as a ‘Rothification,’ as a revenue raiser [much like the SECURE Act’s 10-year payout rule] but the idea was dropped at that time as ‘political suicide.’ Once again it is being considered as a means to raise federal revenues without increasing income taxes, just like the SECURE Act’s 10-year payout rule.
Other Catch-up Contributions Increased: The annual catch-up contribution for a participant over the age of 50 years is $6,500. Another change would be to increase that catch-up contribution to $10,000 per year for participants who are between the ages of 62 and 64 years, starting in 2023. However, all catch-up contributions starting in 2022 would have to be as Roth after-tax contributions.
Capping the Exclusion from Income: Many of President Biden’s tax proposals harken back to President Obama’s proposals. One of the ‘old’ Obama proposals was to cap the income tax deduction for a contribution to a 401(k) account at 28%. Under this proposed bill, a plan participant in the 37% (back then 39.6%) income tax bracket would pay an 11.6% tax on a regular 401(k) contribution. Yet another revenue raiser if passed.
Capping the Total Benefit: President Obama had also proposed capping the total benefit that a participant could accumulate in IRAs, defined contribution plans, i.e. 401(k) accounts, and defined benefit pension plans at an aggregate $3.0 million current fair market value. A more workable proposal is now being floated at this time would be to cap a combined IRA and defined contribution balances at $2.0 million per participant (but this rule would ignore the value of a defined benefit pension.)
Convert a Tax Deduction to a Tax Credit: Yet another proposal in the bill would be to eliminate the 401(k) income tax deduction for contributions to that account, replacing that contribution ‘exclusion’ from taxable income with an income tax credit of some magnitude. Fortunately, there apparently is not much support in Congress for this deduction-to-credit proposal, as it is perceived as being too complex to implement, and perhaps too expensive for the IRS to monitor (or both.)
Automatic Enrollment for New Plans: As a retirement savings stimulus, one provision in the bill would require automatic enrollment for new created retirement plans after 2021. This would apply to ‘new’ 401(k) and (403(b) plans adopted after 2021, as well as SIMPLE IRA plans. This change would require an employee’s pretax contribution of 3% of compensation. The default contribution would increase 1% annually up to 10% of the employee’s compensation. A participant can affirmatively ‘opt-out’ of the automatic enrollment and withholding, or select a different contribution rate.
Tax Treatment of Matching Contributions: Another change under the bill would permit a qualified plan sponsor to amend their plan to allow participants to elect tax treatment on all or a portion of their matching contribution.
Part-time Employees: Part-time employees who work at least 500 hours in three consecutive years are now able to participant in their employer’s 401(k) plan. The SECURE Act 2.0 would reduce the three year qualification period to two years.
SEP and SIMPLE Plans: The bill would allow after-tax Roth contributions to SEP and SIMPLE plans, which currently are not permitted under the Tax Code.
Grace Period: The bill would add a grace period to enable plan sponsors to correct automatic enrollment and increased contribution errors associated with the qualified plan. The sponsor’s correction of the error, without negative consequences to the plan, would have to be within 9 ½ months of the following year.
Limit on Recovery of Excess Plan Distributions: An employer who sponsors the qualified plan would be limited in the steps and time in which the employer-sponsor can recover excess plan distributions made to a plan participant.
National Database: The bill would authorize the creation of a national online database with regard to lost retirement accounts, or existing accounts where the participant cannot be located.

Conclusion: No one has any idea if any of these retirement plan changes will ever see the light of day. However, it is clear that there is far more bipartisan support in Congress to encourage retirement savings than there is to adjust income tax rates or promote governmental spending. Because of that bipartisan support to induce more Americans to save for their retirement, there is a better chance that some of these changes in the SECURE Act 2.0 may actually find their way into legislation that establishes the fiscal year budget in September. It is something to watch as the budget debates begin in earnest.