The much-awaited SECURE 2.0 Act of 2022 was signed into law on Dec. 29, 2022. The Act creates more tax savings for employers and employees, alike, and expands access to a work-sponsored retirement program to many employees.
Here are the key provisions you can expect to see rolling out in the next couple of years:
New benefits established
Establishment of “Starter K"
The new Starter K provisions allow employers that have never sponsored a retirement plan to set up a simplified 401(k)—named the “Starter K.” Under this new plan, employers will not be required to contribute, and employees will be automatically enrolled at 3% of pay. However, contribution limits are much lower for employees than a traditional 401(k). Beginning in 2024, employees can contribute a maximum of $6,000, with a $1,000 catch-up for those 50 or over.¹ In exchange for lowering the deferral limit, employers do not have to worry about annual ADP, ACP, or top-heavy testing.
The Starter K becomes a great option for a small business that cannot afford the administrative complexities and heavier price tag of a regular 401(k), but still want to give workers an opportunity to save for retirement. And especially in states that require an employer-sponsored retirement plan, the Starter K could be a great private alternative to the potentially somewhat clunky State-IRA options. The American Retirement Association estimates that 19 million additional workers will gain access to a workplace retirement plan with this provision enacted. Moreover, the plan will reduce racial inequity in the retirement space, as Black and Hispanic workers would see a a 22% increase in access to workplace retirement plans.
Pension-linked Emergency Savings Accounts
Another of the more exciting provisions is the creation of Pension-Linked Emergency Savings Accounts (PLESAs), which are employer-sponsored accounts linked to a retirement plan, where non-highly compensated employees can withdraw more regularly and without penalty.
The account is to be set up as a designated Roth account and invested in highly liquid assets, such as a money market fund. Contributions must cease after the account balance reaches $2,500, and any additional savings goes to the Roth 401(k) account instead.
Participants can be auto-enrolled at 3% of gross income as an after-tax elective deferral. Employers need to match the funds with whatever 401(k) matching formula is used, and the match would be contributed to the 401(k) account. Participants can withdraw funds at least once monthly. They will also be able to replenish funds back up to the $2,500 cap at any time.
Not only do PLESAs have the potential to help alleviate the nationwide problem of households not having enough liquid emergency funds; they will also encourage retirement plan participation, since one of the main reasons for not participating is the fear of needing liquidity if an emergency were to occur.
Auto-enrollment
While not a new plan option, the new rules will now require all newly established 401(k) and 403(b) plans to include automatic enrollment, along with auto-escalation, as default features beginning Jan. 1, 2025. The initial auto-enrollment default must be between 3% and 10%, and the rate must increase every year by 1%, until the participant hits at least a 10%, and no more than 15%, contribution.
Employees can opt out or set their own contribution rate at any time, but this will ensure those who don’t take any action will automatically begin to save for retirement. There is an exception for small businesses with 10 or fewer employees, new businesses, church plans, and governmental plans. Plans established as of Dec. 23, 2022 are also grandfathered.
The Senate noted that auto-enrollment increases participation among younger, lower-paid employees and the racial gap in participation rates is nearly eliminated. No doubt that participation should significantly increase—however, given that auto-enrollment will be a requirement, there’s a chance the current $500 auto-enrollment tax credit for new plans will disappear as that incentive will no longer be needed. At Guideline, we believe that auto enrollment provides many benefits to employers and employees, which is why all eligible participants are automatically enrolled in their employer-sponsored 401(k) plan if they don’t either self-enroll or opt-out by the prescribed deadline.
Employer incentives
Increase in tax credits
Though auto-enrollment credit might eventually go away, SECURE 2.0 provides a wealth of additional tax incentives over the current ones.
The original SECURE Act, passed in 2019, increased the Retirement Plans Startup Cost Tax Credit to the greater of $500 or the lesser of either $250 for each eligible non-highly compensated employee (NHCE) or $5,000. The credit applies for up to three years and is limited to 50% of eligible startup costs, which include ordinary and necessary costs to set up and administer the plan, as well as educate employees about the plan.
Employers qualify for this credit if they have 100 or fewer employees, have at least one plan participant that is an NHCE, and have not sponsored a plan in the last three years.
SECURE 2.0 removes the 50% cap for qualifying businesses with up to 50 employees so that 100% of startup costs could potentially be covered. The maximum credit is still $15,000 over three years.
SECURE 2.0 also provides an additional credit for employer contributions, up to $1,000 per employee. Employers with up to 50 employees are eligible for the full credit, which is phased out for employers with 51-100 employees.
The new tax credit provisions, effective as of Jan. 1, 2023, significantly increase the benefits of starting a 401(k) plan for the smallest businesses and also provide monetary incentive for small businesses to start a safe harbor plan, which can make plan administration less of a burden in the long run.
Saver’s match
SECURE 2.0 turns the current Saver’s Credit into a saver’s match. Currently, individuals under a certain income threshold who save into their retirement account are eligible to receive a non-refundable tax credit of 50%, 20%, or 10% of their retirement contributions up to $2,000.
The new provisions require that this credit be deposited directly into a retirement account. The amount of the credit will remain the same based on prior requirements and again is phased out depending on income.
This provision is a clever way of ensuring that the saver’s retirement tax benefit is actually contributed towards their retirement and helps to boost retirement savings for those in a lower income tax bracket. However, it won’t be effective until after 2026—likely to figure out administrative challenges in how to deposit those funds.
Student loan matching
There is also good news for those paying off student debt. Starting in 2024, employers will be able to match payments employees make toward qualified student loans. The match must follow the same formula and vesting schedule as whatever is tied to the retirement plan, and the contribution will be deposited into the employee’s retirement account.
Employers will be able to rely on the employee’s certification that loan payments are being made. The student loan participants may also be tested separately from the rest of the plan for ADP purposes.
The new rules will allow employees with large student debt to still capitalize on any matching contributions offered by their company to help them keep on track for retirement.
Participant provisions
Catch-up contributions
The Act includes some nice adjustments for later-stage participants, beginning with an increase in catch-up contributions.
Starting in 2025, the catch-up contribution limit will increase to $10,000 for employees aged 60 to 63. The limit will be indexed for inflation every year, and—here's the catch—all catch-up contributions will now be required to be Roth, unless the employee earns $145,000 or less annually.
Some have mixed feelings about this provision. On the one hand, employees nearer to retirement are allowed to save even more in a tax-advantaged way, but on the other hand, the immediate tax benefit gets taken away from them. Older participants generally prefer to save money on a pre-tax basis if possible, as the tax advantage of Roth contributions increases exponentially the longer you hold money in your account.
Required minimum distributions
Another favorable provision for later-stage savers is the required minimum distribution (RMD) age increase to 73, beginning on Jan. 1, 2023. The current RMD age is 72. The RMD age will also increase to age 75 in 2033. And starting in 2024 designated Roth contributions will no longer be included when calculating the RMD amount.
The late withdrawal penalty is also decreased to either 10 or 25% (down from 50%), depending on how soon the error is corrected. The provisions provide a logical adjustment to required distributions as life expectancy increases, allowing individuals more time to determine their best withdrawal strategy for tax purposes.
On the whole, we are excited about the new SECURE provisions and believe there will be an overall positive impact on the retirement readiness of American workers. Guideline looks forward to supporting the required immediate changes and adjusting our offerings in the future to accommodate the rest.
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¹Subject to IRS cost-of-living adjustments.
