With the recent passing of the bipartisan budget bill, a number of substantive changes were also enacted. These changes impact who is eligible for workplace retirement benefits and how they are implemented, how contributions into qualified retirements work, and how distributions from these accounts during retirement work. This article is divided into those three sections to make it easier in figuring out what changes may affect you, along with our commentary at the end of the article.
While it is our goal in this article to provide you with complete and accurate information, we encourage you to consult with your financial planner and/or tax professional for personalized recommendations.
Eligibility Changes to Workplace Retirement Benefits
- Starting in 2025, businesses starting new 401(k) and 403(b) plans will be required to automatically enroll employees with a contribution rate of at least 3%.
- Plans can offer automatic portability service, transferring the old plan to the new one when changing jobs for small balance employees.
- Defined contribution plans can add on a Roth account eligible to be withdrawn for emergency savings without penalty. Contributions are limited to a maximum of $2,500 (limit set by the employer). The first four withdrawals from the account would not have any tax consequences/penalties.This begins in 2024.
- In tackling student debt, employers will be able to “match” employee student loan payments starting in the 2024 tax year.
Changes to Contributions Into Qualified Retirement Accounts
- Currently, the catch-up contribution limit for retirement through a 401(k), 403(b), 457 plan, or a TSP is $6,500. This number will be increased to $7,500 for 2023.
- Starting in 2025, a “special” catch-up contribution limit will exist where workers aged 60-63 years old equal to the greater of $10,000 or 150% of the “standard” catch-up contribution amount for 2024. The $10,000 amount will be adjusted for inflation each year after, starting in 2026.
- The SIMPLE IRA catch-up contribution limit for workers age 50 and older currently is $3,000, increasing to $3,500 in 2023. Starting in 2024, the catch-up contribution limit for a SIMPLE IRA is $3,850, and in 2025 similar to a 401(k), the limit will be equal to the greater of $5,000 or 150% of the 2025 catch-up contribution limit. The $5,000 amount will be adjusted for inflation on an annual basis.
- Beginning in 2024, all catch-up contributions for workers with wages over $145,000 during the previous year must be deposited into a Roth (after-tax) account. The wage threshold will be adjusted for inflation annually beginning in 2025.
- Starting in 2023, the maximum contribution into IRAs increases from $6,000 to $6,500. This has been adjusted periodically to reflect inflation.
- Starting in 2024, the $1,000 “catch-up” contribution allowed for people aged 50 and older will also begin to be adjusted annually for inflation, in multiples of $100.
- The Savers Credit, which historically has existed to try and encourage low-income Americans to contribute to a retirement plan, is changing starting in 2027 into a “Savers Match.”
- Under this new program, the government will match 50% of the first $2,000 contributed to eligible retirement accounts.
- The phase-out ranges will be expanded and treated similarly to how IRA contribution limits phase-out based on income as opposed to the current system, which has hard income limit cut-offs.
Changes to Distributions From Qualified Retirement Accounts
- Beginning in 2023, the Required Minimum Distribution (RMD) age increases from age 72 to age 73. A decade from now in 2033, that age will increase again to 75 years of age.
- Starting in 2023, the “excise tax” for failing to take an RMD will be considerably less punitive – 25% versus the current penalty of 50%. If you take the necessary RMD by the end of the second year following the year it was due, that percentage penalty drops to 10%.
- Starting in 2024, Roth 401(k)s will no longer have the requirement to roll over funds into a Roth IRA to avoid taking RMDs.
- Annuity payments within a qualified retirement account will qualify as counting toward RMDs if several conditions are met:
- Annuity payments that increase at least annually up to 5% per year
- Lump sum payments that shorten the payment period with respect to an annuity
- Full or partial commutation of annuity payments
- In-plan annuity payments exceeding the RMD amount can be applied to the following tax year’s RMD.
- Payments in the nature of a dividend payment
- Final payments on death that do not exceed the total amount of consideration paid for the annuity payments, minus prior distributions or payments from the contract.
- Currently, the amount allowed to be contributed into a qualifying longevity annuity contract (QLAC) is the lesser of $130,000 or 25% of a retirement account, shielding them from RMDs. The 25% limit aspect has been repealed, while simultaneously increasing the limit to $200,000, adjusted for inflation on an annual basis.
Increasing the ease of usage and portability of retirement savings, particularly for beginning investors, will be very helpful in encouraging buy-in from all workers to contribute and save for their retirement. Additionally, leveraging the research found in “nudging” by making retirement contributions opt-out rather than opt-in will substantially increase both the participation rate and amount being contributed long-term by workers. This is important given that currently, the median 65-75 year old only has $265,000 in total net worth, including their house. With half the country doing worse than that, it is likely that Medicaid enrollment will increase dramatically in the next 15-20 years, with 3-4 times as many seniors participating compared to now (which would amount to about 40 million people reliant on Medicaid).
Moreover, the addition of Roth accounts with emergency savings characteristics likely provides the flexibility many need who might fear investing and losing access to their funds in the case of a severe emergency. While we do not see this vehicle as ideal due to the nature of the market tending to correlate with negative risk events that cause clients to tap into emergency savings, if it psychologically gives someone permission to save that they might not otherwise have, we view this as a net positive. However, it is important to stress that what they are offering in that flexibility is in our view an entirely inadequate amount of emergency savings for virtually any client, and its exposure to market risk is in our view a non-starter in the foundation of a financial plan. We would suggest thinking of it as an extra perk rather than a means to an actual end; we tend to underestimate our emergency needs when we are not under duress.
It is excellent to see that catch-up contribution limits will now at long last be subject to inflation-based increases. This has been a deficiency for a long time. However, a chief concern in our research has been that middle and middle-upper households who are required to characterize catch-up contributions as Roth-treated would lose a significant portion of their retirement savings, upwards of $100,000 over their lifetime, as a result of this policy. While the income limit being used is a starting point, unfortunately we feel that this is actually not a high enough bar to effectively tamp down the negative long-term effects of such a policy; it is more window dressing than anything else. It is curious why they did not select at a minimum a threshold that already exists – the phase-out range for Roth IRA and Coverdell ESA contributions, which begins to phase out in 2023 at $218,000. This in our view would have gone a much longer way to address the potential fallout from penalizing older workers who choose to save by forcing them to pay what is likely to be the highest marginal income tax rate of their lives on money designated for their future needs, versus allowing them to defer taxation and while potentially paying lower tax rates, also significantly reduce the risk of them running out of money during their lives and ending up on Medicaid. This revenue-raising effort in our view is a policy error, and we will advocate for that threshold to be increased.
Generally speaking, we support the common sense mechanical changes that have been adopted here. Roth 401(k)s being treated differently than Roth IRAs and forcing people to rollover those accounts to avoid RMDs never made sense, so removing that stipulation is a long overdue rule change. The current excise tax on RMDs is brutal, so reducing that penalty and reducing it further in the event of an accidental missed distribution makes sense. We will advocate to see that penalty reduced further – HSAs for example have just a 6% penalty on overcontributions, so a number more in line with similar errors would seem to make sense. A number closer to 6% would also reflect a more moderate growth investment strategy, which is typically what an account for a retiree or pre-retiree might aim to achieve long-term. 10% is still 66% too punitive in our opinion.
The change with respect to the age for RMDs is substantial. As shown in our actuarial research earlier this year, shifting the RMD age from 72 to 75 means that about 5% of the population will pass away in those three years, making Roth IRAs significantly more risky to use as an investment vehicle given that there is now an additional 1 in 20 chance that the client may never realize the benefit of prepayment of taxes as a means of foregoing tax payments later. While the lack of required scheduled distributions is still a major benefit of such an account, it cannot be understated that significantly less people will benefit from such treatment, especially if they also have other risk factors that increase the likelihood of early morbidity. Given that the increase in RMD age is going up to 75 within the next decade, and the behavior/willingness Congress has shown to shift the goalposts, if life expectancies continue to increase it is plausible that this age shifts up even further, perhaps as high as 77 or 78 by 2050. Awareness of these potential policy changes is important in managing the holistic risk management of client funds not just from an investment management perspective, but from a tax management perspective as well. This is a risk management challenge that does not just affect one demographic; it affects the risk-reward being offered all the way down to the youngest clients, and likely favors at a minimum a more diversified usage of various investment vehicles to have flexibility in potential tax treatment years if not decades from now.
Finally, it is important to note not only the breadth of these changes, but the willingness once again for Congress to change the rules of the game. While some in our industry may enjoy the gamification of attempting to maximize benefits based on the rules as they are currently presented, they entirely miss the idea that these rules have been changed now twice in just 36 months, are likely to change again, and will likely continue to disrupt strategies that are purely focused on maximizing returns in a theoretical bubble. Outside of that set of risks, life sometimes offers challenging situations, where a number of bad outcomes can and do occur all at once. It is at these moments where having a comprehensive long-term approach, from access to funds to tax treatment to investment decisions, are all coalesced under one contiguous strategy.
That comprehensive, contiguous approach is what we do.