Big Changes to 401(k) Retirement Plans Move Ahead in Congress (WSJ)

 

Congress is on the verge of passing a bill that aims to help Americans save more for retirement and leave their retirement savings untouched and untaxed for longer.

The bill nearing approval raises the age people are required to start withdrawing money from tax-deferred retirement accounts to 75 from 72. It increases retirement savings contribution limits for older workers and provides an increased incentive to people with low and moderate incomes to save in retirement accounts. It also paves the way for more employers to offer emergency savings accounts inside 401(k) plans.

Congress, which published the final details of the bill on Tuesday, is expected to pass the measure in the next few days as part of a larger year-end spending bill. President Biden is expected to sign it soon after.

Lawmakers have been writing and negotiating the changes to America’s retirement system for several years in response to an aging U.S. population. Also driving the need for changes, say lawmakers and many investment professionals, is that more employers have shifted responsibility for retirement savings to individuals. Roughly half of American households aren’t saving enough to sustain their standards of living after retirement, according to Boston College’s Center for Retirement Research.

The bipartisan retirement measure builds on retirement-policy changes enacted in 2019 that, among other things, raised the age people were required to start withdrawing money from retirement accounts to 72 from 70½. 

Postpones Required Minimum Distributions

The new legislation raises that age again, from 72 today to 73 starting on Jan. 1, 2023 and to 75 starting on Jan. 1, 2033.

These required withdrawals can be a source of frustration for taxpayers who are still working or are trying to make their savings last in retirement. The point of the mandatory distributions is to make sure individuals spend a portion of their retirement savings during their lifetimes, making the accounts tax-deferred, not tax-free.

The bill will help certain people who can afford to leave their money untouched, but it could expose them to higher tax bills in future years. That is because when required distributions start, account owners will have to withdraw more money annually over a shorter time period that matches their life expectancy, said Ed Slott, a certified public accountant and IRA specialist in Rockville Centre, N.Y. About 80% of people subject to mandatory retirement account distributions withdraw more than the required minimum because they need the money, said Mr. Slott.

Automatic Enrollment Required

Backed by legislators including Sen. Rob Portman (R., Ohio) and Rep. Kevin Brady (R., Texas), both of whom are retiring, the legislation also seeks to expand retirement plan participation by requiring many newly created 401(k) or 403(b) plans to automatically enroll workers starting in 2025 at between 3% and 10% of pay, something the legislators say will boost participation rates for minorities. It also raises the savings rate by 1 percentage point a year until it hits 10% to 15%. 

Another provision in the bill will allow older workers to make extra catch-up contributions to 401(k)-style retirement accounts. In 2023, people 50 and older will be able to contribute an extra $7,500 a year to these accounts. The bill would raise the catch-up amount to at least $11,250 a year for people 60 to 63 starting in 2025.

Brokers, asset managers, 401(k) record-keepers and insurers are likely to benefit from these measures, because the more money that is saved in retirement accounts, the more money they make from fees. The financial services industry lobbied for the package.

Some lawmakers, academics and policy analysts have criticized some of the provisions, including the move to raise the age of required retirement account distributions to 75. They argue much of the legislation benefits the wealthy and the financial-services industry. 

“It will primarily subsidize the wealthy and worsen the racial wealth gap,” said a statement from Americans for Tax Fairness. The coalition of progressive groups that favors raising taxes on high-income people urged Congress instead to expand Social Security.

Several changes in the legislation revolve around Roth 401(k)s, which require people to contribute after-tax money into a retirement plan, forgoing the tax deductions they would get with traditional accounts. 

The legislation allows people with these Roth 401(k)s to skip required distributions, starting in 2024.

Backers of the bill say that it won’t significantly change federal revenue over the next 10-year congressional budgeting window. In that period, the larger tax breaks for savings would reduce revenue while pushing people toward Roth accounts with post-tax contributions that would raise revenue. In the longer run, though, Roth accounts would reduce federal revenue through tax-free appreciation and withdrawals. 

Savings for Emergencies in 401(k)s

The legislation tries to balance the tax incentives to encourage long-term savings with the need to allow flexibility for emergencies and other financial goals.

It removes legal barriers that currently prevent employers from automatically enrolling employees in emergency savings accounts within 401(k) plans. It allows employees to save up to $2,500 in a rainy-day Roth account, although employers can set lower limits. Additional contributions and any employer match would be invested in retirement savings. When an employee taps the emergency fund, the money would come out free of taxes and the 10% penalty that people under age 59 ½ typically owe. 

The provision “would help people take advantage of their employer’s 401(k) match even if they cannot save for retirement,” said Shai Akabas, director of economic policy at the Bipartisan Policy Center.

Former Treasury Department official Mark Iwry said he expects the measure to spur significant adoption of employer-facilitated emergency savings accounts in 401(k) plans and independent of those plans. 

Due in part to a wave of early 401(k) withdrawals amid the pandemic in 2020, more employers have grown concerned that when employees are unable to cover unexpected expenses, they often resort to raiding their retirement savings.

The bill would also allow people to roll up to $35,000 from 529 plan accounts into Roth IRAs. That would be available only for accounts in existence for at least 15 years and would be subject to Roth contribution limits. 

The bill includes provisions for some penalty-free withdrawals for the terminally ill, victims of domestic abuse, and the payment of certain long-term-care insurance premiums. Those affected by federally-declared disasters can take up to $22,000 penalty-free and have the option to pay the income tax over three years and repay the money.

To encourage people with low and moderate incomes to save in retirement accounts, the measure restructures a tax credit available to certain workers. The government would put up to $1,000 annually into the retirement accounts of eligible workers starting in 2027, regardless of whether they have an income tax liability. Currently, the credit is only available to people with an income tax liability.

Write to Anne Tergesen at anne.tergesen@wsj.com and Richard Rubin at richard.rubin@wsj.com