Congress is set to pass a bill that will make some major changes to the American 401(k) Retirement Plan. The bill comes as a bi-partisan effort of the Senate Finance Committee, and builds upon the 2019 Secure Act.
The 2019 bill took away the individual retirement account (IRA) contribution age cap. It also incentivized workers to allow employers to raise their annual savings rate from 10 percent to 15 percent.
The 2023 bill is designed to assist Americans in saving more for retirement by allowing them to leave their retirement savings untouched, and thus untaxed, for longer.
These recent changes to American retirement plans are being made to combat an aging population that isn’t able to save enough for retirement. The majority of employers have shifted the responsibility of saving for retirement to individuals. Meanwhile, median incomes and social security have not increased in years.
Here are the highlights of the 401k changes 2023 that you should know.
What is a 401(k)?
A 401(k) is a type of retirement savings fund that is sponsored by an employer. These allow employees to take advantage of some financial incentives. First, they can make their contributions using pre-tax income. Not only does this lower their taxable income, it allows their contributions to grow in a tax-deferred environment. Second, these retirement accounts are sponsored by the employer, meaning that the employee doesn’t have to pay fees to start or maintain the account. Last but not least, most employers offer some sort of incentive program, such as 401(k) matching. This means that if you meet certain contribution minimums, your employer will contribute the same amount to your fund. Essentially, such a program can double your retirement savings. Learn more about 401(k) plans and other types of retirement funds here.
Required minimum distributions postponed
Starting on January 1, 2023, aging Americans will be able to postpone taking their required minimum distributions. The age will be raised from 72 to 73. Starting January 1, 2033, the age will be raised a second time to 75.
Mandatory distributions encourage aging Americans to use their retirement savings during their lifetimes. However, these accounts are tax-deferred but not tax-free.
Because many Americans are behind on saving for retirement and are working for much longer, these mandatory distributions have been a source of frustration. Taxpayers who are still working and trying to catch up on their retirement savings don’t want to take these mandatory withdrawals.
The bill will allow them to leave their money untouched for longer. However, taxpayers should note that this could lead them to higher tax bills in future years because they will have to withdraw more money over shorter time periods.
Automatic enrollment will be required
In 2025, workers will be enrolled automatically to newly created 401(k) and 403(b) plans. These required automatic enrollments will begin at between 3 to 10 percent of pay scales. The bill will also raise the savings rate by 1 percent each year until it reaches 10 to 15 percent. These requirements aim to increase retirement plan participation rates, especially amongst minorities.
Older workers will be allowed to make additional catch-up contributions to their retirement accounts. Workers aged 50 and above will be allowed to contribute an extra $7,5000 per year. Those aged 60 to 63 will be able to increase that catch-up amount to $11,250 or more starting in 2025.
There will also be changes regarding Roth 401(k) retirement plans. These plans are used by individuals who opt to contribute after-tax money into their retirement plan. When they withdraw money during retirement, they don’t have to pay income tax since they were already paid. The new bill will allow these individuals to skip their required distributions beginning in 2024.
Savings for emergencies in 401(k)s
The 2023 bill also aims to provide more flexibility for individuals who need to access their 401(k) savings for emergencies.
Currently, there is a 10 percent penalty assessed for individuals aged under 59 ½ who tap into their retirement accounts as an emergency fund. (These withdrawn funds are also taxed as income, which essentially creates a double-penalty.)
During the COVID-19 pandemic, there was a wave of early 401(k) withdrawals despite the heavy penalties, causing employers to grow concerned.
The new bill will allow employers to automatically enroll employees in emergency savings accounts that are held within their 401(k) plans. Employees will be allowed to save up to $2,500 in a rainy-day account. If the employee has to tap into their emergency fund, the fund would come out tax-free and without the 10 percent penalty.
The bill also includes new exceptions allowing penalty-free withdrawals for special circumstances, such as for the terminally ill, domestic abuse victims, and for the payment of long-term-care insurance. Victims of federal disasters will be able to withdraw up to $22,000 without the 10 percent penalty, plus the option to repay the money and income taxes owed over three years.
The government will also begin to put $1,000 annually into eligible retirement accounts, starting in 2027. This is designed to encourage low-to-moderate income workers to participate in retirement savings. This credit currently applies to individuals with an income tax liability, but will be extended to workers even if they do not have an income tax liability.
Update your estate plan today
Many economists and researchers are sounding the alarm over what is being called the American retirement savings crisis. Too many Americans are unable to save up enough money for and in time for retirement.
As a result, bi-partisan efforts are being made to reform American retirement savings plans to provide some relief to aging Americans. However, it remains to be seen whether the 401k changes 2023 will indeed help; it also remains to be seen whether the Social Security program will be expanded.
Regardless, it is undeniable that these congressional changes are major. It is a great idea to review how these changes will impact your own retirement savings strategy and future plan for retirement. It may even require that you take action by revising your estate plan to incorporate these changes. For example, we talked about how the 2019 SECURE Act could impact estate planning in several ways.
Luckily, we’re here to help you so that you don’t have to go through the process alone! Trust & Will makes it extremely easy to set up, manage, review, and update your estate planning documents online! Any time a major congressional change comes your way, you can have peace of mind knowing that if you’re impacted, you can update your personal documents without any stress. Take our free quiz to see where you should get started, or compare our different estate planning and settlement options today!
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