With the new SECURE Act 2.0 up for review in the Senate, now is the time for HR professionals to get proactive about setting employees up for a successful retirement in the new landscape of retirement planning.
Our team of Retirement specialists broke down the most notable features of the SECURE Act 2.0 to help you and your team prepare.
The original SECURE Act (Setting Every Community Up for Retirement Enhancement) was passed in 2019 and went into effect in 2020. Its intent was to help employers offer retirement plans that empower workers at all income levels to save for their futures. Now, two years later, further reforms may be signed into law in a matter of months or even weeks.
Here’s what you need to know about the SECURE Act 2.0 and how it will affect your employees:
Raising the age of the Required Minimum Distribution (RMD.)
The age at which an individual is required to start drawing money out of their pre-taxed retirement accounts is going up. The first SECURE Act raised the age from 71.5 to age 72, and the new version includes a plan that extends it to age 73 in 2023, then to age 74 in 2030, and finally to age 75 in 2033. This is overall a positive change because individuals are no longer forced to take money out as early. Of course, if they want to, then they can, but it is not required.
The penalty for missing the RMD is less severe.
While it is still significant, the SECURE Act 2.0 lowers the penalty for missing the RMD. In the scenario that an individual forgets to take money out from their retirement account, the penalty will be decreased. For example: In the past, if an individual was required to take out $10,000 from an IRA and forgot to do so, the penalty was 50%. So, that person would still have to take the $10,000 out, report it on their taxes, and then pay a $5000 penalty. The new SECURE Act 2.0 drops the penalty to 25%.
The SECURE Act 2.0 requires auto-enrollment to new employees. When a new hire starts at your company, they will automatically be enrolled in the firm’s retirement program at 3%. There is also an auto-increase feature, increasing the contribution each year by 1% until it reaches 10%. Of course, employees may opt to put in any amount they’d like, but this move ensures that the default for all employees is to contribute. While this is a great feature for many employees who would otherwise forget to enroll, this amount is often not enough for an individual to set up a successful retirement plan. There’s a chance this handy set-it-and-forget-it policy could leave some employees wondering why their nest egg isn’t what it needs to be.
Increased catch-up contributions.
Under the current law, an individual is allowed to contribute more toward their retirement once they turn 50. With the SECURE Act 2.0, this allowance is increased at ages 62, 63, and 64. All catch-up contributions will be considered Roth contributions, which means the individual will pay taxes on them upfront. This new rule is helpful in that it gives individuals the ability to save more in that final push to prepare for retirement.
Retirement Savers’ Contribution Credit.
We love this one. This credit is a dollar-for-dollar reduction that an individual does not need to pay back. It really is a tax credit just for saving up for retirement, which employees should be doing anyway. For those who are eligible, the credit is 50% per person – which means, if they are married, their spouse could likely take the same credit. That’s a win!
This adjustment to the SECURE Act is about – you guessed it – matching contributions to student loan payments. As an employer, you may already have a program where you already pay or match your employees’ student loan payments. It appears that this new feature would make it so that these matches can go straight into the employees’ 401(k). This could be a great asset to recruitment for those employees who are not able to make both a student loan payment and a 401(k) contribution.
More potential Roth contributions.
Currently, the employer match on retirement contributions goes into the traditional 401(k). However, in the SECURE Act 2.0, employer-matching contributions will be allowed to be made as Roth contributions. This is helpful for employees in low tax brackets saving up for Roth, as another way to get more dollars in their Roth 401(k), growing tax-free for their financial future.
Employers are now allowed to incentivize employees to participate in their retirement plan.
Finally, employers are now able to encourage employees to participate in their retirement program by providing incentives, such as small gift cards. Any token that reminds an employee to participate is a win for both the employee and the employer.
In summary, the SECURE Act 2.0 provides more options for retirees, but the new rules can be a little complex. We recommend preparing communications for employees ahead of time so they can start thinking about their new landscape of retirement planning.
This is a great time for HR Professionals to review their company retirement programs and make changes to successfully recruit and retire valued employees. For an assessment of your current plan, guidance on choosing a new plan, or questions regarding the SECURE Act 2.0 or other retirement-related questions, please reach out to our Retirement team.
When considering deductible retirement plans, many business owners and CPAs only think about 401(k) and Simplified Employee Pension (SEP) plans. But there’s another option on the table they should be considering — defined benefit/cash balance retirement plans.
Why? The most an employer can contribute to a 401(k) or SEP is the lesser of 25% of compensation or $55,000 ($61,000 for those 50 and over). While fine for some small businesses and professional groups, the recent Tax Cuts and Jobs Act of 2017 (TCJA) means that many small to medium-sized business owners are now paying less in taxes and have more than that amount to save for retirement.
This is where a well-designed cash balance plan combined with a 401(k) plan comes into play. It can provide deductions of $100,000, $150,000, $200,000, and more, for highly compensated employees, with smaller amounts to non-highly compensated employees.
How a Cash Balance Plan Works
Remember the old-school defined-benefit plans our grandfathers had back in the 1950s, working for companies such as General Motors? A cash balance plan is similar, but has a 401(k)-like twist to it.
Traditional pension plans promise participants a certain benefit at retirement, such as 50% of their final monthly paycheck paid to them for as long as they live. A cash balance plan also provides a promised benefit but in an account that looks like the lump sum balance in a 401(k) account, rather than as a monthly income stream.
The closer one is to retirement, the more the employer can sock away for the employee on a deductible basis without that amount being reportable as compensation to the employee. A 60-year-old employee who wants to retire at age 66, for example, can have more than $200,000 as a tax-deductible contribution — a pretty good deal thanks to the recent tax reform legislation. The money would be taxable when paid out in retirement, but tax brackets may be lower then.
Benefits of Cash Balance Plans
The workforce is aging. Many employees don’t even begin to start thinking about retirement savings until their late 30s and early 40s. Some don’t get serious about doing anything until their mid-to-late 40s or even into their 50s.
By then it may be too late to fully fund a 401(k) plan to get the retirement outcome a highly compensated person wants. But the higher deductible limits allowed under a cash balance plan, combined with tax deductible dollars and tax deferred growth can turbocharge the plan and help reach the desired retirement outcome on time.
Who Should Use Them
The most significant cash balance plan action is taking place at small- to medium-sized employers. There have been increasing levels of interest from the technology sector, retail industry, and manufacturing companies, but the greatest interest comes from professional service firms. Doctors, lawyers, and accountants are typically highly compensated and are eager to save when the numbers for them are big, yet the contribution is deductible.
The growing gig economy of entrepreneurial consultants, professionals, and others can also benefit from these plans. Just one, two, or three employees in a combination 401(k)/cash balance plan can help employees and owners get larger deductions and more cash for their retirement. Regardless of industry, the best outcomes are generally for plans covering those over age 50.
Here’s an example of how a 401(k) combined with a cash balance plan worked for a small professional firm with 23 employees including three owners. The objective was to provide the three owners with deductible contributions of varying amounts chosen by each owner. Owners one and two wanted to contribute $100,000, while owner three wanted to contribute just $50,000 to the cash balance plan. They also wanted to make company contributions of as little as possible to the other 20 employees. Every employee could defer as much as they wanted (up to the limits allowed) to the 401(k) plan, which was a safe harbor plan. This meant the company would contribute 3% of each eligible employee’s pay, which allowed any highly compensated employee to make the maximum contribution to the 401(k) plan. As a result, almost 80% of the company contributions went to the three owners, while the company took a tax deduction of more than $500,000.
Setting up a Cash Balance Plan
How do I set up a plan? What does it typically cost, and what should make me think twice about doing it?
An actuary must design and certify the funding of the plan every year. A third-party administrator (TPA) generally prepares the plan document and provides all the ministerial services for the plan on an annual basis. There may also be investment advisory and brokerage fees. Expect to pay anywhere from $2,000 to $5,000 to set up the plan, with additional annual fees of $1,500 to many thousands of dollars depending on the number of participants.
The government also wants the plan to be permanent. An attorney who has a gigantic fee this year, or a real estate agent who has a career best commission that results in a windfall of taxable income that is unlikely to happen again, and wants to use a cash balance plan to reduce what would otherwise be a big income tax, shouldn’t use this plan for that sort of event without thinking through how to handle contributions in future years. Plan sponsors should think about doing similar contributions to the plan for a number of years. If everything stays the same, employee population and their compensation, investment returns for the plan, etc., then the contribution amounts will be about the same each year.
Is it Right for You?
The TCJA has given many business owners more cash to invest in things like retirement plans. If you’re looking for a tax-advantaged way to set aside some of the tax dollars you now have as a result of the TCJA, it might be a good time to look closely at how a cash balance retirement plan can work for you.
About the Authors
Mike Weintraub is president of the Retirement Plans Division at Relation Insurance Services in Walnut Creek, CA. He can be reached on LinkedIn, via email at [email protected] or via phone (925) 407-0412.
This article originally appeared on TheStreet website.
Written by Michael Weintraub
I was the Chair of the Life Happens® board back when the nonprofit was called the LIFE Foundation. (My wife loved to introduce me to others as the Chair of LIFE!) Last year, the board asked me to return as a member of its executive committee and take the position as Treasurer for its general board. I accepted the roles, as I can say I genuinely love and appreciate this organization for what they do. While many insurance companies and salespeople often make the simple complex by using complicated jargon and confusing spreadsheets, Life Happens® is all about presenting life insurance in a framework everyone can understand. They help consumers (and advisors) understand that people buy life insurance because of their love for someone else.
Check out one of their videos below on the long-lasting effects of life insurance. It’s short, only 90 seconds, but it’s truly powerful. The premiums for life insurance are at historical lows, so if this video helps motivate others to review their life-insurance policies, we want to help by sharing it.
About Life Happens
Life Happens is a nonprofit organization dedicated to helping Americans take personal financial responsibility through the ownership of life insurance and related products, including disability and long-term care insurance. They were formed in 1994 by seven leading insurance producer organizations, which recognized the need to better educate the public about important insurance planning topics.
Life Happens consistently creates impactful and award-winning content that consumers see and the industry uses. They’ve garnered awards and nominations from the Webby Awards, Best in Biz Awards, Web Awards, The Telly Awards, and others.