The United States is on the brink of a retirement crisis. The primary savings tool for Americans – your 401(k) – isn’t helping.
By the end of the decade, about 21% of the country’s population will be 65 or older, up from 15% in 2016, according to forecasts by the Census Bureau. Most non-retired adults have some type of retirement savings, but only 36% think their savings are on track.
Now, Congress is looking to help Americans save by bolstering 401(k) programs – the tax-deferred, company-sponsored retirement accounts to which employees can contribute income, and employers can match their contributions.
A new bill, expected to reach President Joe Biden’s desk by the end of the year, could require most employer-sponsored retirement plans to enroll their workers automatically, making it easier for student-loan borrowers to save, and for older workers to make catch-up contributions. It will also lower costs for smaller businesses.
Retirement savings in the United States were long thought of as a three-legged stool. Americans had pension plans, Social Security benefits, and defined contribution plans like the 401(k). Not any more.
Social Security payments still provide about 90% of income for a quarter of older adults, according to Social Security Agency surveys. But the Social Security trust fund is facing a 75-year deficit, and without intervention it will be depleted by the mid-2030s. Lawmakers have faced a decades long political stalemate on how to fix it.
What’s left is the 401(k), which 68% of private industry workers have access to, but only 50% use.
“I don’t think it was ever anticipated that this would be the primary leg of the stool,” said Jonathan Barber, head of compensation and benefits policy research at Ayco Personal Financial Management, a unit of Goldman Sachs that provides investment services to hundreds of US companies and more than a million corporate employees.
Indeed, the 401(k) was never designed to be the primary retirement tool for Americans when it was introduced into the US tax code in 1978. “When it works, it works really well,” said Sri Reddy, senior vice president of retirement and income solutions for Principal Financial Group.
The 401(k) naturally appeals as a savings vehicle to Americans who bring in more money, say critics. Under the current plan, an employee in the highest tax bracket saves 37%. But an employee in the lowest tax bracket would gain a pre-tax advantage of saving only 10% on deferred income.
The tax breaks for these retirement savings are expected to cost the government nearly $200 billion this year, with most of those benefits going to the top 20% of earners, according to the Center on Budget and Policy Priorities.
Less than 40% of lower-paid workers have retirement accounts, compared with 80% of middle- and upper-income families, according to Vanguard. Making a 401(k) plan more accessible doesn’t help Americans who don’t have money to save in the first place.
Still, Congress thinks there’s a solution.
In late 2019, one of the most significant pieces of retirement legislation in the past 15 years, was signed into law by President Donald Trump: the bipartisan Setting Every Community Up for Retirement Enhancement, or SECURE Act. The bill removed maximum age limits on retirement contributions, provided tax credits for small businesses to offer their employees 401(k) plans, and extended retirement benefits to some long-term but part-time employees.
Last week Congress almost unanimously passed another bill, SECURE 2.0, that has even broader changes. The Senate is expected to pass its version in the coming weeks.
Here’s a look at how the primary retirement savings plan in the US may soon change.
In what would be the largest change to the 401(k) program, SECURE 2.0 would require employers to automatically enroll all eligible workers into their 401(k) plans at a savings rate of 3% of salary. (Many employees currently have to opt in and then choose their contribution level.) The new rule also applies to the 403(b), a similar program for employees of certain public and tax-exempt organizations.
Enrolled workers’ contribution rates would be automatically increased each year by 1% until their contribution reaches 10% annually.
While workers have the option to opt out of the plan or change their contribution level after they enroll, automatically enrolling workers into these plans would make a huge change in younger and low-waged employees’ participation in the program.
A 2012 study cited in the SECURE 2.0 bill found that, “[t]he most dramatic increases in enrollment rates are among younger, low-paid employees, and the racial gap in participation rates is nearly eliminated among employees subject to auto-enrollment.”
About one in six of employers already offer automatic enrollment, and about 90% of new hires who use them participate in retirement plans, compared with just 28% under voluntary enrollment, according to a recent study by Vanguard, the largest provider of mutual funds in the United States.
Older workers who are between the ages of 62 and 64 can increase their catch-up contributions to $10,000 a year, up from $6,500 now. Beginning in 2023, these catch-up contributions would be taxed as Roth contributions, meaning they’d be taxed before being invested for retirement, though earnings would be indexed to inflation.
People generally earn more as they age, said Reddy, and people in their 60s are typically earning more than they spend. Giving them the ability to increase their contributions makes a huge difference in retirement savings. “If you have people who are motivated and have incremental means, it’s a wonderful way of helping them get caught up for retirement,” he said.
Barber, who heads up benefits research at Goldman Sachs’ Ayco Personal Financial Management, worries that this change may be overly complex.
Currently, most 401(k) contributions come from employees’ paychecks pre-tax, so investors don’t really feel the bite until they’re ready to withdraw their savings. Under the new plan, the catch-up contribution will be raised, but employees must pay taxes before they contribute.
For investors, “that might be a shock to some people who don’t understand the financial impact of that, especially if they’ve never had a Roth account,” said Barber.
About 43.4 million borrowers in the United States have federal student loan debt, totaling a whopping $1.7 trillion, and many employees tend to forgo saving for retirement until they pay their loans in full.
Losing out on those early years of potential savings puts them at a significant disadvantage. The plan has a solution to that.
Employers could treat student loan repayments as elective retirement account deferrals, and provide a matching contribution to their 401(k). So if you pay off $1,000 in student loan debt, it would be the same as putting $1,000 into a retirement plan, as far as matching goes. If a company matches by 6%, that’s an extra $60 in savings.
“The earlier you do [invest], the more those investment gains can multiply,” said T. Lake Moore V, an employee benefits attorney at McAfee & Taft.
Americans are retiring later and living longer. Secure 2.0 lifts the minimum age at which enrollees must begin withdrawing money from their accounts each year to 75 from 72. That allows for three additional years of tax-free growth on their retirement investments.
(The penalty for those who fail to withdraw the required minimum from their account after 75 would be halved, to 25% from 50%.
Under the proposed act, companies that offer a 401(k) plan would be required to allow part-time employees who work at least 500 hours a year for two years, (the equivalent of just under 10 hours a week) to contribute to a retirement account. That would include part-time workers, gig employees, freelancers, caregivers and independent contractors.
The plan would also extend tax credits to small businesses for providing greater access to retirement plans for their workers, and create an online database for Americans to locate lost retirement funds.