LAST REVIEWED Dec 15 2020 13 MIN READ
By Damian Davila
The “Setting Every Community Up for Retirement Enhancement” legislation, better known as the SECURE Act, was passed by the House of Representatives back in July and signed into legislation by the Senate on December 19, 2019.
From increasing access to tax-advantaged accounts and preventing older Americans from outliving their assets, the SECURE Act is one of the most significant pieces of retirement legislation in over 13 years and puts into place numerous provisions affecting employers and employees across the country. Let’s break down what are the key implications for employers and employees starting this January 1, 2020.
SECURE Act for Employers:
Incentives to set up 401(k) & inclusion of part-time employees
As its name implies, the SECURE Act sets up rules to allow more American workers to save for retirement. Since workplace retirement plans are one of the most tax-efficient ways to do so, the SECURE Act introduces the following changes for employers and plan administrators.
Increase of cap from 10% of wages to 15% for safe harbor retirement plans
A safe harbor 401(k) plan is a type of tax-deductible 401(k) plan that ensures all employees at a company have some set of minimum contributions made to their individual 401(k) plans, regardless of their title, compensation, or length of service. Employers make annual contributions on behalf of their employees without a vesting period.
Safe harbor plans are particularly valuable for small- and medium-sized businesses, especially those with low levels of employee contributions and concerns about meeting compliance testing (automatic pass on non-discrimination and top-heavy testing). By increasing the cap of 10% to 15% of wages under which employers can automatically enrolls in safe harbor retirement plans, the SECURE Act aims to lessen the administrative burden of business owners.
Bigger tax credits
Unlike deductions and exemptions, which reduce the amount of taxable income, tax credits reduce the actual amount of tax owed. So, most business owners love tax credits! This is why Uncle Sam is beefing not just one but two tax credits for small businesses (100 or fewer employees) that set up retirement plans.
First, the SECURE Act increases the Retirement Plans Startup Costs Tax Credit from up to $500 per year to up to $5,000 per year. The new guideline for the new limit on the tax credit is the greater of (1) $500 or (2) the lesser of (a) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan or (b) $5,000. The setup tax credit continues to apply for three years.
Second, the bill introduces a new tax credit of $500 per year for any business that adds an automatic enrollment feature to a new or existing workplace retirement plan. Between these two retirement plan tax credits, an eligible small business may erase up to $16,500 in taxes over a three-year period!
Learn more about the new 401(k) tax credits and how to claim them.
Eligibility of part-time employees
America is enjoying one of the lowest periods of unemployment in history, making it an employees’ market as businesses need to bring more to the bargaining table. The SECURE Act provides employers now an extra incentive to lure part-time talent: allowing long-term, part-time workers to contribute to 401(k) plans.
Under the new rules, a part-time employee must complete either:
One year of service with at least 1,000 work hours, or
Three consecutive years of service with at least 500 work hours.
The second rule works out to be about twenty-five 20-hour workweeks per year, which enables a large pool of workers to become eligible for workplace 401(k) coverage. If your business requires recruiting a large number of qualified part-time workers, adding them to your workplace 401(k) is something worth looking into.
Deadline filing extension
The SECURE Act extends the deadline to create a workplace-sponsored plan to be eligible for tax filing from December 31st of the current year to the actual filing date. Through this change, businesses have up to an extra three and a half months to set up a plan (April 15th of the next year).
This is another great hiring and retention tool as now employers have extra time to process new workplace plans and allow employees joining between January 1st and April 15 to delay taxes on retirement savings on the previous year’s return.
Ability for unrelated employers to offer a joint retirement plan to their employees
Under the SECURE Act, employers can pool resources together to create economies of scale and access more features at better prices. The reality is that a larger number of employees allows employers to have more bargaining power when shopping around for plans. The SECURE Act doesn’t require that all employers to be in the same industry.
The objective of this change is to increase the ability of small businesses to offer some form of retirement savings to their employees by coming together to set up and offer 401(k) plans with reduced fiduciary liability and cost concerns.
Now, let’s take a look at key implications of the SECURE Act for employees.
SECURE Act for Employees:
This new piece of legislation will have a significantly positive impact on how workers are planning for retirement.
Increased required minimum distribution age
Prior to the SECURE Act, 401(k) or traditional IRA holders had to start taking required minimum distributions (RMDs) in the year that they turned age 70 ½. The new legislation increases that age 72 in 2020.
This change is mainly an update to better reflect the higher life expectancy of Americans today. Still, it provides much welcomed “extra inning” to delay RMDs and continue fattening your nest egg.
Update: 4/13/20: Note that, as a result of COVID-19, RMDs are postponed for 2020. See more on our CARES Act blog.
Eliminated maximum age for traditional IRA contributions
Currently, you can’t make regular contributions to a traditional IRA in the year you reach 70 ½ and older. (Note: you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional IRA regardless of your age.)
The SECURE Act eliminates the maximum age for traditional IRA contributions starting in 2020.
Inclusion of annuities in investment choices
With life expectancy continuing to rise, current and future retirees need to think about securing their income as long as they live. Other than pensions and Social Security, annuities are the only retirement option that can guarantee income for as long as you live.
The SECURE Act promotes the addition of more annuities in 401(k) plans by removing the fear of legal liability if the annuity provider fails to provide and also not requiring employers to choose the lowest-cost plan. Advocates of annuities point out that these financial vehicles can be great retirement planning tools because you can still invest in one after you max out your 401(k) contributions for the year. Critics of annuities are quick to point out that they are complicated and often full of sneaky fees.
To help you decide whether or not an annuity is right for you, here’s a comparison of annuities vs 401(k)s.
Lifetime income disclosure for defined contribution plans
Continuing with the topic of greater life expectancy, the SECURE Act delivers a disclosure requirement to declare how much the lump sum balance in the plan could generate. The specific calculations and information on assumptions for those calculations are still being developed at the time this article was written.
More permissible withdrawals
In 2020 plan holders can now count on two new penalty-free distributions:
Birth or adoption
Now you can withdraw up to $5,000 from 401(k) accounts in the event of having or adopting a child (up to one year from birth/adoption date to make a withdrawal). While your permissible withdrawal will be exempt from the 10% penalty tax of the IRS, you’re still liable for applicable income taxes, including those for capital gains.
Student loan payment using 529 plan
The SECURE Act makes it now also possible to pay costs of apprenticeship and student loan payments. You can withdraw up to $10,000 in the lifetime of each beneficiary and siblings. For example, a family with two children can take a $10,000 distribution to pay student loans for each child for a total of $20,000.
No double-dipping: interest paid with 529 proceeds can’t be claimed as a tax deduction.
Heads up on the “death of the stretch IRA”
From the list of changes that the SECURE Act, you can see that they all focus on providing tax breaks to employers and employees. Of course, then a big question rises: “how is all of this going to be paid out?”
The answer comes in the “death of the stretch of IRA”. Prior to the SECURE Act, the owner of an IRA could defer RMDs by assigning younger, non-spouses as new beneficiaries. This was a great estate planning tool that allowed families to “stretch” an IRA over long periods of time. Starting in 2020, the SECURE Act will require a full payout from the inherited IRA within 10 years of the death of the original account holder, raising an estimated $15.7 billion in additional tax revenue.
If you have been consistently saving on an IRA, make sure to discuss your action plan with your financial advisor and find out all of your options, including biting the tax bullet and converting to a Roth IRA.
In 2020, are you interested in setting up a 401(k) plan for your business or need to prepare to make the best out of the upcoming changes with the SECURE Act?
Human Interest has helped businesses of all sizes to set up, implement, and maintain a 401(k). We’ll take care of creating employee accounts, processing contributions every pay period and syncing them with your payroll provider, and ensuring that compliance testing and paperwork is completely taken care of.
If you would like to learn more about the process of setting up a 401(k) or any other plan that better suits your organization’s needs, please contact us and we’d be happy to help!
Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.