New legislation aims to improve 401(k) plans.
THERE HAVE BEEN A LOT of recent changes to 401(k) plans, which is generally good news for workers saving for retirement. The Setting Every Community Up for Retirement Enhancement Act has brought some dramatic changes for retirees. “This is considered the biggest set of changes to retirement legislation in more than 10 years,” says David Schneider, a certified financial planner and founder of Schneider Wealth Strategies in New York City. The SECURE Act became law on Jan. 1, 2020.
Here are some recent 401(k) changes that could help you save more for retirement:
- An older age for required minimum distributions.
- Part-time employees gain access to company 401(k) plans.
- Increased access to 401(k)s for small businesses.
- Penalty-free 401(k) withdrawals for a birth or adoption.
- Funds in inherited 401(k)s must be withdrawn sooner.
An Older Age for Required Minimum Distributions
Previously, retirement account owners were required to begin distributions after age 70 1/2 or face a stiff penalty of 50% of the amount of the mandated withdrawal. This old law clashed with the new realities of retirement. People are living longer and working longer, and some people were forced to take distributions before they needed them and while they were still working. The SECURE Act increases the required minimum distribution age to 72 for those who turn 70 1/2 in 2020 or later. “A lot of clients, especially wealthier ones, didn’t want to take money at 70 1/2,” says Jeff Corliss, managing director and partner of RDM Financial Group in Westport, Connecticut. “Instead of taking it out at 70 1/2, now you wait until 72.”
Part-Time Employees Gain Access to Company 401(k) Plans
Employees usually had to work a minimum of 1,000 hours per year to join a company 401(k) plan. Now part-time employees who work 500 hours a year for three consecutive years are eligible to participate in 401(k) plans. “Now long-term part-time workers qualify,” Corliss says. “Before the rule change, part-time workers weren’t allowed to participate. Now they are opening it up for people who work part time.”
Increased Access to 401(k)s for Small Businesses
The SECURE Act allows two or more unrelated employers to join together in a multi-employer pooled retirement plan. The new law also increases financial incentives to help small businesses with start-up costs for retirement plans.
Penalty-Free 401(k) Withdrawals for a Birth or Adoption
401(k) account owners are newly eligible to withdraw up to $5,000 following a birth or adoption without incurring the usual 10% early withdrawal penalty. Workers can later repay the distribution as a rollover contribution.
Funds in Inherited 401(k)s Must Be Withdrawn Sooner
The new law requires people who inherit 401(k)s and IRAs to withdraw the money in those accounts within 10 years. Previously, people who inherited a defined contribution plan could withdraw the funds over their lifetime, and delay or “stretch” the taxes owed on those accounts – thus the nickname stretch IRA. “The death of the stretch IRA is probably the biggest (change) that affects the most people we deal with in retirement planning,” says Daren Blonski, managing principal at Sonoma Wealth Advisors in Sonoma, California.
Taking distributions over 10 years can have huge tax consequences for people who inherit retirement accounts. “When most people inherit money, they are probably in their peak earning years – in their 40s or 50s,” Schneider says. “If they inherited an IRA in peak earning years and are forced to take large distributions when their tax bracket is already high, they can be bumped into an even higher bracket.”
You can delay taking any distributions until year 10, but then you will need to pay taxes on the entire withdrawal in a single year. “It just makes the tax bomb bigger,” says Skip Johnson, founder of Great Waters Financial in Minneapolis, Minnesota. However, there are exceptions to the 10-year withdrawal rule, including for a surviving spouse, a minor child, a disabled or chronically ill heir and beneficiaries who are less than 10 years younger than the 401(k) account owner.