Retirement in the United States is fraught with peril. Over the past several decades, society has moved from a retirement system backed by both Social Security and pensions to one in which Social Security is often the only guaranteed source of retirement income people can rely on, and even that has its uncertainties. Pensions have become increasingly rare, replaced by 401(k)s that, while less burdensome on employers, shift responsibility for saving and planning for retirement onto the workers.
The problem with this system is that it requires workers to actively participate in planning for an event that won’t happen for, in some cases, half a century. That’s hard to imagine, since some people have trouble planning for things that will happen next week!
One of the biggest changes in Secure Act 2.0, and one that I think will have a significant impact on retirement, is the automatic 401(k) enrollment for employers. Before this Act, workers had to actively sign up for their employer’s 401(k). Many didn’t. Oftentimes this wasn’t because they were being intentionally irresponsible, rather preferring to spend more money today at the expense of not having money to spend in retirement.
For many, decision-making inertia means they tend to do things that don’t require them to act. They’re not enrolled in a 401(k), and don’t act to sign up for one. Were they already enrolled, their tendency toward inaction would result in continuing to be enrolled in that 401(k).
While automatic enrollment will be a major advantage of Secure Act 2.0, it also points to a disadvantage of the Act. Automatically-enrolled employees are only required to contribute 3% of their salary. While this does increase by 1% per year up to 10–15%, that’s still a pretty slow start to retirement savings.
At Asset Preservation Wealth and Tax, we favor a contribution of 10%, and preferably 15%. Starting at 3% and adding 1% per year means a worker won’t hit a 15% contribution rate until more than a decade after they start working. That’s a lot of years lost to sub-optimal retirement contributions.
I worry that the very inertia that will likely keep people in those auto-enrolled 401(k)s will also keep them at those minimal contribution levels for far too long. Whether you’re automatically enrolled in your employer’s 401(k) or not, it’s important to save early and consistently to give yourself the best chance at a comfortable, secure retirement.
Secure Act 2.0 also fixed what I consider a glaring glitch in the first Secure Act, which mandated required minimum distributions (RMDs) from Roth 401(k)s. This requirement didn’t make any sense; the government instituted RMDs to collect taxes from tax-deferred retirement accounts.
But Roth accounts are not tax-deferred; you pay taxes on the funds you contribute to them, and you don’t pay taxes when you withdraw from them in retirement. There’s no reason to require distributions, which means people with Roth 401(k)s were forced to realize income unnecessarily, depleting their retirement savings unnecessarily.
Fortunately, this misstep has been corrected in Secure Act 2.0, and retirees will no longer have to take RMDs from Roth accounts.
To Delay or Not To Delay?
Speaking of RMDs, Secure Act 2.0 will delay the age at which you must begin taking them. Currently RMDs start when you turn age 72, but that will increase over time until 2033, when RMDs won’t start until age 75. As with other aspects of Secure Act 2.0, this has positive and negative implications.
Having the option to delay taking distributions from your 401(k) or IRA is good, but actually delaying those distributions without reason is not! If you choose to delay distributions to give yourself a more favorable tax picture later, that’s a good idea. If you delay them simply because you can, without any plans for what that delay will accomplish, you’re potentially setting yourself up for a tax bomb later.
Instead, consider really digging into the tax consequences of your decision. If you’re going to defer RMDs now, when we’re in the most efficient tax window in history, what are you doing to fill out the tax bracket you’re currently in?
For example, I had a client who was planning to delay taking RMDs, but had a large tax credit that helped ensure his standard deduction was well above his taxable income. This didn’t make sense. With such a large gap between his income and the standard deduction, he could have converted that retirement account to a Roth for free! If he followed his original plan, he’d have ended up paying unnecessary taxes.
That client isn’t alone — there are far too many people who delay RMDs, or fail to maximize their tax brackets, or make other financial decisions without properly considering the consequences. Financial planning is complicated, and it’s easy for the uninitiated to miss crucial steps. That’s why it’s vital to work with an experienced financial planner to help you navigate the complexities, especially when laws change as with Secure Act 2.0.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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