There are a lot of changes on the horizon for 401(k) plans, which is generally good news for workers saving for retirement. Some large companies are offering long-needed improvements that will give their employees more options and greater flexibility. In addition, the U.S. House of Representatives has passed legislation, the SECURE Act, which would further enhance retirement accounts for workers and potentially expand benefits to millions more people. There is optimism that the Senate will pass similar legislation and it will also have the support of the White House.
Here are some 401(k) changes that could help you save more for retirement:
-- More employers are offering a Roth 401(k) option.
-- Annuity options in 401(k) plans provide lifetime income.
-- Potential SECURE Act provisions would adjust 401(k) rules.
Some of these enhancements are available now, while others might only be available if the SECURE Act, or something like it, becomes law.
A Roth 401(k) Option
The benefits of a Roth account were formerly available to individual retirement accounts with highly restrictive income limits. But now 70% of large and midsize U.S. companies provide a Roth 401(k) savings option to their employees, according to a Willis Towers Watson survey. And 401(k) plans don't have the same income restrictions as IRAs. "There have been some new innovations in the retirement planning space provided by employers," says H. Adam Holt, a certified financial planner and CEO of Asset-Map in Philadelphia. "With the addition of the Roth features allowing tax-free growth and distribution, higher earning families can forgo the traditional income limitations placed on Roth IRA contributions."
Deposits into a traditional 401(k) are tax-deferred, meaning you don't have to pay taxes until you withdraw your money. But a Roth 401(k) is funded with after-tax money, which means you pay no taxes on distributions, including the growth in your account. "It gives those that are really doing strategic planning the opportunity to choose between how they want to allocate their funds between taxable and tax-deferred," says Eric Bailey, a certified financial planner and CEO of Bailey Wealth Advisors in Silver Spring, Maryland. "With a Roth, you're looking at increasing the amount of your tax-free income during retirement. You are giving up some of the tax-deferred income today."
Young people have a lot to gain by saving for retirement in a Roth 401(k), because their money has decades to compound and won't be taxed again. "If you are over 40, it may not be the right move," says Chad Parks, founder and CEO of Ubiquity Retirement + Savings in San Francisco. "The best benefit of the Roth is having a long time horizon to grow money. In a shorter time horizon, your money may not grow as much."
Annuities in 401(k) Plans
Most employers prefer that you take your 401(k) savings with you when you retire. But there are several reasons to leave your money in the 401(k) plan, and there can be advantages to sticking with your workplace retirement account. "A 401(k) provider can do what we call 'annuitize' your retirement," Parks says. "If you have $500,000 and have done the calculations and want $2,000 a month, that is doable, but not a lot of companies do that."
Annuities can prevent you from spending down your retirement savings too quickly by converting your savings into a steady stream of payments for the rest of your life. "Annuities are the only product on the market that can guarantee lifetime income," says Ray Caucci, chairman and CEO of Vantis Life Insurance Company in Windsor, Connecticut. "What people are concerned about in retirement is they will live too long and run out of money. Having an annuity, that won't happen. It's a tremendous thing for consumers because it eases that fear. They can enjoy retirement and spend down assets in other ways knowing they have income coming to them as long as they live."
An annuity provides you with retirement income, regardless of how the stock market performs. "Adding an annuity and lifetime income option is a no-brainer," Bailey says. "Consumers are saying that the things that concern them the most are that they might outlive their money and they worry about market volatility. Those two things can be addressed to some degree with a lifetime income annuity option."
But annuities are not without some concerns. "You get the security of lifetime income, but at what cost?" Parks says. "Annuities can be complicated in the way they calculate expenses and benefits. The concern is there may not be enough transparency and they may be complicated, and some people maybe take advantage of that. You want to make sure there is some guidance and standardization."
Potential SECURE Act Provisions
The Setting Every Community Up for Retirement Enhancement Act was approved by the House of Representatives in a nonpartisan 417-3 vote in May 2019. Provisions in this bill would make it easier to add an annuity option to 401(k)s, increase the age for required minimum distributions and encourage more small businesses to offer 401(k)s.
Here are some of the potential 401(k) changes in the SECURE Act:
401(k) eligibility for part-time employees. The SECURE Act aims to increase the ability of part-time workers to participate in a 401(k) plan. Currently a company can deny access to their 401(k) to those who do not work at least 1,000 hours per year. The SECURE Act would lower that to 500 hours, enabling millions more part-time workers to be eligible for retirement savings plans.
[Read: What Is the SECURE Act?]
Delayed required minimum distributions. Owners of tax-deferred retirement accounts, such as IRAs and 401(k)s, are typically required to begin taking distributions at age 70 1/2. These mandatory withdrawals can cause problems for some people, especially those who are still working or who will be pushed into a higher tax bracket. "Raising the RMD age from 70 1/2 to 72 is a win for consumers, especially consumers who don't need the money," Bailey says.
An older required minimum distribution age gives you more time to defer paying taxes on your retirement savings. "Since (people) are living longer, it's more time for those accounts to build out," Caucci says. "It's giving them another year and a half."
401(k) incentives for small businesses. The SECURE Act offers incentives for small businesses to provide 401(k) plans, including making it easier for small companies to band together to offer their employees tax-deferred retirement plans. "Given the size (and) economic and voting strength of the retirement age baby boomers, we can expect to see continued legislative pressure to innovate the retirement plan space," Holt says. "Both tax benefits and income distribution planning will be at the forefront of these discussions."
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