Three 401(k) Changes and Possible Updates
Retirement plans are often thought of as “set it and forget it.” You add money to your 401(k), hopefully your employer can add a matching sum, and you wait for it to grow. However, you should regularly revisit and review your plan. This way, you can confirm your investment allocation, review plan updates, and understand regulatory changes. Understanding 401(k) changes and possible proposed changes ahead can help you prepare today.
Here are some of the changes to 401(k)s that have already occurred under the CARES Act of 2020 and proposed changes from the Biden administration.
CARES Act 401(k) Changes
The 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES Act) included a number of changes for 401(k)s and Individual Retirement Accounts (IRAs). The act allowed coronavirus-related distributions to be made in 2020, free from the 10% penalty (but still subject to income tax), even if the account holder was under 59 ½ (the age that one normally must be to take money out of a 401(k) without incurring a penalty). Therefore, an investor could have taken up to a $100,000 distribution in 2020 without having to pay the 10% penalty. The Act also gives you up to 3 years to return this money to your account, instead of the normal 60 days. These distributions were only allowed between January 1, 2020 and December 30, 2020, so for now, any 2021 distributions that happen before you are 59 ½ are subject to the 10% penalty.
The CARES Act waived Required Minimum Distributions during 2020 for IRAs and 401(k) account holders. However, RMDs will have to be taken in 2021. Contribution limits for these retirement accounts will remain unchanged for 2021.
401(k) Tax Incentives
The Biden administration’s 401(k) proposal would replace the current tax deduction with a flat tax credit for plan contributions. This tax credit would be 26% under the proposal. The administration’s hope is that this would equalize benefits across the income scale. Under the current system, a tax incentive increases with the size of the contribution and earnings of the participant. This makes it more attractive to contribute a higher amount when you enter a higher tax bracket.
If the current proposal were to become law, it may incentivize earners in the lower tax brackets to contribute more or to begin contributing to a 401(k) retirement account. The impact of these proposed changes could cause earners in the higher tax brackets to adopt Roth IRA accounts, since the tax benefit is reduced for high income earners.
Automatic 401(k) Enrollment
Part of President Biden’s proposed changes call for an automatic 401(k) enrollment for those who do not have access to a retirement plan through their job. The strategy is to allow even greater access into retirement plans. During Biden’s campaign, there were talks of increasing tax credits for startup costs and adding an automatic enrollment feature to further promote saving for low- and middle-income earners. High income earners may change the way they save for retirement, opting for Roth IRAs and Roth 401(k)s.
Although these last two items are currently only proposals, it is important to understand your investments and the impact that proposed changes could have on your retirement planning.
Marshall Financial Group is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.