May 9, 2023
The 401(k) plan is the most popular employer-sponsored retirement plan in the United States. As of September 30, 2022, more than $6.3 trillion in assets were held in 401(k) accounts by more than 60 million active participants, as well as millions of former employees and retirees. So 401(k) plans are a key payroll responsibility for most businesses.
New legislation is anticipated to increase participation in these plans. The SECURE 2.0 Act — a follow-up to the SECURE Act passed in 2019 — became law in late 2022. It introduces several features and rules that your business should prepare for.
When employees choose to participate in their employer’s 401(k) plan, they are able to defer part of their salary, within generous annual limits, to an account set up on their behalf. The contributions are made on a pre-tax basis and are deducted from an employee’s wages by the company’s payroll department. Employers must meet strict nondiscrimination requirements under complex regulations to preserve 401(k) plan tax benefits.
Pre-tax contributions are invested within each employee’s account. Usually, employers provide a range of mutual funds and other investment options. Earnings within accounts can compound tax-deferred until employees make withdrawals. At that point, distributions generally are taxed at the participant’s ordinary income tax rate.
Employers may offer matching contributions up to a stated percentage of employees’ salaries. Typically, employers provide a match of 50% for the first 6% of salary deferred by employees — or 3% of salaries. As with employee contributions, matching contributions aren’t subject to current tax but are taxable upon withdrawal.
New Law Changes
SECURE 2.0 makes these significant changes to the administration of 401(k) plans:
Automatic enrollment. With respect to new plans adopted after December 29, 2022, for plan years beginning in 2025, employers must automatically enroll eligible employees at a rate of at least 3%, but at a rate no more than 10%, of compensation. Employees may opt out of the plan.
Similarly, these plans must adhere to an automatic escalation provision, meaning they must increase employee contribution amounts over time. Certain employers — such as those in business for less than three years or employers with 10 or fewer workers — are exempt from these mandates.
Catch-up contributions. Currently, an employee can contribute a “catch-up contribution” of an extra $7,500 to a 401(k) plan in 2023 if they’re age 50 or older (in addition to the standard deferral limit of $22,500). Beginning in 2025, the limit for catch-up contributions increases to the greater of $10,000 (plus inflation indexing after 2025) or 150% of the regular catch-up contribution for workers between ages 60 and 63. Also, after 2023, all catch-up contributions for participants earning more than $145,000 annually must be made to a Roth 401(k) account, rather than to a traditional 401(k) account, on an after-tax basis.
Roth 401(k) accounts. Employers must revise their plans to allow employees to elect for employer matching and nonelective contributions to be made to a Roth 401(k) account if the participants are fully vested when making contributions. The IRS is expected to issue relevant guidance on this aspect soon.
Matching student loan payments. Beginning in 2024, employers may make matching contributions to 401(k) plans on behalf of employees paying student loans instead of contributing to retirement accounts. Workers may be required to annually certify the amount of their qualifying student loan payments.
Retirement saver’s match. SECURE 2.0 replaces the existing retirement saver’s credit with a matching program in 2027. Employees who contribute to a 401(k) account may receive a limited matching contribution from the federal government, subject to a phaseout. The contribution would be a maximum 50% of up to $2,000 in contributions for a maximum of $1,000 match per person.
Emergency savings accounts. Beginning in 2024, employers may allow plan participants to use a special emergency savings account (ESA) up to $2,500. Employers can automatically enroll workers to contribute as much as 3% of their compensation (up to the $2,500 cap), but participants may opt out. Also, participating employees must be able to take at least one withdrawal per month. Contributions to ESAs need to be eligible for the same matching contributions available to elective deferrals.
Part-time workers. Initial changes to the SECURE Act after it became law enabled part-time workers to participate in an employer’s 401(k) plan if they worked between 500 and 999 hours annually for three consecutive years. SECURE 2.0 changes the period from three to two consecutive years, beginning in 2025. Note that this provision doesn’t apply to employees in collectively bargained plans or to nonresident aliens.
This is just a brief description of several new rules that may require your organization to change how it administers its 401(k) plan. Other provisions of SECURE 2.0 could emerge as IRS and other federal guidance is issued. Watch the recording of GRF’s webinar, Secure Act 2.0 – How the Act Will Impact Your Retirement Plan, for a more comprehensive overview.