New Savings Opportunities for Young Professionals – SECURE Act 2.0
By Brittany Brinckerhoff
Ah, what better way to start a new year than with a long list of new retirement planning rules! SECURE Act 2.0, signed into law at the end of 2022, is a lengthy bill with a wide variety of retirement planning changes, some effective immediately and others slated for the mid-2020s.
Some of the changes have a bigger impact on retired (or soon-to-be retired) investors, while others are more applicable to younger investors. Regardless of what phase of life you’re in though, all of these changes should be viewed in light of your broader financial goals. (If you’re closer to retirement, check out this blog post that reviews SECURE 2.0 for retirees and near-retirees.)
For younger investors, we believe the overarching theme of SECURE 2.0 is greater opportunities to save. If you want to make it rain for your retirement portfolio, here are five of the biggest updates to be aware of:
Employees will be auto-enrolled in new retirement plans, and their contribution rates will auto-escalate.
Starting in 2025, employers who adopt new retirement plans are required to automatically enroll eligible employees into the plan, at a minimum contribution rate of 3-10% of salary. These savings rates will also automatically escalate, increasing by 1% per year up to 10-15%. Employees can choose to opt out of the auto-enrollment or auto-escalation, and there are also employers who will be exempt entirely from this rule. However, this change as a whole should mean that more people will automatically participate in their employer’s retirement plan AND save at a higher rate.
Employers can treat student loan payments as employee salary deferrals for the purpose of matching contributions to their retirement plan.
Effective in 2024, employers can choose to treat employees’ student loan payments as if they were deferrals to the retirement plan, making the employee eligible to receive an employer match in the plan. This would allow employees who currently can’t afford to save for retirement (because they’re busy paying down student loans) to still be able to receive their employer match, meaning they can start to build up retirement savings while paying down debt. Win-win!
Money that is left over in a 529 plan can be transferred to a Roth IRA.
Starting in 2024, money can be transferred from a 529 plan to a Roth IRA, subject to limitations. As a reminder: 529 plans are education savings accounts that receive preferential tax treatment when the funds are used for qualified education expenses. Under the old rules, if the funds are withdrawn and NOT used for education expenses, distribution of the earnings could be subject to taxes and penalties, so it wasn’t always advantageous to put too much money into a 529 plan. This new rule could potentially offer a solution for anyone who has money left over in a 529 and wants to divert those funds to retirement savings.
However, there are several stipulations that could make it difficult to actually take advantage of this rule. For example: the 529 plan must have been open for 15+ years, the Roth IRA must be in the name of the 529 plan beneficiary, the total amount that can be transferred is limited to $35k lifetime, and annual transfers are subject to annual Roth IRA contribution limits ($6.5k for 2023). The upshot is that this rule could be quite helpful, but careful planning is needed.
Employers may make matching and nonelective contributions to the Roth side of the retirement plan.
Effective immediately, employers can decide whether their contributions to employees’ accounts are treated as pre-tax or Roth contributions (previously, employers could only make pre-tax contributions). Roth money is generally tax-free in retirement, so this change could help people accumulate a larger sum of tax-free retirement savings. One warning: employer contributions made to the Roth side of the retirement plan will count as income to the employee in that calendar year.
While it is great to have tax-free money to use in retirement, sometimes it is advantageous to maximize pre-tax retirement savings instead of Roth. This is why it’s important to consider the big picture – one’s current and future tax situation AND overall retirement goals.
The “Backdoor Roth” strategy lives on.
Ok, this is not an update…but it’s important to recognize what did not change in the SECURE Act 2.0: the “Backdoor Roth” is still allowed! This strategy allows people to get funds into a Roth IRA even if they’re above the income limit for making contributions. A related strategy, the “Mega Backdoor Roth 401(k)” allows people to put funds into the after-tax side of their retirement plan even if they’ve hit the annual salary deferral limit. Some lawmakers have indicated that they view these strategies as loopholes in the tax law and that they’d like to take away these options, but SECURE 2.0 has left them alone.
In short, these strategies can be a great fit for people who have high income, are maxing out their basic retirement savings options, and are looking for ways to build up their Roth retirement savings.
As a younger investor, you typically have a longer time frame to take advantage of any additional savings opportunities, so it can be especially valuable to be aware of changes to retirement planning rules. However, the SECURE Act 2.0 is a great example of how complicated and intricate some of these new rules can be. This is one reason why working with a financial advisor can be so helpful – we are here to sift through the details and make sure you’re not overlooking an opportunity that will get you closer to your goals!
For more details about how we work with young professionals, check out our Ascend service.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Hilltop Wealth Advisors does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.
The information contained herein is believed to be true as of the date of publication. It may be rendered out of date by subsequent legal or tax-rule changes, as well as variable economic and market conditions.