Your 401(k) Just Got Some New Powers

Sections of the SECURE Act 2.0 will phase in over the coming years.

First introduced in May 2021, the SECURE Act 2.0 has been in the works for over a year and a half, and in December it was signed into law by President Biden. It brings with it some serious modifications to your 401(k), and it will change retirement planning for millions of Americans.

Auto enrollment and escalation

As the old adage goes, you can lead a horse to water, but you can't make it drink. Politicians are learning that the same lesson applies to workers and their retirement plans: You can offer them a 401(k), but you can't make them invest for the future. That's why the foremost provision of the SECURE Act 2.0 seeks to boost retirement plan participation through automatic enrollment and contribution escalation.

The idea of automatically enrolling workers in retirement plans is not a new one. As far back as 2017, the state of Oregon implemented a similar program automatically enrolling workers in Individual Retirement Accounts; nine states and two cities have followed suit. The Senate Committee on Finance points to a study indicating that auto enrollment dramatically increases saving rates among younger and lower-paid employees and narrows the racial gap in participation rates.

The SECURE Act 2.0 calls for new 401(k) and 403(b) plans to automatically enroll eligible employees at a deferral rate of between 3% and 10%, with an annual escalation of 1%, up to a maximum of 15% total deferral. The provision will go into effect in 2025, but it will not affect 401(k) and 403(b) plans that already exist. Additionally, participants are free to opt out of the program at any time.

401(k)-linked emergency savings

According to a report by the Federal Reserve, nearly half of Americans would struggle to pay an unexpected $400 expense. That's the basis for Section 127 of the SECURE Act 2.0, which introduces pension-linked emergency funds tied to employer-sponsored retirement plans.

More specifically, the provision allows for employees to contribute up to $2,500 into an emergency savings account held by their employer. Any contributions to the account would be on a "Roth-like" basis, making them includable in taxable income. Additionally, the plan sponsor can match employees' contributions. Under the law, plan sponsors may automatically enroll employees in the savings accounts and defer up to 3% of their income. Employees can opt out at any time.

When an emergency strikes, a plan participant can withdraw emergency funds, up to four times per year, without incurring any penalties or fees. If an employee leaves their employer, they have the option to take the emergency fund balance as cash or roll it over into a Roth account.

Roth employer contributions

Roth 401(k)s have been an option for tax-conscious savers since 2006. These accounts allow even high-income earners to save for retirement on a post-tax basis, provided their employer sponsors a Roth plan. However, while employees could save on a Roth basis, employer contributions, including matching and non-elective contributions, could only be made on a pre-tax basis.

As of the date the SECURE Act 2.0 was passed, employers can make Roth contributions to workers' retirement accounts. Note that while employers can now offer and contribute to Roth retirement accounts the law does not require employers to either 1) provide a Roth 401(k) to employees or 2) offer Roth matching or non-elective contributions.

Like its 2019 predecessor, the SECURE Act 2.0 made some major changes to the ways Americans will save for retirement. 401(k) participants may see auto enrollment and escalation, new ways to save for an emergency, and Roth contributions from their employers.