Retirement Tax Reform: How the New Rules Affect You

Recent legislation, primarily the SECURE 2.0 Act, has changed the rules for retirement savings in the United States. The reform aims to expand access to retirement plans, encourage savings, and simplify administration for employers. These new rules create different opportunities and requirements for both individual savers and businesses. The changes alter timelines for distributions, contribution strategies, and the structure of some retirement accounts, impacting how Americans plan for their financial future. The reforms are designed to adapt to a changing economic landscape and workforce.

Key Provisions Affecting Individual Savers

Required Minimum Distribution (RMD) Age Changes

The SECURE 2.0 Act increased the Required Minimum Distribution (RMD) age from 72 to 73, effective January 1, 2023. This age will increase again to 75 on January 1, 2033. An individual’s RMD start date is now tied to their birth year, allowing for more years of tax-deferred growth in retirement accounts.

For those who do not need the funds immediately for living expenses, the delay allows investments to compound for a longer period. The legislation also reduced the penalty for failing to take a required distribution. The excise tax for an RMD shortfall has been lowered from 50% to 25% of the amount that should have been withdrawn, and it can be further reduced to 10% if the mistake is corrected in a timely manner.

New Catch-Up Contribution Rules

The rules for catch-up contributions, which allow individuals aged 50 and over to save more in their retirement accounts, have been modified. Effective January 1, 2025, individuals aged 60 through 63 will be able to make catch-up contributions up to 150% of the regular catch-up limit for that year. This provision is designed to give savers a final opportunity to boost their retirement funds significantly before they stop working.

Beginning in 2026, any participant in a 401(k) or 403(b) plan with prior-year wages exceeding $145,000 will be required to make their catch-up contributions on a Roth (after-tax) basis. This means the contributions will not lower their current taxable income, but qualified withdrawals in retirement will be tax-free. For Individual Retirement Accounts (IRAs), the $1,000 catch-up contribution limit will now be indexed to inflation, allowing it to increase over time.

Employer Matching for Student Loan Payments

Starting in 2024, employers can make matching contributions to an employee’s retirement account based on their qualified student loan payments. This means that even if an employee cannot afford to contribute to their 401(k) because they are making student loan payments, they can still receive the employer match on those amounts.

This rule addresses the challenge many younger workers face in saving for retirement while managing educational debt. The student loan payments are treated as if they were employee contributions for the purpose of calculating the employer match, allowing individuals to begin building a retirement nest egg.

New Emergency Withdrawal and Savings Options

New rules introduce options for accessing retirement funds for emergencies without the standard 10% early withdrawal penalty. Individuals can now withdraw up to $1,000 per year from their retirement account for unforeseeable or immediate financial needs. This distribution is not subject to the early withdrawal penalty, although it is still subject to income tax.

The law allows the individual to repay the withdrawn amount within three years. If the distribution is not repaid, no further emergency withdrawals are permitted for the next three years. Separately, employers are now permitted to add a “pension-linked emergency savings account” to their retirement plans, allowing non-highly compensated employees to access up to $2,500 for emergencies without penalty.

Modifications to Retirement Account Structures

Expansion of Roth Accounts

The reforms have broadened the availability of Roth (after-tax) retirement savings options. Employers are now permitted to offer Roth versions of SIMPLE and SEP IRAs, which previously only allowed for pre-tax contributions. This change gives employees and self-employed individuals the ability to contribute after-tax dollars to these plans, allowing for tax-free qualified distributions in retirement. The decision to contribute to a Roth versus a traditional account depends on an individual’s current and expected future income tax rates.

The legislation also introduces the option for employers to allow employees to designate employer-matching contributions or non-elective contributions as Roth contributions. Unlike employee Roth 401(k) deferrals, these employer contributions would be included in the employee’s income for the year they are made. This gives employees more control over the tax treatment of their retirement savings, though it requires them to pay taxes on the matched funds upfront.

Rollovers from 529 Plans to Roth IRAs

A new feature allows for rollovers from long-term 529 college savings plans to Roth IRAs. This provision addresses the concern of what to do with leftover funds in a 529 account if the beneficiary does not pursue higher education or has funds remaining after completing their schooling. The rule permits the beneficiary of the 529 plan to roll over funds into their Roth IRA without tax or penalty, subject to specific conditions.

To be eligible for this rollover, the 529 account must have been open for at least 15 years. The amount rolled over is subject to the annual Roth IRA contribution limits for that year, and there is a lifetime maximum of $35,000 that can be moved from a 529 plan to a Roth IRA. This change provides a new pathway to convert education savings into retirement savings.

New Rules and Incentives for Employers

Enhanced Tax Credits for New Plans

To encourage more small businesses to offer retirement benefits, the legislation increases the tax credits available for starting a new plan. For employers with 50 or fewer employees, the credit for plan start-up costs has been increased from 50% to 100% of qualified expenses, offsetting administrative costs. A new credit is also available to these smaller employers based on the contributions they make to their employees’ accounts. This credit is capped per employee and phases out for businesses with 51 to 100 employees.

Incentives for Automatic Enrollment

For most new 401(k) and 403(b) plans established after December 29, 2022, automatic enrollment of eligible employees is mandatory, effective starting in 2025. The initial automatic contribution rate must be at least 3% but not more than 10%, and it must increase by 1% each year until it reaches at least 10% but not more than 15%. Employees can always opt out of this feature. To encourage existing plans to adopt this feature, a new tax credit is available for small employers who add an automatic enrollment provision to their plans.

Simplified Plan Administration

The reforms include several provisions aimed at reducing the administrative burdens and costs for employers. These changes include simplified rules for plan notices and disclosures that must be sent to employees, making ongoing management less complex. Another simplification allows for the creation of “starter 401(k)” plans for employers who do not currently sponsor a retirement plan. These plans have streamlined requirements, requiring all employees to be automatically enrolled at a specified deferral rate, with contribution limits mirroring IRA limits and no employer matching permitted.