Significant 401k Changes Affecting Your Retirement

Recent legislative updates, largely driven by the SECURE 2.0 Act, have introduced new rules and opportunities for retirement savers. These changes affect nearly every aspect of a 401k plan, from contribution amounts to how you can access your funds. The adjustments are designed to expand access to retirement savings plans and provide greater flexibility for both employees and employers.

Enhanced Contribution and Savings Opportunities

Recent legislation has introduced several new avenues for increasing retirement savings within 401k plans. These changes create new strategies for employees to grow their retirement accounts, sometimes without directly contributing more from their paychecks.

A development is the enhancement of catch-up contributions for older workers. Beginning January 1, 2025, individuals aged 60 through 63 can make a larger catch-up contribution. This amount is the greater of $10,000 or 150% of the regular catch-up amount for that year. For 2025, an eligible person could contribute an additional $11,250.

Starting in 2026, any catch-up contributions made by employees who earned more than $145,000 in the prior calendar year must be directed into a Roth account. This means the contributions are made with after-tax dollars, eliminating the immediate tax deduction but allowing for tax-free withdrawals in retirement.

Effective in 2024, employers can match employee student loan payments. Under this optional program, an employer can make a matching contribution to an employee’s 401k based on their qualified student loan payments. These student loan payments do not count against the employee’s annual 401k contribution limit.

Employers also have the option to make their matching or nonelective contributions directly into an employee’s Roth 401k account. If an employer chooses this Roth option, the contribution amount is included in the employee’s taxable income for that year. In exchange, these employer-funded contributions and their earnings can be withdrawn tax-free in retirement.

Expanded Access to 401k Funds

The rules governing when and how individuals can access their 401k funds have been revised, offering more flexibility. These updates provide new ways to access funds without penalty in specific situations and alter the timeline for mandatory withdrawals.

The age for Required Minimum Distributions (RMDs) has increased. The age at which account holders must begin taking withdrawals from their pre-tax retirement accounts was raised to 73 starting in 2023. This age is set to increase again to 75 on January 1, 2033, allowing funds more time to grow tax-deferred.

RMDs are now eliminated for Roth 401k accounts during the original owner’s lifetime, aligning the rules with those that have long governed Roth IRAs. These funds can remain in the account and grow tax-free for the life of the account holder, without the pressure of forced withdrawals.

New provisions permit penalty-free withdrawals for certain emergency situations, although ordinary income tax still applies. Individuals can take one distribution per year of up to $1,000 for immediate financial needs without the 10% early withdrawal penalty. The law allows individuals to repay this withdrawal within a specified period.

Survivors of domestic abuse can withdraw the lesser of $10,000 or 50% of their vested account balance, penalty-free. They have a three-year window to repay the distribution. A separate provision allows penalty-free distributions for individuals with a terminal illness.

Access to funds has also been expanded for those impacted by federally declared disasters. Affected individuals can take distributions of up to $22,000 from their retirement accounts without the 10% early withdrawal penalty. The associated income tax can be spread over three years, and there is a three-year period to repay the funds.

Evolving Plan Features and Employer Rules

The structure of how 401k plans operate is also transforming, with new rules affecting plan design and employee eligibility. These changes are aimed at increasing participation and ensuring more workers have the opportunity to save for retirement.

Most employers establishing a new 401k plan are now required to automatically enroll their eligible employees with a starting contribution rate between 3% and 10%. The provision also includes an automatic escalation feature, which increases the contribution percentage by one point each year until it reaches a cap between 10% and 15%. Employees can opt out of this arrangement at any time.

Certain employers, such as businesses with 10 or fewer employees and those in operation for less than three years, are exempt from this requirement.

Eligibility rules for part-time employees have been updated to allow them to participate in 401k plans sooner. The service requirement for long-term, part-time workers has been reduced from three years to two years. This means employees who work at least 500 hours per year for two consecutive years must be allowed to make their own contributions.

A new feature available to employers is the Pension-Linked Emergency Savings Account (PLESA). As an optional add-on to a 401k plan, it creates a savings vehicle for non-highly compensated employees. Contributions are made on a Roth basis and are capped at $2,500, although employers can set a lower limit.

These emergency funds are designed for easy, tax-free, and penalty-free access, with plans required to permit at least one withdrawal per month. Any employer match on regular 401k contributions must also be applied to employee contributions to the PLESA. These matching funds are deposited into the employee’s standard retirement account.