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Big changes are coming for your 401(k). Here’s what you need to know

April 6, 2022

Now, Congress is looking to help Americans save by bolstering 401(k) programs — the tax-deferred, company-sponsored retirement accounts to which employees can contribute income, and employers can match their contributions.

A new bill, expected to reach President Joe Biden’s desk by the end of the year, could require most employer-sponsored retirement plans to enroll their workers automatically, making it easier for student-loan borrowers to save, and for older workers to make catch -up contributions. It will also lower costs for smaller businesses.

Retirement savings in the United States were long thought of as a three-legged stool. Americans had pension plans, Social Security benefits, and defined contribution plans like the 401(k). Not any more.

Pension plans are nearly extinct. About half of private sector workers were covered by those so-called defined-benefit plans in the mid-1980s, but by 2021 only 15% of private sector workers had them.

Social Security payments still provide about 90% of income for a quarter of older adults, according to Social Security Agency surveys. But the Social Security trust fund is facing a 75-year deficit, and without intervention it will be depleted by the mid-2030s. Lawmakers have faced a decades long political stalemate on how to fix it.

What’s left is the 401(k), which 68% of private industry workers have access to, but only 50% use.

“I don’t think it was ever anticipated that this would be the primary leg of the stool,” said Jonathan Barber, head of compensation and benefits policy research at Ayco Personal Financial Management, a unit of Goldman Sachs that provides investment services to hundreds of US companies and more than a million corporate employees.

Indeed, the 401(k) was never designed to be the primary retirement tool for Americans when it was introduced into the US tax code in 1978. “When it works, it works really well,” said Sri Reddy, senior vice president of retirement and income solutions for Principal Financial Group.

The 401(k) naturally appeals as a savings vehicle to Americans who bring in more money, say critics. Under the current plan, an employee in the highest tax bracket saves 37%. But an employee in the lowest tax bracket would gain a pre-tax advantage of saving only 10% on deferred income.

The tax breaks for these retirement savings are expected to cost the government nearly $200 billion this year, with most of those benefits going to the top 20% of earners, according to the Center on Budget and Policy Priorities.

Less than 40% of lower-paid workers have retirement accounts, compared with 80% of middle- and upper-income families, according to Vanguard. Making a 401(k) plan more accessible doesn’t help Americans who don’t have money to save in the first place.

Still, Congress thinks there’s a solution.

In late 2019, one of the most significant pieces of retirement legislation in the past 15 years, was signed into law by President Donald Trump: the bipartisan Setting Every Community Up for Retirement Enhancement, or SECURE Act. The bill removed maximum age limits on retirement contributions, provided tax credits for small businesses to offer their employees 401(k) plans, and extended retirement benefits to some long-term but part-time employees.

Last week Congress almost unanimously passed another bill, SECURE 2.0, that has even broader changes. The Senate is expected to pass its version in the coming weeks.

Here’s a look at how the primary retirement savings plan in the US may soon change.

Automatic enrollment

In what would be the largest change to the 401(k) program, SECURE 2.0 would require employers to automatically enroll all eligible workers into their 401(k) plans at a savings rate of 3% of salary. (Many employees currently have to opt in and then choose their contribution level.) The new rule also applies to the 403(b), a similar program for employees of certain public and tax-exempt organizations.

Enrolled workers’ contribution rates would be automatically increased each year by 1% until their contribution reaches 10% annually.

While workers have the option to opt out of the plan or change their contribution level after they enroll, automatically enrolling workers into these plans would make a huge change in younger and low-waged employees’ participation in the program.

A 2012 study cited in the SECURE 2.0 bill found that, ”