The SECURE 2.0 Act of 2022 (SECURE 2.0) makes sweeping changes to retirement plans – particularly plans sponsored by small businesses. Like the original SECURE Act enacted in 2019, 2.0 seeks to increase retirement plan coverage and retirement savings by incentivizing new plan adoption by small businesses and contributions by participants.
I am a big fan of SECURE 2.0, but wish the law had banned hidden 401(k) fees – most notably, revenue sharing. I believe hidden fees fuel public skepticism about 401(k) plans – making business owners less likely to adopt a plan and workers less likely to contribute.
My favorite SECURE 2.0 provisions will – in my view – increase retirement plan coverage and retirement savings the most. Below are my top five provisions and why I think not banning hidden 401(k) fees was a mistake.
My Top 5 Favorite SECURE 2.0 Provisions
Small Business Tax Credits
According to 2022 U.S. Bureau of Labor Statistics, 90 percent of workers employed by a large employer (500+ workers) in the United States are covered by a workplace retirement plan, while only 56 percent of workers employed by a small business (1-49 workers) are covered. Closing this coverage gap is important. According to AARP, workers are 15 times more likely to save for retirement when a plan is in place.
SECURE 2.0 seeks to close the gap by increasing the retirement plan startup credit from 50 percent to 100 percent for employers with up to 50 employees. Small businesses can earn an additional credit by making employer contributions, up to a per-employee cap of $1,000. This full additional credit is limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees.
My view – The enhanced startup credit can make a new low-cost 401(k) plan effectively free for a small business for up to three years. In my view, this SECURE 2.0 provision will increase retirement plan coverage the most.
Starter 401(k) Plans
A recent Pew Charitable Trusts study found that cost and “a lack of administrative resources” are the top reasons why small- and mid-sized businesses do not offer their employees a retirement plan today. Addressing these concerns should encourage more businesses to offer a plan.
The starter 401(k) plans created by SECURE 2.0 should help. Unlike a traditional 401(k) plan, starter plans aren’t subject to ADP/ACP or top heavy testing - or have a safe harbor contribution requirement. Instead, they must automatically enroll employees at a 3 to 15 percent of compensation deferral rate unless the employee elects otherwise. The IRA limit ($6,500 for 2023) will apply to annual contributions.
My view – With no testing or employer contribution requirement, starter 401(k) plans should cost less and require less administration than a traditional plan. That advantage should incentivize more retirement plan coverage by small businesses with limited resources.
When workers contribute to a 401(k) plan, they are paying now for income in retirement. When you consider that income may need to last 10, 20, even 30 years, it’s easy to understand why retirement is not cheap. Given the cost of retirement, saving for it can seem futile. In truth, compound interest can make retirement affordable for just about any 401(k) participant willing and able to make annual contributions throughout their working years – even if the annual amounts are small.
SECURE 2.0 will boost the annual 401(k) contributions of low- to middle-income workers by converting saver’s tax credit into a matching contribution made by the federal government to an eligible retirement account – including a 401(k). The amount could be up to $1,000 per year.
My view: This change should help a lot more 401(k) participants afford a secure retirement decades from now due to the power of compound interest. After 40 years, a $1,000 annual match could add almost $300,000 to a 401(k) account balance (assuming an 8% annual interest rate).
Roth Matching and Nonelective Contributions
In our latest 401(k) plan design study, we found almost 80% of small business plans allow participants to designate a portion of their elective deferrals as Roth contributions. Employee demand is likely behind the high adoption rate. For 401(k) plans that allow Roth contributions, we’re seeing more participants than ever choose them over pre-tax deferrals to achieve tax-free income in retirement.
SECURE 2.0 allows participants to designate matching or nonelective contributions as Roth contributions when permitted by their plan.
My view: Given the rising popularity of Roth deferrals, I expect employee demand for Roth matching and nonelective contributions to be strong. I also expect this SECURE 2.0 provision to drive more 401(k) plan adoption by small businesses given the interest we’ve seen from small business owners in the mega backdoor Roth strategy.
Higher Catch-up Contribution Limits
Most 401(k) plans today allow participants age 50 or over to make catch-up contributions to their account. These contributions give participants who delayed saving for retirement the chance to "catch up" and bolster their savings before retirement.
SECURE 2.0 increases the catch-up limit to the greater of $10,000 or 50 percent more than the regular catch-up limit ($7,500 for 2023) for individuals who have attained ages 60, 61, 62, and 63.
My view: Higher annual contribution limits are good news for all 401(k) participants.
What About Hidden Fees?
All 401(k) providers charge plan administration fees. When paid from plan assets, these fees can be either “direct” or “indirect” in nature. Indirect are often called “hidden” fees because they lack the transparency of direct fees. The most common form is revenue sharing. I think hidden 401(k) fees should be illegal for the following reasons:
- When 401(k) fees are paid from plan assets, they reduce the returns of plan participants dollar-for-dollar. The missed compound interest on these losses can snowball dramatically over time. Given the stakes, I think all 401(k) fees paid from assets should be transparent. Only direct fees fit that bill.
- Hidden fee payments are usually based on a percentage of assets. That means their amount can get excessive fast as account assets grow.
- Revenue sharing can limit participant access to top-performing 401(k) investments that pay none to 401(k) providers.
Our most recent 401(k) fee study found 75% of small business plans pay hidden fees. I am certain their ubiquity fuels public skepticism about 401(k) plans. I believe banning them would make skeptical business owners more likely to adopt a plan and skeptical workers more likely to contribute - increasing retirement plan coverage and retirement savings in the process.
SECURE Act 2.0 Offers Welcome Reform!
In my view, hidden fees are the root cause for the top sources of 401(k) fiduciary liability today. By not banning them, I think SECURE 2.0 missed an opportunity to further increase plan adoption and participation.
However, this omission doesn’t make SECURE 2.0 a disappointment. Quite the contrary – the law probably represents the most consequential retirement plan reform in my lifetime. My top five provisions will do the most good, in my view.