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Retirement Readiness
Automatic Salary Deductions Position Employers to Help Employees Get on Track for Retirement
Last Updated: May 04, 2023
When the Internal Revenue Service (IRS) issued new rules that allowed employees to contribute to 401(k)s in 1981, one very important effect drastically impacted the retirement planning landscape. That change? The addition of automatic salary deductions. This gave plan participants the ability to put money directly into their retirement plan from their paycheck, without the hassle of moving it over themselves. The age-old adage, “Out of sight, out of mind” with their retirement savings, just like that box of Oreos hidden in the back of the pantry.
Automatic salary deductions helped jump-start the popularity of 401(k) plans in the United States dramatically. According to the Employee Benefit Research Institute, “Within two years, surveys showed that nearly half of all large firms were either already offering a 401(k) plan or considering one.”1 Despite this increase in employers offering plans, today, there is an overwhelming and alarming majority of Americans that are still not on track to meet their goals in retirement.
The worst-case scenario is if the participant cashes out their plan and has to start from square one in their next plan. In a recent study done by Alight Solutions, “What do workers do with their retirement savings after they leave their employers,” they found that the largest portion of participants decide to take a full cash distribution. Retirement plan leakage is a huge issue, and it is one of the most important areas that all plans need to focus on to improve the retirement readiness of their participants.2
With the recent passing of SECURE 2.0, the government is making progress to tackle the leakage issue by utilizing some of the same features that make the 401(k) work so well.3 The new bill introduces the “Emergency Savings Account.” If adopted into the plan, it will allow participants to use automatic salary deductions to build up an emergency savings balance. The big picture is that if participants can build those additional savings, and access those, they won’t have to pull from their 401(k). This new law allows participants to take up to four penalty-free distributions per year. They also do not have to worry about taxes on their distributions, because they are treated as Roth contributions and are taxed before going into the account.
As a retirement plan fiduciary committee, this is a great opportunity to make a positive impact on employees and help them increase their financial security. The bill also allows employers to automatically enroll participants into the emergency savings account, giving them the same ability to opt out that they have in the retirement plan. Just like in their 401(k)s, this changes the question that participants are asked from, “Do you want to opt-in?” to, “Do you want to opt out?”
It’s important to note that participants can only contribute a maximum of $2,500 per year to the account. One of the best components of the new legislation is that if the participant reaches their $2,500 contribution limit, the additional savings do not stop. They are placed in the retirement plan instead. This will encourage participants to continue their good saving habits and increase the likelihood that they will maximize their contributions down the road.
When it is used correctly it can dramatically impact retirement readiness. With the decrease in leakage from the plan, it is expected that average plan balances will rise. Automatic salary deductions will continue to prove to be a great resource for employers to help employees get on track for retirement.
And this is just the start of improving the overall retirement readiness for American workers.
If you would like to learn more about the benefits of the new emergency savings account provision under SECURE Act 2.0, reach out to our experts today!
Sources:
1Employee Benefit Research Institute. “History of 401(k) Plans: An Update.” https://www.ebri.org/docs/default-source/fast-facts/ff-318-k-40year-5nov18.pdf
2Alight Solutions. “What do workers do with their retirement savings after they leave their employers? A deep dive into post-termination behavior, 2008–2017.” https://www.alight.com/thought-leadership/distributions-retirement-plans-after-employment
3This article represents a selective summary of certain provisions included in the Secure 2.0 Act passed by the U.S. Congress and signed into law on December 29, 2022. A complete summary of the Act can be found at
https://www.finance.senate.gov/imo/media/doc/Secure%202.0_Section%20by%20Section%20Summary%2012-19-22%20FINAL.pdf
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