Late last year, the SECURE (Setting Every Community Up for Retirement Enhancement) Act 2.0 was enacted, which brought about changes in many retirement plans. The actual bill is over 4,000 pages in length, so while the bill is technically available, we still don’t know for sure how everything will work out. As bills of this kind are written, the actual rules and laws will be tested and interpreted in the court system.
There are many changes in the SECURE Act 2.0, but one such notable change to Roth retirement plans is this: if you have access to a Roth 401(k) or 403(b), you can elect to have your employer match be directed to your Roth retirement accounts. The employer match on retirement plans in the past has always been made to the traditional retirement plan accounts, so the business could enjoy the tax deduction on the matching contribution. In prior years the employee could fund the Roth account and/or the traditional account, but the employer could only fund the traditional retirement plan account – so if you funded a Roth retirement plan that was matched, you had both Roth and traditional retirement plans.
While it sounds great to have your employer fund your Roth account on your behalf, there’s a catch. All matching into Roth retirement accounts will be considered taxable salary to the employee. Knowing this helps you make decisions about whether it’s suitable to take advantage of Roth matching contributions or not. If you max out your 403(b) contributions at $22,000 and have a dollar-for-dollar match, your employer will contribute an additional $22,000 to your account. If you chose both your contribution and your employer’s contribution to be directed to your Roth account, you would pay taxes on $44,000 of salary to fund the Roth account.
Here are some examples below. In all examples, the employee earns $250,000 annually, is in the 35% tax bracket, and contributes $22,000 to a 403(b) with a dollar-for-dollar match for the full contribution. The employee can choose either Roth or traditional accounts.
Scenario 1:
Employee Contribution: Traditional retirement plan
Employer Match: Traditional retirement plan
Employee tax consequence: Pays taxes on $238,000 due to deductions of $22,000 traditional retirement plan contributions. Income tax liability is reduced by $7,700 due to contribution deductions. No additional tax is resulted from the employer matching the traditional retirement plan.
Scenario 2:
Employee Contribution: Roth retirement plan
Employer Match: Traditional retirement plan
Employee tax consequence: Pays taxes on $250,000 due to after-tax contributions of $22,000 of Roth retirement plan contributions (employee pays tax on Roth contributions). Employee pays $7,700 of income tax on Roth contributions. No additional tax is resulted from the employer matching the traditional retirement plan.
Scenario 3:
Employee Contribution: Roth retirement plan
Employer Match: Roth retirement plan
Employee tax consequence: Pays taxes on $272,000 due to after-tax contributions of $22,000 of Roth retirement plan contributions (employee pays tax on Roth contributions). Additional $22,000 income tax is imposed on employee for employer matching the Roth retirement account. Total tax liability on Roth contribution plus Roth employer matching is $15,400.
When selecting between traditional and Roth retirement plans, it’s important to understand the greater tax impact. There is not a right-or-wrong answer in choosing to fund or match one retirement plan over the other, but there are more suitable situations in certain circumstances. Some retirement plans stand to improve current cash flow, while others can create additional income taxes now for a tax benefit in the future. The retirement plan landscape is changing consistently, so it’s critical to understand how these changes may be beneficial or limiting for your particular situation. The SECURE Act 2.0, in my opinion, seeks to neither simplify the retirement plan landscape, nor reduce taxes to retirement savers. It is a complicated bill that remains largely unclear on how it will change retirement accounts moving forward.