Simplifying 401K and IRA Rules Around Automatic Enrollment, Unused Vacation Contributions and Rollover Payments

The IRS and Treasury department will roll out a number of updated and streamlined 401K and IRA rules under the guidance of the Obama administration. These are aimed at encouraging Americans who haven’t been regularly setting aside money in private accounts to save for retirement. The changes include:

1. Streamlining the process for small businesses to automatically enroll employees in savings programs when they start; they have to manually opt-out if they choose not to participate. “Automatic enrollment has made a big difference in participation rates by making it simpler for workers to save,” President Obama said in his weekly radio and Internet address. “And that’s why we’re going to expand it to more people.”

The IRS will provide approved language for employers to use when amending their retirement-savings plans to include automatic-enrollment unlike the current rules where each employer has to typically ask the IRS to approve their plan’s language when they add the automatic-enrollment feature. With the pre-approved language for auto-enrollment, employers will be able to more quickly and easily adopt the feature which tends to improve workers’ plan participation rates.

In general, about 70% of eligible workers participate in workplace plans such as 401(k)s, but that figure rises to more than 90% when companies adopt automatic enrollment, according to a statement by the administration.

2. Expand the ability for employers to put payments for unused vacation time into retirement savings. However such contributions, combined with regular salary-based contributions, are still subject to the current annual-contribution limits.

3. Provide an option for individuals to have federal tax refunds paid as a savings bond; This would be implemented in the upcoming 2010 tax season, where taxpayers will be able to choose to buy savings bonds with their tax refund simply by checking a box on their tax return, the administration said. Taxpayers wouldn’t have to open a Treasury account or even have a bank account – the bonds will be mailed to those who check the box.

4. Simplify Roll Over Retirement Distributions into IRAs or other plans. A key risk to lifetime savings is when an employee spends his or her lump sum payment, instead of electing to roll over the payment to an IRA or other retirement plan. The updated tax rules will simplify the presentation of an employee’s options when receiving an eligible rollover distribution. It provides a rollover roadmap that satisfies the required notice that must be provided to employees taking their retirement assets.

The notice also reflects law changes (such as information on a distribution from a designated Roth account under an employer plan) and explains rules that apply in special situations (such as when a distribution is made to a surviving spouse or other beneficiary).

5. Provide an easy to understand website that clarifies and simplifies IRS rules in an effort to get employers and their workers to use tax-advantaged 401(k)s and IRA. Many of the administration’s moves are not new rules but a new emphasis on existing laws. But these laws are somewhat complex and the administration (via the Treasury and IRS) will create new explanatory road maps to make it easier for employers and workers to take advantage of these retirement provisions.

New options to fund 401K or IRA’s, like using tax refunds and unused vacation dollars, are part of the administration’s longer term effort to improve the nation sub-par savings rate and help the over 78 million Americans, or about half the workforce, that don’t participate in a retirement plan at work. Of those who don’t participate in workplace pan, fewer than 10% contribute to a private retirement plan (like an IRA). Further, Boston-based Fidelity Investments, the largest U.S. provider of workplace retirement plans, did a study released in July that found automatic enrollment helped younger and lower income employees the most – many who otherwise have not saved. More than half of the automatically enrolled participants in Fidelity managed plans were between 20 and 34 and 56% made less than $40,000 a year, according to the study by the Boston based firm.

“We cannot continue on this course and we certainly cannot go back to an economy based on inflated profits and maxed-out credit cards. “Working Americans should be able to retire with dignity and security, but nearly half of the nation’s workforce has little or nothing beyond Social Security benefits to get by on in old age,” Treasury Secretary Timothy Geithner said in a statement. “The measures will give more choices to families who want to save.”

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