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Is Proposed Bill Easing 401k Participation Of Workers Under Age 21 Focusing On The Wrong Thing?
by Christopher Carosa August 20, 2024
Congress is considering a bill that would make it easier for employers to add employees under age 21 to their 401k plans. There are pluses and minuses to this. The idea is that by removing regulatory roadblocks and encourage companies to include younger workers in their 401k plans, those younger workers will be able to take advantage of long-term compounding effects of saving for retirement.
Of course, just because it’s available doesn’t mean those younger employees will save, especially when they’re at an age where spending has the priority (and we’re not talking frivolous spending, but basic needs spending).
“Currently, employers that sponsor retirement plans, such as 401k plans, are not required by law to allow those who are under age 21 to be eligible to participate in the plan,” says Michelle Capezza, Of Counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “As a result, many employers choose not to extend plan eligibility to workers who have not attained the later of age 21 or the required hours of service due to potential high turnover of younger workers, increased plan administrative costs and potential plan testing issues. Some plan sponsors, however, do allow those who are at least age 18 to be eligible for plan participation. Therefore, depending on where a younger worker chooses to work, they may or may not have access to participation in an employer-sponsored retirement plan to save for retirement for three additional years compared to some of their peers.”
As a practical reality, ERISA currently imposes impediments on employers who wish to include plan participants below the age of 21. “Some current issues include eligibility restrictions, lack of awareness or understanding of the benefits, and potential limitations on contributions,” says Harold Evensky, founder of Evensky & Katz in Lubbock, Texas.
Specifically, how do these issues play out presently for plan sponsors?
“The potential issues under current law with expanding eligibility requirements to children under age 21 are nondiscrimination testing; increasing the likelihood that an audit of the plan would be required; eligibility of participants under age 21 for employer matching and non-elective contributions; and the application of the long term part-time employee provisions of SECURE and SECURE 2.0 to these employees,” says Marcia S. Wagner of the Wagner Law Firm in Boston, Massachusetts. “The proposed bipartisan legislation seeks to address each of these issues. Employees under age 21 would still need to complete 1,000 hours in a 12 month period; employers would not be required to make matching or non-elective contributions; there would be exclusions from nondiscrimination testing; and special rules with respect to audits would apply. In comparison to IRAs, IRAs have no minimum age type exclusions, so individuals even under age 18 can participate in those plans, and they do not necessarily need to reduce their compensation to contribute. A parent, grandparent or other third-party could gift them $7,000, to contribute to an IRA.”
The bipartisan proposal in Congress was introduced by Brittany Pettersen (D-CO) and Tim Walberg (R-MI). It follows a similar bipartisan bill proposed in the Senate last year by Bill Cassidy (R-LA) and Tim Kaine (D-VA).
“The ‘Helping Young Americans Save for Retirement Act,’ currently under consideration in Congress, aims to address the significant challenges younger workers face in participating in retirement savings plans like 401ks,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “One of the Act’s key provisions is to lower the minimum age requirement for participation in these plans. Many employers set the eligibility age at 21, which delays a young worker’s ability to start saving for retirement. By lowering this age requirement, the Act seeks to enable younger employees to begin accumulating retirement savings earlier, allowing them to take full advantage of compound interest over a longer period.”
While workers always have the option of saving for retirement through an IRA, the company 401k does make it easier to save. “The ability to defer via an employer’s established 401k via payroll system is the inherent advantage over an employee opting for an IRA,” says Lawrence (Larry) Starr of Cornerstone Retirement/QPC in West Springfield, Massachusetts.
A broader comparison between 401k plans and IRAs shows each has its advantages.
“IRAs have features superior to those of 401k plans, and vice versa,” says Jack Towarnicky, Of Counsel at Koehler Fitzgerald, LLC in Powell, Ohio. “The primary difference is in contribution limits and access. The 401k contribution limits are IN ADDITION TO the contribution limits on IRAs. In terms of access, in-service withdrawals of 401k deferrals (Roth or pre-tax) are limited by tax code provisions. No such limit applies to IRA withdrawals. And, in terms of access, an employer-sponsored plan may, but is not required to provide for plan loans. An IRA cannot permit loans.”
While 401k plans offer loan provisions not available in IRAs, IRAs offer penalty-free early withdrawal opportunities that target spending most likely to occur in the lives of younger workers.
“Early IRA distributions get the added benefit (over 401k distributions) of avoiding the 10% penalty (12.5% in CA) when used for qualified higher education expenses, home-buying, or for health insurance premiums paid while unemployed,” says Jason R Escamilla, founder and CIO at Impact Advisor LLC in San Francisco, California.
In the end, any focus on younger employees in terms of saving for retirement may all be for naught. For these often lower-paid workers, the higher contribution caps for 401k plans may not any practical benefit.
“For the majority of workers under 21, especially those juggling school and part-time work, the idea of maxing out a 401k seems implausible,” says Bavetz. “A part-time worker making $15 an hour and clocking in 20 hours a week would bring home about $15,600 annually. Even if they managed to save 15% of that income in a 401k, they’d only be putting away $2,340 a year—well below the $7,000 IRA limit. That’s assuming they don’t need that money for things like tuition, rent, or just surviving daily. In reality, most of these young workers will prioritize immediate financial concerns over long-term savings, making it highly unlikely that they’ll come anywhere near the 401(k) contribution limits Congress is boasting about.
Perhaps Congress would be better off focusing on ways to increase savings in Child IRAs (maybe in a manner similar to the treatment of Spousal IRAs). This gets retirement savings compounding started at a much earlier age and could also instill important financial habits in children.
Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions.