SECURE Act 2.0, which was signed into law by President Biden on December 29, 2022, contains many provisions that can significantly impact investors and retirees. This retirement plan legislation represents an expanded version of the SECURE Act of 2019. (Setting Every Community Up for Retirement Enhancement.)
In this week’s blog, I review many of SECURE Act 2.0’s key tax and retirement provisions. Where applicable, I also discuss the potential impact of the changes. I am also considering offering a workshop on SECURE Act 2.0 in early February. I will send out information soon to gauge interest.
Please note that these changes do not have uniform effective dates. For example, the increase in the age for required minimum distributions gets phased in over a decade.
1. CHANGE TO AGE FOR REQUIRED MINIMUM DISTRIBUTIONS
Only a few years ago, retirement account owners had to start taking required minimum distributions (RMDs) in the year they turned age 70 ½. With the passage of the original SECURE Act in 2019, this age increased to 72 effective with the 2020 tax year. Under the new bill, beginning in 2023, this age increases to 73. Effective January 1, 2033, it jumps to 75.
Note that if you turn 72 in 2023, your first RMD will be for 2024, the year you turn 73.
Those who start withdrawing money from their IRAs or 401ks before their required beginning date due to either financial need or tax-planning strategies will not be affected by this change.
The Impact: Account owners can leave money in their accounts for a longer period. That can lead to greater tax-deferred appreciation. It can also enhance the opportunity to implement more tax planning strategies such as Roth conversions. Unfortunately, these changes may harm the beneficiaries of these accounts.
With the passage of the 2019 act, the stretch IRA was eliminated for most non-spouse beneficiaries. This left them with only 10 years to withdraw funds from an inherited IRA compared. Previously, they could withdraw funds over their life. The delayed start for RMDs could result in beneficiaries receiving a larger inheritance of tax-deferred funds than they would have before the rules changed. This could result in to a heftier tax bill when withdrawing the funds.
While the law still allows retirees to take distributions before age 73, some will leave the money untouched until the government requires them to withdraw it. This provision could ultimately increase government tax revenues and result in less total money in the hands of beneficiaries.
Roth conversions and other tax-planning strategies involved in creating a retirement paycheck can help to minimize the tax burden associated with distributing money from your retirement accounts. The increased age for RMDs makes it more important to create a strategy to proactively manage your distributions in a tax-efficient manner.
2. PENALTY RELIEF FOR LATE RMDs
Under current law, taxpayers pay a 50% excise tax for missing RMDs. The new law reduces this penalty to 25%. But if corrected promptly, a further reduction to 10% applies. The correction window starts either when the IRS demands payment or on the last day of the second taxable year that begins after the end of the taxable year in which the tax is imposed. For example, if you miss your RMD in 2024, you will have the earliest of when notified, or December 31, 2025, to take the distribution.
The Impact: In general, lowering the penalty represents a positive development. But the lower penalty could also decrease the likelihood that the IRS would accept requests for penalty waivers or relief.
3. RETROACTIVE FIRST-YEAR ELECTIVE DEFERRALS FOR SOLE PROPRIETORS
Sole proprietors who wish to establish Solo 401ks have until their tax filing deadlines (without extensions) to fund a plan. Under prior law, you had to establish and fund these accounts by December 31. The new rules allow individual business owners until their tax filing deadline in 2023 to establish and fund their Solo 401k accounts for 2022.
4. UNUSED FUNDS IN A 529 PLAN PERMITTED TO BE ROLLED INTO A ROTH IRA
What do you do if you save for your child’s college education using a 529 account, and he or she doesn’t go to college? Or what money is left in the account after your child graduates? You could treat the remaining balance as a legacy and pass it on to your grandchildren. If you wanted to go back to school to take a class, you could use it to cover that, too. But, for many, these – and other similar outcomes – for leftover funds were less than desirable.
Under SECURE Act 2.0, taxpayers now have the option to roll leftover balances to the beneficiary’s Roth IRA. But as discussed below, some limitations apply.
Please note that the 529 rollover provisions are not bound by the income limitations associated with Roth IRAs. Thus, high earners with excess tuition savings can still participate in these transactions.
The Impact: Under SECURE 2.0, you have a new option that represents a potential game changer. Beginning in 2024 unused funds in a 529 college savings plan – up to a lifetime limit of $35,000 – may be rolled into a Roth IRA. To qualify, the 529 plan must have been open for at least 15 years. You can’t roll over funds contributed during the last five years. The amount rolled over also gets subjected to the Roth contribution limit, which is currently $6,500.
Some uncertainty remains though. We don’t yet know if changing the beneficiary requires a new 15-year waiting period. Unless you can change the beneficiary, the parent, grandparent, or another person who funded the account cannot roll over the funds to their Roth account. In that case, only your child or grandchild can receive the Roth funds. We also don’t know if withdrawals of earnings from a 529 plan transferred to a Roth account get subjected to the rule requiring earnings to remain in a Roth IRA for at least five years.
Due to the time frame limitations, parents should open and fund 529 plans for their children as early as possible. If you open a 529 account for your toddler, any remaining balance could be eligible for rollover right after your child finishes college.
5. EXPANDING AUTOMATIC ENROLLMENT IN NEWLY ESTABLISHED RETIREMENT PLANS
For newly created 401k or 403b plans, participants will be required during the first year of participation to contribute a minimum of 3% and a maximum of 10% unless the participant specifically opts out or selects a different contribution percentage. This rule exempts businesses that have been in existence for less than three years.
The Impact: This change makes contributions the default option for newly established retirement plans. It should result in greater participation levels.
6. MODIFICATION OF CREDIT FOR SMALL EMPLOYER PENSION PLAN STARTUP COSTS
Employers with 50 or fewer employees are eligible for an enhanced tax credit for start-up plans commencing in 2023. The credit will cover 100% of startup costs totaling up to $5,000 for three years. Eligible businesses with 51 to 100 employees remain subject to the original SECURE Act. It gave startup businesses with up to 100 employees a tax credit equal to 50% of administrative costs. It also had a $5,000 annual cap.
7. QUALIFIED CHARITABLE DISTRIBUTIONS (QCDs) INDEXED FOR INFLATION ANNUALLY
Since 2015 IRA owners could transfer up to $100,000 annually to a charity in the form of a QCD. Under SECURE 2.0, this amount gets indexed for inflation in $1,000 increments. This will allow taxpayers to make larger tax-free charitable gifts over time.
The Impact: This represents another positive development. Please keep in mind that while the age for RMDs continues to increase, the minimum age for QCDs remains at 70 ½. The confusion around these different ages relates to the fact that you can use QCDs to satisfy an RMD up to the current $100,000 limit.
One additional consideration. You cannot make a QCD from an employer-sponsored retirement plan. Charitably inclined individuals should consider rolling over 401k balances to an IRA when they turn 70 ½. This can also allow you to draw down large retirement plan balances before you start taking RMDs. It may also help you save on taxes during your distribution years.
8. INDEXING IRA AND 401k/403b CATCH-UP LIMITS
Historically, IRA annual catch-up limits for those aged 50 and over have been limited to $1,000. Beginning in 2024, the IRS will index this amount for inflation.
Catch-up contributions to employer retirement plans will jump from $6,500 to $10,000 for eligible participants who would attain the ages of 62, 63, and 64 but not 65 before 2023 ends. These catch-up amounts also get indexed for inflation.
9. OPTION TO TREAT EMPLOYER MATCHING CONTRIBUTIONS AS ROTH CONTRIBUTIONS
Before SECURE Act 2.0, you could only receive pre-tax employer-matching contributions. With the passage of SECURE Act 2.0, such contributions can go to your Roth account as well. You should note that such amounts will also be taxable.
The Impact: Diversification of accounts by type from a tax perspective can allow you to withdraw funds during retirement in a more tax-efficient manner. This change allows you to increase the value of your Roth accounts without completing Roth conversions. But you will pay taxes on the employer match. In the past, deposits to your regular 401k were tax-free.
10. CHANGE TO CATCH-UP CONTRIBUTIONS TO EMPLOYER RETIREMENT PLANS
Under SECURE Act 2.0, if you make $145,000 or more, you must make catch-up contributions to employer retirement plans – but apparently not IRAs – with Roth after-tax dollars. Those who make less than $145,000 can still make catch-up contributions with pre-tax dollars.
The Impact: This represents one of – if not the – biggest tax increases in the new law. It helps to pay for some of the other tax breaks it provides.
11. NO RMDs ON ROTH SAVINGS
Beginning in 2024, Roth money in a 401k will no longer be subject to RMDs. Under current law, only Roth IRAs were exempt from RMDs.
The Impact: The RMD requirement associated with Roth 401ks often caused workers to rollover amounts from their employer plans to Roth IRAs to avoid the RMD requirement. This change can make it harder for an advisor to justify recommending such a rollover in the future.
12. TREATMENT OF STUDENT LOAN PAYMENTS AS ELECTIVE DEFERRALS FOR PURPOSES OF MATCHING CONTRIBUTIONS
Recent graduates with outstanding student loan balances often find it difficult to contribute to their retirement plans. Under SECURE Act 2.0, student loan debt payments will equate to 401k, 403b, or SIMPLE IRA salary deferrals and allow for employer plan matching.
The Impact: This change makes it easier for those repaying student loans to save for retirement at the same time thanks to their employer. This can help recent graduates start building their nest egg through an employer match.
13. AGE OF DISABILITY ONSET INCREASED FOR ABLE ACCOUNT ELIGIBILITY
ABLE accounts, also referred to as 529A accounts, represent tax-deferred accounts that can be used to save for expenses related to your or a loved one’s disability. The new legislation increases the age at which the disability can occur from 26 to 46. This change takes effect in 2026.
The Impact: The change provides those who suffer disabilities at older ages – and those who want to support those individuals – with the opportunity to protect and grow more funds for the disabled person’s benefit.
14. IMPROVED COVERAGE FOR PART-TIME WORKERS
SECURE Act 2.0 makes it easier for part-time workers to participate in company retirement plans. It reduces the service requirements for eligibility from three years to the first consecutive 24-month period.
15. CREATION OF A LOST AND FOUND DATABASE
Many people often change jobs, move, and lose track of their retirement savings. The new law requires the Department of Labor to create a “lost and found” database within two years. This would allow you to type in your name and find any retirement money you may have forgotten about. This should work similarly to the lost property databases run by states. These databases have made it much easier for people to find lost bank accounts and other assets.
16. SURVIVING SPOUSE CAN ELECT TO BE TREATED AS AN EMPLOYEE
If an employee who has designated a spouse as a sole beneficiary dies before RMDs have started under an employer-provided qualified retirement plan, SECURE Act 2.0 allows the designated beneficiary’s surviving spouse to elect special treatment. This allows them to be treated as if he or she was an employee for purposes of the RMD rules.
The Impact: The most likely scenario for electing this rule would be where the surviving spouse inherits retirement accounts from a younger spouse. This could allow them to delay RMDs. Or once RMDs start they would be smaller than if the spouse had completed a spousal rollover or remained a beneficiary of the account.
SECURE ACT 2.0 – TAX CONSIDERATIONS
Rules such as the increase in the age to start RMDs may sound good, but they can result in a tax crunch. Just because you can delay RMDs does not necessarily mean you should. If you are fortunate enough to not need the money in your retirement accounts for living expenses, you should still consider the tax implications. Delaying your withdrawals can result in larger RMDs when you reach the requisite age.
Rather than waiting until you reach RMD age to do tax planning, under SECURE Act 2.0, you may have a better opportunity to manage the tax consequences if you start years ahead of time. Oftentimes, the phrase, “the sooner the better” should guide your decisions as to when to start withdrawing money from your IRA or complete a Roth conversion. Such thinking can lead to paying less in taxes as you withdraw money from your retirement accounts. It can also result in lower Medicare premiums. Such actions can also allow you to postpone claiming Social Security benefits until age 70. This would allow you to receive your full benefit. Remember that your benefit grows 8% per year from full retirement age – 67 for those born in 1960 or later and age 70.
Larger RMDs can result in higher current taxes. They can also lead to higher Medicare premiums. The tax bill for a surviving spouse could also increase. Finally, the tax burden on your heirs could also rise. Remember that once you start taking RMDs any Roth conversions come after your RMDs. Raising the RMD age can allow you to complete Roth conversions on a more proactive basis. This can lower the overall tax cost of withdrawing money from your tax-deferred retirement accounts. (See this blog for more discussion around these potential concerns.)
Final Thoughts About SECURE Act 2.0
SECURE Act 2.0 provides for some significant changes to the tax and retirement landscape. It pushes the age for RMDs out further – to 73 for those born between 1951 and 1959 and 75 for those born in 1960 or later. It also includes a significant number of Roth-related changes. These involve both Roth IRAs and Roth accounts in employer retirement plans.
In addition, you will find provisions meant to increase retirement savings through larger catch-up contributions that are now subject to cost-of-living adjustments as well. Plus, it provides incentives for small employers to start retirement plans. You should also note the changes associated with catch-up retirement plan contributions for those 50 and over.
The change that treats student loan payments as elective deferrals for employer matching purposes in workplace retirement accounts will allow student borrowers to benefit from an employer match sooner. Many of these individuals couldn’t start building their retirement savings because they were overburdened by debt.
I hope you find the above discussion helpful. If you have questions or would like some help determining how these rules might impact you or how you can take advantage of them, please schedule a free call. I’ll gladly answer any questions and assist in whatever way I can.
I’ll be back next week with “Apprise’s Five Favorite Reads of the Week.”
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Phil Weiss founded Apprise Wealth Management. He started his financial services career in 1987 working as a tax professional for Deloitte & Touche. For the past 25+ years, he has worked extensively in the areas of financial planning and investment management. Phil is both a CFA charterholder and a CPA.
Located just north of Baltimore, Apprise works with clients face-to-face locally and can also work virtually regardless of location.