The SECURE Act 2.0 is the newest of recent tax law changes, and it provides opportunities for many families. Beginning with the Tax Cuts and Jobs Act, otherwise known as “Trump Tax Reform” that was passed at the end of 2017, Americans have seen significant new tax legislation passed almost annually including the SECURE Act in 2019, the CARES Act in 2020, the American Rescue Plan in 2021, and the Inflation Reduction Act in 2022. With rapid changes in tax law, it’s not surprising that more individuals are searching for advice when it comes to taxes and their retirement.
As we enter 2023, it appears the rate of change in tax and retirement rules is not about to slow down anytime soon with President Biden signing the SECURE Act 2.0 into law on December 29th, 2022.
Like the original SECURE Act which extended the Required Minimum Distribution (RMD) age from 70 ½ to 72 and eliminated the ability for most beneficiaries to stretch inherited IRA distributions over their lifetime, the SECURE Act 2.0 includes significant changes that are likely to impact a large number of Americans.
The most notable changes in the SECURE Act 2.0 include additional changes to RMD ages, reduced penalties for missed RMDs, changes to Roth accounts within employer retirement plans, increased catch-up contributions, and limited flexibility to use 529 account balances to fund Roth IRA contributions.
Required Minimum Distributions – Pushed Back:
While the original SECURE Act increased the RMD age from 70 ½ to 72, the SECURE Act 2.0 increases the RMD age to 73 for anyone born between 1951 and 1959 and to age 75 for anyone born in 1960 or later.
While the added complexity of multiple RMD ages can be confusing, the bottom line is that moving the RMD age back for certain individuals simply increases the flexibility for retirement withdrawals by avoiding mandated withdrawals at an earlier age.
For retirees who need distributions from their retirement accounts to cover their living expenses, the changes in RMD ages may have minimal effect. However, individuals who have sufficient income from other sources may find the added flexibility helpful in minimizing income on their tax return for a few additional years which can reduce the taxability of their Social Security benefits, reduce their exposure to Medicare Income Related Monthly Adjustments Amounts, and increase their ability to efficiently convert pre-tax IRA balances to Roth IRAs.
The following table shows each individual’s updated RMD age based on their date of birth.
Key Takeaway:
The SECURE Act 2.0 increases planning options and flexibility by raising the Required Minimum Distribution age for many individuals.
Required Minimum Distributions – Penalties Reduced:
Given RMD ages are different depending on birth dates, it is not surprising that individuals may not realize they’ve reached RMD age or may simply forget to take their RMD in a given year.
Historically the penalty for such an oversight was 50% of the amount that should have been distributed. For an individual with a $1,000,000 IRA that penalty would exceed $18,000 – a steep price to pay for a simple oversight.
Starting in 2023 the SECURE Act 2.0 reduces this penalty from 50% of the amount that should have been distributed to 25%, and if the oversight is corrected in a timely manner, the penalty can be further lowered to 10%.
While the updated penalty amounts are a significant improvement on the original 50% penalty, missing an RMD remains a costly oversight that can be easily avoided by simply taking RMDs when they are due.
Key Takeaway:
The penalty for not taking a Required Minimum Distribution has been reduced but still represents a significant penalty for what often is a simple oversight.
Employer Plan – Additional Roth Options:
The SECURE Act 2.0 makes several changes for Roth accounts within employer-based plans such as 401(k) and 403(b) plans. While we receive frequent questions asking whether Congress will ever reduce or limit the substantial benefits of Roth accounts, the changes by the SECURE Act 2.0 increase the availability of Roth accounts rather than restrict them.
First, beginning in 2024, Roth accounts within employer plans will no longer require participants to take RMDs during their lifetime. While this is currently the case for Roth IRAs, Roth accounts within employer plans were not afforded the same treatment. This change increases individuals’ ability to harness the power of tax-free growth for life.
Second, employer contributions to employee retirement accounts can be made to the Roth component of the plan. Until now, all employer contributions were required to be made on a pre-tax basis.
Now if the plan chooses to allow it, employers can make contributions directly to the employee’s Roth account within the plan. If this option is elected, the contribution will be treated as taxable income to the employee in the year the contribution is made and the contribution will be non-forfeitable by the employee.
Third, beginning in 2024, individuals age 50 and older who make over $145,000 in wages will only be allowed to make catch-up contributions to the Roth component of their plan. Historically catch-up contributions have been allowed on a pre-tax basis regardless of income.
The language in the SECURE Act 2.0 specifies that the $145,000 threshold is “wages (as defined in section 3121(a)) for the preceding calendar year from the employer sponsoring the plan.” Accordingly, it appears that there is leeway for certain high-income individuals to still make pre-tax catch-up contributions.
For example, self-employed individuals who have “net earnings from self-employment” instead of “wages” and employees who make over the limit but recently switched jobs such that they did not earn $145,000 in wages from the “employer sponsoring the plan” in the current year may still be able to make pre-tax catch-up contributions depending on the final interpretation of this provision.
Regardless of the final interpretation of this nuanced language, the bottom line is that many high-income taxpayers will be required to make catch-up contributions within their employer plans to a Roth account rather than pre-tax accounts in the future.
One additional note regarding Roth catch-up contributions under the SECURE Act 2.0 is that any plan that does not make a Roth account available for catch-up contributions will not be eligible for any catch-up contributions at all – including pre-tax contributions by employees whose wages are under the $145,000 threshold. Many employers will need to review their plans and add a Roth deferral option to ensure that employees are able to retain their ability to make catch-up contributions.
Key Takeaway:
Congress appears to be expanding the use of Roth accounts rather than restricting them. SECURE Act 2.0 eliminates RMDs on employer plan Roth accounts, allows employers to make contributions to Roth accounts, and requires high-income taxpayers to make catch-up contributions to Roth accounts vs pre-tax accounts.
Catch-up Contributions – Increased:
In an effort to assist taxpayers who are nearing retirement and would like to accelerate their savings, the SECURE Act 2.0 includes a provision that takes effect in 2025 that will allow individuals who turn age 60, 61, 62, or 63 during a given year to make a catch-up contribution to their employer plan (e.g. 401(k) or 403(b) plan) that is 50% larger than the standard catch-up contribution.
Using the 2023 allowed catch-up contribution of $7,500 for context, individuals age 60-63 would be able to make an $11,250 catch-up contribution ($7,500 x 150%) as shown in the graphic below (while we are using 2023 limits for context, this provision is not effective until 2025).
While this level of additional contributions won’t fully make up for years of lost saving opportunities, it certainly can help provide a boost to those who are saving aggressively at the end of their working careers.
The SECURE Act 2.0 also modifies the catch-up contributions for IRAs. Currently IRA rules allow individuals age 50 and over to make a $1,000 catch-up contribution each year; however, that limit is not indexed to inflation. Going forward, the SECURE Act 2.0 requires the IRA catch-up limit to be indexed to inflation.
Key Takeaway:
Beginning in 2025, individuals age 60, 61, 62, or 63 will be able to make larger catch-up contributions to their employer plans.
Excess 529 Education Account Funds to Roth IRA Transfer Available:
One of the interesting provisions included in the SECURE Act 2.0 is a provision that allows individuals to use funds in a 529 education account to make Roth IRA contributions. This option will be available starting in 2024 and has significant promise for families who have overfunded 529 accounts or have avoided making 529 contributions for fear they may over contribute.
This new rule will provide a tax efficient way to utilize any 529 funds that exceed the amounts used for education and may provide a planning opportunity for families to fund a 529 account with the idea that those funds can always be used to fund Roth IRA contributions in the future.
To avoid abuse of this provision, Congress has included multiple stipulations that must be followed to remain compliant.
- The contribution from the 529 account can only be made to a Roth IRA owned by the beneficiary of the 529 plan.
- The 529 account must have been maintained for 15 years as of the date of the contribution.
- The amount eligible to be contributed to the Roth IRA in a given year cannot exceed the portion of the 529 balance that can be traced to contributions made at least 5 years prior and any related earnings.
- Annual contributions to a Roth IRA are still subject to the Roth IRA contribution limit whether the contributions come from the 529 account or elsewhere.
- Lifetime contributions to a Roth IRA from a 529 plan are limited to $35,000 per beneficiary.
Given these restrictions, there are a few takeaways to consider. First, there is less risk to funding a 529 account for educational purposes now because there is an option to shift up to $35,000 of excess funds into retirement savings for the beneficiary without paying tax or penalty.
Second, it generally will make sense to set up the 529 account sooner rather than later and begin making contributions to start the 15-year clock for maintenance of the 529 account and the 5-year clock for contributions into the plan.
Third, as the law is currently written, contributions to the beneficiary’s Roth IRA from the 529 account are subject to the annual Roth IRA contribution threshold, but they are not subject to the income limitations for Roth IRA contributions. Accordingly, individuals with incomes that exceed the contribution limit can still receive Roth IRA contributions from their 529 account.
Therefore, the 529 to Roth IRA transfer rules may provide an opportunity for individuals with incomes that exceed the limit for direct Roth IRA contributions to avoid the income limits and ultimately contribute to a Roth IRA.
Key Takeaway:
The ability to use excess 529 account funds to make Roth IRA contributions for the beneficiary significantly reduces the risk of overfunding a 529 account.
Conclusion:
The SECURE Act 2.0, passed at the end of 2022, is another installment in the rapidly changing tax landscape that began with Trump Tax Reform at the end of 2017. With significant tax and retirement laws changing year by year, staying up to date on current rules is key for families who want to ensure they are prepared for the future.
Many of the changes in the SECURE Act 2.0 provide families with additional flexibility including pushing back RMD ages and allowing 529 account transfers to Roth IRAs, but some of the changes such as restricting catch-up contributions for high-wage taxpayers to Roth accounts will reduce options and may ultimately remove the option all together if the plan does not allow Roth catch-up contributions.
One thing the rapidly changing tax and retirement landscape has shown over the past 5 years is the importance of having a well-designed financial strategy for your future – one that contemplates current tax law and is also flexible to adapt to future legislation that may be passed.
If you are interested in meeting with one of our Family CFOs to learn more about how to create a financial plan for your future while adapting to new rules as they come, we would love to connect to see if what we do is right for you.
