401(k) Financial Planning Retirement Income Retirement Planning Taxes in Retirement Uncategorized

Secure act 2.0 relevant Changes

In the waning hours of 2022, Congress passed a $1.7 trillion omnibus spending bill. The Consolidated Appropriations Act of 2023 was introduced December 20th and just before Christmas this legislation was rushed through the senate and house of representatives, and finally signed into law by President Biden.

Inserted into the legislation was a host of retirement focused language that would further overhaul the American retirement system. The Secure Act 2.0 is an encore to legislation by the same name passed in 2019.

There are over 100 provisions included in the Secure Act 2.0, and many of them will not apply to the majority of folks reading this. However, a handful of notable provisions will impact the many folks that we serve in a significant way. I wanted to address the provisions that are most likely to be meaningful to many of you. What follows is a summary of the various provisions, and how they may impact your retirement plans.

Required Minimum Distribution Age Changed from 72 to 73 (and then 75 by 2035)

The Secure Act of 2019 changed the minimum age at which Required Minimum Distributions (RMDs) from retirement accounts were to begin from age 70 ½ to age 72. The Secure Act 2.0 further altered the beginning age of RMDs. Beginning in 2023 the age at which RMDs must begin is now 73. By 2033 that age will be bumped back to age 75.

As an interesting side note, no one will have their required beginning date occur in 2023. If you were already 72 in 2022, and required to begin taking distributions you would be 73 in 2023, and therefore must continue to take them. However, your beginning date did not start in 2023. On the other hand, if you turn 72 in 2023 you are not required to begin until 2024. Therefore, no one will have his or her required beginning date start in 2023.

Your Required Beginning Date by year of birth:

  • RMD Required Beginning Age
    • Age 70 ½ – Born June 30th 1949 or earlier
    • Age 72 – Born July 1st 1949 through and including December 31st 1950
    • Age 73 – Born Jan. 1st 1951 through and including December 31st 1959
    • Age 75 – Born Jan. 1st 1960 or later (folks age 63 or younger in 2023).

Delaying taking distributions (although allowed) may not be the right move. Delaying will likely result in pushing more pretax money further into retirement. Eventually it will be forced out at larger ratios (smaller RMD divisors) and could create a big tax problem for retirees with large pre-tax accounts. Systematic withdrawals, strategic partial Roth Conversions, and Qualified Charitable Distributions also known as QCDs (beginning at age 70 ½) may reduce the burden of future RMDs.

IRA Catchup Contributions to be Indexed for Inflation

Beginning at age 50 you are permitted to make catchup contributions to you traditional IRAs and Roth IRAs. The catch-up contribution limit has been set at $1,000 for many years. However, effective in 2024 inflation adjustments to the current $1,000 catch up contributions begin. Adjustments will be made in increments of $100 depending on the rate of inflation. I can only imagine these annual adjustments will be made public each fall when other inflation adjustments related to tax brackets and entitlement programs are announced.

New Rules Permitting Access to Pre-tax Accounts Prior to Age 59 ½ Without Penalty

Withdrawing money from your retirement accounts prematurely will generally result in a penalty. The government has established rules around retirement accounts to encourage them to be used for, well, retirement.  While there are several exceptions to the early withdrawal rule, they are quite restrictive, and specific. However, beginning in 2024 a new emergency withdrawal provision will permit someone to access up to $1,000 per year without a penalty.

Another provision will allow for distributions from pre-tax accounts to be made to pay qualified long term care premiums.  Beginning in 2026 retirement account owners will be allowed to withdrawal the lesser of 10% of their account value or $2,500 annually to pay for long term care insurance premiums. To qualify the owner must have paid or been assessed premiums equal to or greater than the distribution in the year the distribution was made. Qualified distributions may be made by the account owner for the account owner’s insurance premiums or the account owner’s spouse if they file jointly.

It is important to note that while penalties are waived for these new provisions, taxes are not! If you withdrawal money from your forever-taxed retirement accounts like IRAs and 401ks, and other IOUs to the IRS, you still have to pay taxes as ordinary income.

Never-Taxed Roth Options for SIMPLE and SEP IRAs

Beginning in 2023, and for the first time ever, Roth contributions will be permitted into SMPLE and SEP IRAs. Although individuals can technically begin making Roth SEP and SIMPLE IRA contributions beginning January 1st 2023, finding a custodian that is ready to open and administer such accounts is unlikely. Most have been caught off guard, and it will take months for them to make necessary changes to open these account types.

This change may seem more monumental than it actually is in practice. SEP IRA owners have long been able to convert SEP IRA contributions to a Roth IRA as soon as they are made. The same is true of SIMPLE IRA contributions as long as the SIMPLE IRA had been open for at least 2 years or more.

Being able to directly contribute to a ROTH SEP and ROTH SIMPLE may reduce administrative work previously necessary to effectuate the same outcome.

Rollovers From 529 Plans Into Roth IRAs

Beginning in 2024 rollovers from 529 plans to Roth IRAs will be allowed. Albeit with several nuanced rules about who can, when they can, how they can do it. For example, the Roth IRA must be in the name of the 529 beneficiary, and the it must have been maintained for at least 15 years.

Any contributions that have been made in the past 5 years and the earnings on those contributions are not eligible to be rolled over (enjoy the accounting on that one!).

The annual limit that can be rolled over is equal to the contribution limit to a Roth IRA for that year (example $6,500 in 2023), less any contributions that have already been made to a traditional or Roth IRA for the same year. The Roth IRA owner must have earned income at least equal to the amount of the rollover, and the lifetime maximum that could be rolled over from a 529 to a Roth IRA is limited to $35,000.

There appears to be no income limit restriction, however. Foreseeably high-income earners who may have been prohibited from making direct contributions to a Roth IRA could roll over 529 money so long as it has been maintained for at least 15 years.

There’s uncertainty as to whether changing the beneficiary of a 529 plan resets the 15-year rule and we expect to receive additional guidance from the government related to this caveat.

For example, a 529 maintained for 15 years in John’s name is rolled over each year to a maximum of $35,000. The remaining 529 balance is $20K. If the beneficiary is changed to his spouse Pam can she then rollover the remnants each year to her Roth IRA?

This question needs clarification at this point, but the language seems to indicate that there’s no resetting of the 15-year rule upon changing the beneficiary.

Employer Contributions Directed to Roth

Up until now employer contributions to workplace retirement plans, such as matching or non-elective contributions, were required to be directed to the pre-tax portion of the plan participant’s account. Beginning in 2023 if your employer sponsored retirement plan includes a designated Roth account you may direct employer contributions to it.

Such amounts must be included in the employee’s income for the year of the contribution and be nonforfeitable. Therefore, we may see employers with vesting schedules likely choose to only permit this election of Roth employer contributions for employees who have already met the vesting schedule.

New Class of Retirement Plan Catchup Contributors

An additional class of catch-up contributions cohorts will be created beginning in 2025. This will allow folks ages 60 thru 63 to make an additional $10,000 catch-up contributions to workplace retirement plans on top of the inflation adjusted catch-up contributions that already exist. This special carveout is intended to help late starters get back on the retirement-savings track. Beginning in 2025 participants who are age 60, 61, 62, or 63 will be permitted to make catch up contributions to the greater of $10,000 or 150% of regular catch-up contributions adjusted for inflation.

Similar catch-up rules will apply to SIMPLE IRAs. The limit will be $5,000 or 150% of regular catch-up contributions for the same cohort 60-63 year olds.

Higher Wage Earners Required to Use the Designated Roth Account for Catch-Up Contributions

Beginning in 2024 certain highly compensated employees will be required to use the Roth Option if they choose to make catch up contributions to their workplace sponsored retirement plans. If an eligible participant’s wages for the preceding year exceeded $145,000 (adjusted for inflation each year) the participant is not permitted to direct contributions to the tax-deferred portion of the plan.

The government wants its tax money now, not later. Forcing “highly compensated” employees who are making catch up contributions to their workplace plans do so in the designated Roth account will result in contributed income to be recognized as taxable income for the year it is contributed.

Interestingly, the language of the Secure Act 2.0 specifies that if the “preceding years income from the sponsoring employer” exceeds $145,000 then the Roth Option must be utilized. Therefore, if an employee changed jobs mid-year, and the current employers preceding years wages was less than $145,000 the Roth Option for catch up contributions would not be required even if the combined total income from the previous employer and current employer in the preceding year was greater than $145,000.

This provision applies to 401Ks, 403Bs, and Governmental 457 plans. It does not affect catch up contributions to IRAs and SIMPLE IRAs.

Employer plans can offer a designated Roth account option but they are not required to do so. However, the Secure Act 2.0 specifies that if no Roth Option exists, and the highly compensated wage earner is unable to make catch-up contributions as a result – no one is allowed to make catch up contributions regardless of whether their preceding years wages was below the $145,000 threshold!

This provision will likely force many plan sponsors (AKA: employers) who have yet to add a Roth Option to their plan document to do so moving forward. 

New Death Benefit Options for a Surviving Spouse of a Retirement Plan or IRA

Beginning in 2024 the surviving spouse may now elect to be treated as the deceased spouse. While this may seem like an odd thing to do, it may be beneficial in certain instances. For example, say an older spouse who has reached her beginning RMD age is the beneficiary of her younger spouse who has not reached his beginning RMD age. The younger spouse passes and the older surviving spouse elects to be treated as the deceased spouse. RMDs would be based on age of the deceased spouse who had not yet reached his beginning required age. Therefore, RMDs would not begin until the deceased spouse would have reached his required beginning age. The older surviving spouses might benefit from this provision in this case.

Here’s another more detailed example. Say 75-year-old survivor who inherits an IRA from his 71-year-old deceased spouse. The deceased spouse would not have to begin taking RMDs until age 73, or 2025, at which time the older surviving spouse would have been 77.

If the surviving spouse passed prior to the date at which the deceased spouse would have begun distributions, then the beneficiaries of the now-deceased surviving spouse will be treated as if they were the original beneficiaries of the deceased spouse (including allowing an Eligible Designated Beneficiary – like a second marriage spouse) to stretch the IRA instead being subject to the 10-year rule

No More RMDS for Plan Roth Accounts (401ks, 403Bs, 457s, etc.)

Currently the are no RMDs for Roth IRAs throughout the lifetime of the owner. However, owners of Designated Roth Accounts (DRAs) within an employer sponsored retirement plans such as Roth 401Ks, Roth 403bs, Roth 457s and Roth Thrift Savings plans are required to make distributions during the lifetime of the owner.

Beginning in 2024 DRAs in retirement plans will no longer be subject to RMDs during the life of the owner. If a retirement plan participant is already being forced to take RMDs from a DRA they will be able to stop in 2024. 

Reduction in Penalty for Missed RMDs

Effective in 2023 the penalty for a missed RMD will be reduced from 50% of the missed RMD to 25%. However, if the RMD shortfall is rectified within the correction window the penalty is further reduced to 10%.

This change does not prevent an IRA owner from requesting the penalty to be waived altogether. However, it may incentivize some folks to pay the lesser penalty rather than go through the hassle of making the written request to the IRS and filing the proper form 5329. 

Qualified Longevity Annuity Contracts (QLACs) Limits Increased

Qualified Longevity Annuity Contracts (QLACs) are special annuity contracts funded with pre-tax money, such as an IRA. They are generally designed to protect against outliving your income, and payments often don’t begin until much later in retirement. For example many QLACs don’t begin distributing income until the owner is in her late 70’s or early 80s.

The pre-tax money used to fund a QLAC would generally have been subject to required minimum distributions or RMDs, but when used to fund a QLAC they are exempted.

Beginning in 2023 the 25% of account balance limitation is repealed, and maximum amount that can be purchased is increased from $145,000 to $200,000.

New Rules for Qualified Charitable Distributions (QCDs).

Qualified Charitable Distributions or QCDs allow folks to make direct contributions to a qualified charitable organization using pre-tax money like an IRA.

Generally, any distribution made from a pre-tax account would result in the total distribution being added to the taxable income of that person for the year the distribution was made. This can drive up income, and result in a higher effective tax rate. QCDs however allow someone to bypass the taxable distribution altogether, and give to an organization they are passionate about.

QCDs are permitted to begin at age 70 ½, and can be a great tax planning tool. However, the maximum QCD amount has been limited to $100,000 since the introduction in 2006. Beginning in 2024 however annual QCD limits will be indexed for inflation.

A Massive Piece of Legislation

As you can see, this is sweeping tax legislation. It was passed in the 11th hour of a lame duck congress tucked inside a massive spending bill. Many provisions take effect in 2023. Yet many others will not take effect for years to come.

Although we’ve only addressed a handful of the provision of the Secure Act 2.0 most will be irrelevant to the majority of the folks we serve. However, we think the provisions that we have laid out in this article are most likely to impact the folks that we serve, and are therefore worth keeping an eye on.

If you have questions about the provisions we addressed in this article, and you want to discuss how it might impact your retirement plans please contact our office to schedule a visit.