Secure Act 2.0 Updates of Note
When I read a long, complicated (but super helpful article) written by a well-known financial planning tax expert (Jeffrey Levine), I pull out the blurbs which I think I’m going to need to use and save them in Microsoft OneNote. This week, I thought I'd share what I pulled from Jeffrey Levine's article summarizing the SECURE Act 2.0 Updates - because I'm guessing you'll start to hear about these changes soon.
To read the full article, follow this link: SECURE Act 2.0: Later RMDs, 529-to-Roth Rollovers, And Other Tax Planning Opportunities
Summary headline from Jeffrey Levine: "The SECURE Act 2.0 does not include any provisions that restrict or eliminate existing Roth strategies. To the contrary, the changes highlight Congress’s continued march toward ‘Rothification’, perhaps in an effort to grab tax revenue now in order to make Federal budget estimates look better (or at least less bad)."
REQUIRED MINIMUM DISTRIBUTION AGES ARE PUSHED BACK
Currently, retirees have to start pulling money from qualified retirement accounts (accounts which were funded with tax deductible contributions, and have been growing tax-free), so the government can start to collect taxes on those retirement savings. These distributions are called "Required Minimum Distributions" (RMDs).
One of the major headline changes from the original SECURE Act was raising the age for RMDs from 70 ½ to 72, and SECURE 2.0 pushes this out further to age 73 for individuals born between 1951 and 1959 and age 75 for those born in 1960 or later. In addition, the bill decreases the penalty for missed RMDs (or distributing too little) from 50% to 25% of the shortfall, and if the mistake is corrected in a timely manner, the penalty is reduced to 10%.
Note: The changes to the RMD age made by SECURE Act 2.0 do not impact the age at which Qualified Charitable Distributions (QCDs) can be made. Individuals can still make QCDs starting at age 70 ½. (A qualified charitable distribution (QCD) is a distribution from your individual retirement account (IRA) to a qualified charity. A qualified charitable distribution is not taxed, nor is it included in your taxable income. You can’t deduct a QCD from your taxes, but the savings on your income may still make this kind of donation a tax-savvy move. A qualified charitable distribution counts toward your required minimum distributions (RMDs).)
ELIMINATION OF RMDS FOR PLAN ROTH ACCOUNTS
Effective in 2024, Sec. 325 of SECURE Act 2.0 eliminates RMDs for Roth accounts in qualified employer plans beginning in 2024. (This makes sense because the government wasn't collecting taxes on those distributions to retirees anyway!) Currently, while independent Roth IRAs are not subject to RMDs during the owner’s lifetime, employer plan Roth accounts, such as Roth 401(k) plans, Roth 403(b) plans, governmental Roth 457(b) plans, and the Roth component of the Federal Thrift Savings Plan, are subject to the regular RMD rules, making them subject to RMDs beginning at age 72 (although such distributions are tax-free per the standard rules for Roth account withdrawals).
ADDITIONAL EMPLOYER CONTRIBUTIONS ELIGIBLE FOR ROTH TREATMENT
Section 604 of SECURE Act 2.0 continues the theme of expanding available options for getting money into Roth accounts. More specifically, effective upon enactment, employers will be permitted to deposit matching and/or nonelective contributions to employees’ designated Roth accounts (e.g., Roth accounts in 401(k) and 403(b) plans). Such amounts will be included in the employee’s income in the year of contribution, and must be nonforfeitable (i.e., not subject to a vesting schedule).
CREATION OF NEW EMERGENCY WITHDRAWAL EXCEPTION
Section 115 of SECURE Act 2.0 authorizes “Emergency Withdrawals” from retirement accounts, beginning in 2024. Such distributions will be exempt from the 10% penalty and may be taken by any taxpayer who experiences “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”
That is an extraordinarily broad definition, to the point where Congress almost seems resigned to let just about anything fly as long as it’s within reason (although distributions for an “emergency bachelorette party” probably still won’t qualify). That’s the good news. The bad news is that (perhaps owing to its near-all-encompassing definition), Congress chose to limit individuals to no more than 1 such distribution per calendar year and to cap such distributions at a maximum of $1,000.
In addition to the $1,000 annual maximum Emergency Withdrawal limit, plans will also be prohibited from allowing participants to take any subsequent Emergency Withdrawals until the earlier of the following:
The prior distributions have been fully repaid;
‘Regular’ deferrals and other employee contributions made to the plan since the Emergency Withdrawal total at least as much as the amount of the distribution; or
3 years have passed since the previous Emergency Withdrawal.
Ultimately, many people may qualify to take such a distribution at some point during their lives, but the extremely limited dollar amount that is accessible via the new exception will mean that many individuals will likely still need to seek secondary exceptions to try and avoid the 10% early distribution penalty on all necessary distributions.
CREATION OF A NEW EXCEPTION FOR QUALIFIED LONG-TERM CARE DISTRIBUTIONS
Beginning in 2026, Section 334 of SECURE Act 2.0 allows retirement account owners to take penalty-free “Qualified Long-Term Care Distributions” of up to the lesser of 10% of their vested balance, or $2,500 (adjusted for inflation) annually to pay for long-term care insurance.
CREATION OF LINKED EMERGENCY SAVINGS ACCOUNTS
Beyond the significantly expanded ability to access retirement funds prior to age 59 ½ without incurring a 10% penalty (as described in detail above), to further help individuals save for unanticipated expenses at any age, effective in 2024, Section 127 of SECURE Act 2.0 creates a new type of “Emergency Savings Account”. Such accounts will not be available as standalone individual accounts, but rather, they will be linked to existing employer retirement plans with individual balances, such as 401(k) and 403(b) plan accounts.
Notably, only employees who are otherwise eligible to participate in the sponsoring employer’s retirement plan and who are not “highly-compensated” employees (i.e., they do not own more than a 5% interest in the business, they did not receive more than $135,000 in compensation in the previous year [for 2023], or they are not in the top 20% of compensation at the employer) may contribute to such accounts. Furthermore, for those employees who are eligible to participate in the new Emergency Savings Accounts, contributions must cease once the balance in the account attributable to contributions (i.e., ignoring any interest earned in the account) reaches $2,500. Employers, however, may impose lower maximum limits at their discretion.
(LIMITED) 529-TO-ROTH IRA TRANSFERS ALLOWED AFTER 15 YEARS
One of the provisions of SECURE Act 2.0 that has grabbed a disproportionate percentage of headlines in financial media is the introduction of the ability, beginning in 2024, for some individuals to move 529 plan money directly into a Roth IRA. This new transfer pathway, created by Section 126 of SECURE Act 2.0, will be an intriguing option for some individuals, but it also comes with a number of conditions that must be satisfied for the transfer to be valid and that limit the ability to take advantage of (or abuse) the provision. The conditions include:
The Roth IRA receiving the funds must be in the name of the beneficiary of the 529 plan;
The 529 plan must have been maintained for 15 years or longer;
Any contributions to the 529 plan within the last 5 years (and the earnings on those contributions) are ineligible to be moved to a Roth IRA;
The annual limit for how much can be moved from a 529 plan to a Roth IRA is the IRA contribution limit for the year, less any 'regular' traditional IRA or Roth IRA contributions that are made for the year (in other words, no doubling up with funds from outside the 529 plan); and
The maximum amount that can be moved from a 529 plan to a Roth IRA during an individual’s lifetime is $35,000.
MISCELLANEOUS ITEMS FOR SMALL BUSINESS' OR THE SELF-EMPLOYED (SOLE PROPRIETORS)
Effective for plan years beginning after the date of enactment, Section 317 of SECURE 2.0 now takes that ability one step further by allowing sole proprietors, as well as those businesses treated as such under Federal law for income-tax purposes (e.g., Single Member LLCs), to establish and fund solo-401(k) plans with deferrals for a previous tax year, up to the due date of the individual’s tax return (although notably without extensions).
Effective for plan years beginning in 2024, employers will be able to amend their plans to allow employer matches for amounts paid by participants towards their student debt. Vesting and matching schedules must be the same as if the loan payments had been salary deferrals. Expect to see a lot of employers adopting this provision into their plan in an effort to attract and retain young talent.
Beginning in 2025, many new 401(k) and 403(b) plans will be required to include auto-enrollment. The list of exempt employers, however, is long and includes employers less than 3 years old, church plans, governmental plans, SIMPLE plans, and employers with 10 or fewer employees.
Effective next year (2023), for employers with 50 or fewer employees, the retirement plan start-up credit will now be allowed for up to 100% of plan start-up costs (subject to existing overall limits), up from the previous limit of 50%. In addition, such employers will be eligible for an additional credit attributable to employer contributions to DC plans made during the first 4 years. Retroactive to 2020, employers without an existing retirement plan who join(ed) an existing Multiple Employer Plan (MEP) are eligible for the retirement plan start-up credit.
Effective next year (2023), employers who offer non-highly-compensated military spouses special plan benefits (e.g., participation within 2 months of hiring or immediate vesting of employer contributions) are eligible for an additional credit of up to $500 for each military spouse, for up to 3 years per spouse.
Sec. 601 of SECURE Act 2.0 authorizes the creation of both SIMPLE Roth accounts, as well as SEP Roth IRAs, for 2023 and beyond. Previously, SIMPLE and SEP plans could only include pre-tax funds. This is great for the self-employed or for small business owners.
Effective next year, taxpayers can create a SEP IRA plan for household employees. So, you know, if a client is struggling to land that nanny or cleaning person they really want away from the ‘other guy’, they can now offer their own retirement plan for them!
Beginning in 2024, a new type of employer-sponsored retirement plan, known as a “Starter 401(k)” plan will be available. Yes, that’s right, yet another plan option for small business owners to consider. Such plans will require auto-enrollment (unless the employee opts out), allow for only employee deferrals (with no employer match), and limit deferrals to no more than the IRA contribution limit at the time.
SECURE Act 2.0 contains no provisions that:
Limit the use of the Back-Door Roth or Mega-Back-Door Roth contributions;
Place new limits on who can make Roth conversions;
Create non-age-based RMDs (e.g., require balances in excess of a specified amount to be distributed);
Change the age at which QCDs can be made (as it continues to be age 70 ½);
Implement new restrictions on Qualified Small Business Stock (QSBS);
Eliminate new types of investments (e.g., privately held investments) from being eligible to be purchased with IRA money; or
Correct or clarify the manner in which the 10-Year Rule created by the original SECURE Act should be implemented for Non-Eligible Designated Beneficiaries.
Finally, perhaps most noteworthy of all, there is absolutely nothing in SECURE Act 2.0 that provides any sort of simplification of the rules surrounding retirement accounts. Taxpayers are all but guaranteed to continue to have a nearly endless stream of questions with respect to this complicated area. Accordingly, advisors who exhibit a strong command over such rules, including the many changes made by SECURE Act 2.0, will be best positioned to guide individuals in the years to come and to win the lion’s share of new retirement-related business.