The passage of the original Secure Act in December 2019 brought many retirement plan changes, most notably moving the required minimum distribution age from 70.5 to 72 and eliminating the “stretch IRA” for most non-spouse IRA beneficiaries.
Nearly three years to the day, Secure ACT 2.0 was passed. Here are the most notable highlights and their impact.
Required Minimum Distribution (RMD) Ages Pushed Back Again
The required minimum distribution age of 70.5 existed from 1986 through 2019 with the passage of the original Secure Act in 2019, which moved the RMD age to a nice and tidy 72.
With the passage of Secure Act 2.0, the RMD age moves back to age 73 for those who turn 72 after December 31, 2022, and age 73 before January 1, 2033, the required beginning calendar date for commencing RMD is the year in which the individual turns 73.
So, for those individuals who turn 72 in 2023, their RMD is pushed back to their age 73; thus, skipping this, the initial year in which their RMD would have been required.
In addition, for those individuals who turn 75 after December 31, 2033, their RMD age will be 75.
First, and perhaps most importantly, so-called “backdoor Roth IRA” contributions were not changed, and still one of the best mechanisms for higher earners to save an additional $6,500 for those under the age of 50 and $7,500 for those turning 50 in 2023.
In addition, there remains no upper-income limit on making Roth conversions; given the advancement of tax payments when converting traditional to Roth IRA, it seems unlikely that Congress will ever reinstall an income limit for converting to Roth.
Required Minimum Distribution Changes from Roth 401(k) Plans
Roth IRA and employer Roth 401(k) plan distribution rules have not been perfectly aligned. Secure 2.0 eliminates required minimum distributions on employer Roth 401(k) plans beginning in 2024. The easy workaround was always to roll over Roth 401(k) monies to a Roth IRA, which does not require minimum distributions.
Creation of Roth SIMPLE & SEP
Secure Act 2.0 also opens the door to Roth SIMPLE and SEP IRA contributions, which were unavailable before the Act. While this may seem like a nice new feature of small employer plans, ultimately, Individual/Solo Roth 401(k) plans have existed for several years with higher contribution limits and few regulatory reporting requirements. As with anything, the new Roth SIMPLE and SEP IRA provisions may present planning opportunities for specific individuals.
Secure Act 2.0 permits employers to make non-elective and matching Roth contributions on behalf of the employer. While this sounds great and is an additional planning opportunity, such employer Roth contributions will be taxable to the employee. While this is a nice feature, it will create additional tax planning complexity. From the employer’s perspective, Roth contributions will still be a deductible expense, so there is no change.
Employer Catch-Up Contributions
Beginning in 2024, high-income taxpayers earning over $145,000 in the preceding year and making elective employer plan “catch-up” contributions in 401(k)s, 403(b)s, and governmental 457(b) plans require the “Rothification” of that catch-up contribution and disallows the pre-tax nature currently in existence. Effectively, the Act forces income on those earning above the threshold in 2024 and making catch-up contributions. The 2023 calendar year employer plan catch-up contribution limit is $7,500 for those over age 50, with the base deferral maximum for those under age 50 at $22,500.
The Act alleviates the “Rothification” of catch-up contributions for those employer plans that do not offer Roth deferrals.
High-income earners changing employment mid-year may present planning opportunities to defer catch-up contributions as pre-tax.
The Roth restriction on catch-up contributions applies to those who have wages. It thus would not apply to self-employed individuals such as sole proprietors and partnerships whose income from self-employment is higher than $145,000.
529 Transfers to Roth IRAs
Secure Act 2.0 includes the ability to move 529 plan money directly into a Roth IRA. While this sounds like an exciting option for some, many hurdles must be met when this provision begins in 2024 – they are as follows:
- There is a lifetime transfer limit per individual of $35,000.
- The annual limit of how much is “rollable” to a Roth is the annual maximum ($6,500 for 2023 for those under age 50) and less any other traditional or Roth IRA contributions. Said plainly, you can’t transfer $6,500 from a 529 into a Roth IRA and make a direct contribution in the same amount.
- The 529 plan must have been maintained for 15 years or more, and the funds being rolled into the Roth IRA must match the 529 beneficiary. It’s unclear if the plan inception rule of 15 years and like beneficiary rule test must coincide and be the same 15-year period. As with many families with multiple children, beneficiaries often change as one of the key attractive features of 529 plans in the first place.
- Contributions to the 529 plan within the last five years are not eligible for the new provision. If you’re a parent interested in this new but not fully clear planning technique, you would open the 529 plan for your child by age 3 or 4, depending on their projected age of college entry, and front-load the plan. Front-loading is always desired from a time value perspective; this would add further emphasis to a 529 funding strategy.
- Lastly, income limits for making direct Roth IRA contributions would not apply. For example, suppose your 529 plan beneficiary is earning above the current Roth income contribution phaseout limits for 2023 of $138,000 for single filers and $218,000 for a married couple filing jointly. In that case, the new 529 transfer provisions beginning in 2024 to a Roth IRA are not applicable.
While this provision will be sure to grab headlines and become click-bait for purveyors of broker-sold 529 plans and financial products, it’s not the panacea of wealth transfer it may appear on the surface. The provision may have some attractiveness for grandparents with excess wealth and gifting intent to grandchildren.
Surviving Spouse Beneficiaries
New, more favorable provisions for surviving spouses who inherit a deceased spouse’s IRA will allow the surviving spouse to delay required minimum distributions (RMDs) until the deceased spouse would have been required to commence RMDs. This new provision will be most favorable to a surviving spouse who is/was older than the deceased spouse.
In addition, once RMDs become necessary, the surviving spouse can use the more favorable Uniform Life Table versus the Single Life Table. The Uniform Life Table effectively slows the rate of mandatory distribution and, ultimately, taxation. Finally, of course, a surviving older spouse may want to take the IRA as their own if there is a goal of charitable intent and the use of QCD (see below) is optimal based on the client’s planning goals.
IRA & Employer Plan Catch-Up Contributions
IRA catch-up contributions have been a flat $1,000 since the Pension Protection Act of 2006. Secure Act 2.0 will begin indexing the $1,000 catch-up in increments of $100 starting in 2024. While the Act has simplified several items noted herein, this is one of those where Congress has complicated catch-up contributions.
Also, beginning in 2024, for employer plan participants in 401(k)s, 403(b)s, 457(b)s, SEP IRAs, and SIMPLE IRAs between the ages of 60 and 63, Secure Act 2.0 language indicates catch-up contribution amounts can increase to the “greater of $10,000 or 150%.” I.e., for 2023, this would create a 401(k) catch-up threshold of $11,250, or $7,500 x 150%. It’s unclear if $10,000 will be the cap or 150%.
Qualified Charitable Distributions (QCDs)
Since the inception of the QCD provision in the Pension Protection Act of 2006, the maximum annual limit allowing account owners ages 70.5 and older of traditional pre-tax IRAs to gift directly to 501(c)(3) charities has remained at $100,000. Beginning in 2024, the $100,000 annual limit will be indexed for inflation. QCD is the most tax-effective way for most individuals to give gifts to charity, especially tax filers who are in the 15% marginal bracket or higher. QCDs must be gifted directly from the retirement account to the charity to qualify as a QCD.
Other Notable Provisions
- Missed Required Minimum Distribution (RMD) Penalty – reduces the penalty for a missed RMD from 50% to 25% and 10% if corrective action is taken between January 1st and December 31st of the year following the missed RMD. Notably, individuals have always had the ability (and will continue) to file IRS Form 5329 disclosing the missed RMD along with a letter of explanation requesting the penalty be waived.
- Qualified Disaster Recovery Distributions – makes permanent and retroactive to on or after January 26, 2021, the ability to withdraw up to $22,000 penalty free (not tax-free) within 180 days of the disaster. The withdrawal can be spread over three years for tax purposes.
- Qualified Long-Term Care Insurance Premium Distributions – beginning in 2026, retirement account owners can withdraw up to $2,500 for qualified long-term care insurance premiums if the withdrawal and long-term care premium are assessed and withdrawn in the same calendar year. In addition, this new provision will allow the penalty-free distribution from one spouse’s IRA to render payment for the other spouse’s long-term care premium.
- Governmental 457(b) Elective Deferrals – effective in 2023, participants in these plans can change their deferral percentage at any time versus at the first of the month under the old provision.
If you would like to discuss anything covered herein or something you’ve heard regrading Secure Acct 2.0, please be in touch by clicking this link and scheduling a Quick Connect meeting.
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