The SECURE Act 2.0 – What Does It Mean for You?
Written By: Harmony Wagner, CFP®
Congress passed the SECURE (Setting Every Community Up for Retirement Enhancement) Act 2.0 the last week of December, and with it came many changes for retirees and those saving for retirement. With over 4,000 pages, the bill is a significant one, addressing topics such as Required Minimum Distributions (RMDs), 401(k) plans, Roth retirement savings, and 529s, to name just a few. In total, there are approximately 100 changes enacted by the bill, and although none of them are quite as impactful as some of the headline changes from the original SECURE Act in 2019, there are some that will have an immediate effect on retirees and employees saving for retirement. With any major legislation, it can be difficult to sort through the noise to determine which changes are the most important and relevant to you. This article will help to break down some of the key changes that are expected to have the broadest effects.
Required Minimum Distribution (RMD)
The SECURE Act 2.0 has once again pushed back the age at which IRA or 401(k) account owners are required to begin drawing down their retirement account balances. Previously, individuals were required to begin annual distributions in the year they turned age 72. Going forward, people born in 1951 through 1959 will not be required to take minimum distributions until they reach age 73. People born after 1959 will be allowed to delay distributions even further until age 75. At first glance, the extended RMD age may seem to be a straightforward benefit to IRA owners; however, this change does have some strategic implications beneath the surface. If an IRA owner delays taking distributions until they are required by law, the number of tax years available to distribute assets is fewer and the account holder is likely to have a larger account balance at the end of their life than if distributions started earlier. This account will pass on to their beneficiaries, who (if not a spouse) must fully distribute the assets with 10 years, leaving little time to strategize from a tax perspective. For this reason, it may behoove IRA owners to take some level of distribution in the years before they reach RMD age to take advantage of lower tax brackets and optimize taxes over their life and the lives of their beneficiaries.
Another legislative change, which is to the taxpayers’ benefit, is a reduction in the penalty for missed RMDs. The deadline for first time RMD-takers is April 1st following the year in which they reach RMD age; so someone who turned 72 in 2022 (the last year in which the RMD age was 72) has until April 1st, 2023 to calculate and take their first RMD. However, that deadline extension only applies in the first year of RMD eligibility; for every subsequent year, the IRA owner is required to take their distribution by December 31st to satisfy the requirement. For anyone who fails the take the full amount of their RMD before the deadline, they will now be subject to a penalty equal to 25% of the amount they failed to take, a reduction from 50%. In addition, if the IRA owner realizes their mistake and takes their full RMD amount within a correction window, the penalty will be only 10% of the shortfall. The correction window will end at the earliest of the following:
- A Notice of Deficiency is mailed to the taxpayer
- The tax is assessed by the IRS
- The last day of the second year after the tax was imposed
Even at a reduced level of 25% or 10%, the penalty is still significant, and care should be taken to ensure that the full RMD is taken prior to the corresponding deadline.
401(k) Plan Changes
The new legislation makes several changes to the way 401(k) plans function as well.
- Beginning in 2025, for individuals turning 60, 61, 62, or 63, they are eligible to make additional catch-up contributions to their 401(k) equal to $10,000 or 150% of the regular catch-up available to employees over 50, whichever is greater. This language is a little confusing since 150% of the current catch-up of $7,000 is already greater than $10,000. It also only benefits people aged 60-63, so those 64 or older who are still working will not be able to take advantage of as significant of a catch-up contribution as their younger counterparts can. Regardless of the oddities in this section of the bill, one thing is clear: savers will be able to put away some significant sums of money in their early 60s.
- Starting in 2024, employers may now offer matching 401(k) contributions for employees who are making student loan payments and may not be able to contribute enough to their 401(k) plans to take advantage of the employer match. The vesting and matching rules must apply to student loan payments in the same manner as if the payments were employee deferrals into the 401(k) plan.
- Beginning in 2025, 401(k) plans must adopt an auto-enrollment plan where newly eligible participants will be automatically enrolled at a contribution rate equal to 3% of their compensation, which will increase annually by 1% until it reaches a range of at least 10% but no more than 15%. A participant will have to take action to opt out of the automatic contributions, which will likely lead to more . There are numerous exceptions to this rule, including plans that were established prior to the enactment of the law, church & governmental plans, and employers with less than 10 employees.
Roth retirement accounts allow retirement savers to contribute after-tax dollars to a retirement account and enjoy tax-free growth on the earnings and distributions. Roth IRAs and Roth 401(k)s had been the primary vehicles for this type of retirement savings, but the new bill now allows Roth SIMPLE IRA and Roth SEP IRA accounts. This section of the legislation went into effect immediately; however, financial institutions and custodians are now tasked with the administrative burden of supporting these types of accounts so it may take some time before savers can actually open and fund Roth SIMPLEs or Roth SEPs.
Another Roth-related change is that the retirement plan catch-up contribution for employees earning greater than $145K annually must be Roth contributions, meaning that the employee will not receive a current-year tax deduction for those contributions.
529 to Roth Conversion
People often want to save money for their children or grandchildren’s future, but many families worry about saving into a 529 plan, which must be used for qualified education expenses, out of concern that this account may be too restrictive and the funds may go unused. There are a few existing strategies to avoid that potential pitfall of unused 529 assets (especially in the case of a beneficiary who does not attend private school, college or trade school), and the SECURE Act 2.0 introduced an additional way to use 529 assets for non-education expenses.
The new legislation allows 529 assets to be converted to a Roth IRA in the name of the beneficiary on the original 529 account. Everyone will be allowed to move up to $35,000 of 529 assets to a Roth in their lifetime. To take advantage of this strategy, the 529 account must have been open for a minimum of 15 years, and any assets added to it within the last 5 years are ineligible for conversion. There is currently language requiring that the beneficiary of such a conversion have earned income as well, similar to the requirements for contributing directly to a Roth IRA. This strategy will not be allowed until 2024 and does have some restrictions on how it can be used, but can be an excellent strategy for the right situation.
It is likely that further guidance will need to be provided to explain some of the questions that are unanswered in the bill regarding this provision, such as whether a beneficiary can be changed without resetting the 15-year requirement. While there are still some grey areas to be addressed, this strategy has the potential to ease the worries of parents and grandparents who are concerned about the potential of 529 assets remaining unused.
There can still be some situations where it might be beneficial to leave unused assets in a 529 plan for future generations. Since there is no requirements to move assets from a 529 plan when they transfer to heirs, they can be a great tool to fund educational expenses for future generations.
What the Bill Does Not Cover
One item that SECURE Act 2.0 did not address is the question of whether annual required minimum distributions will be required for Inherited IRA account owners who are currently under the 10-Year distribution rule. Prior to the original SECURE Act, non-spouse beneficiaries of traditional IRA were allowed to stretch their Inherited RMDs over their own life expectancy. The SECURE Act eliminated that stretch provision and required all non-spouse IRA beneficiaries to fully distribute inherited IRA accounts by the end of Year 10 after the decedent’s passing. The big outstanding question for the Inherited IRA owners now is whether they will also be required to take annual RMDs, in addition to taking a full distribution in or before Year 10. Unfortunately, SECURE Act 2.0 did not give any ruling on whether or not annual RMDs will be required for these types of accounts, so inherited IRA owners will have to wait for a future decision to be made in this area.
Nearly every major change outlined in the SECURE Act 2.0 has a positive strategic impact for present and future retirees since most changes are less restrictive than the previous statutes. Despite the generally positive nature of the legislative changes, it is still prudent to speak with a trusted advisor to determine the potential impact on individual situations, since there may be some significant financial planning opportunities now available. While this article explained some of the changes that are expected to have the broadest effects, there are many other provisions that may apply to you. If you have questions about the legislative changes in the SECURE Act 2.0 and how they may affect your situation, please reach out to our advisory team.
Bouchey Financial Group has local offices in Historic Downtown Troy and Saratoga Springs, NY.