By Echo Huang, CFP
The Setting Every Community Up for Retirement Enhancement (SECURE) Act, passed in December 2019, brought significant changes to the retirement planning landscape. These changes included the elimination of the 'stretch' IRA, an increase in the age for required minimum distributions (RMDs) to 72, and provisions designed to encourage greater participation in workplace retirement plans. In December 2022, Congress passed the SECURE 2.0 Act, which brings even more impactful changes to retirement planning than the original SECURE Act.
- The age for required minimum distributions has been raised from 72 to 75. Individuals born in 1950 or earlier will not be affected by this change as they have already reached age 72. Those born between 1951 and 1958 will have to begin RMDs at age 73, while those born in 1959 or later will have to start RMDs at age 75. Starting on January 1, 2023, the age to begin taking RMDs will increase from 72 to 73. If you turned 72 in 2022 or earlier, you will need to continue taking RMDs as scheduled.
If you are turning 72 in 2023 and have already planned your withdrawal, you may want to update your withdrawal plan. You have the option to take your RMD either by December 31, 2024, or delay it until no later than April 1, 2025. If you decide to delay your first RMD until April 1, 2025, you will have to take two RMDs in one tax year: your first RMD by April 1, 2025, which satisfies the RMD for 2024, and your second RMD by December 31, 2025, which satisfies the RMD for 2025. It is important to consult with your tax advisor to consider your other income for both years to avoid moving into a higher tax bracket due to the two RMDs in one year.
To calculate your RMD, divide your year-end account balance from the previous year by the IRS life expectancy factor based on your birthday in the current year. If you own multiple Individual Retirement Accounts (IRAs), you must calculate the RMD for each account, but you can take the total RMD from one IRA or any combination of IRAs. Retirees who own 401(k) balances at age 73 in 2023 are also subject to RMDs on those accounts. However, if you own multiple 401(k)s, you must calculate and take the RMD for each 401(k) account separately. You have until April 1 of the following year (in this case, 2024) to take your first RMD."
- The bill reduces the penalty for missed required minimum distributions or distributing too little from 50% to 25% of the shortfall. If the account holder withdraws the RMD amount that was previously not taken and submits a corrected tax return on time, the penalty is further reduced to 10%. It is good to see that the most severe penalty in the tax code is being reduced.
- The SECURE 2.0 bill increases the catch-up contribution limit for individuals 50 years or older who are able to make catch-up contributions to their retirement plans up to certain limits. Beginning in 2025, the catch-up contribution limit will increase to the greater of $10,000 or 50% more than the regular catch-up amount for individuals aged 60, 61, 62, or 63. The catch-up contribution amount for individuals aged 50 and older in 2023 is currently $7,500. These amounts will be indexed for inflation after 2025.
If you earned more than $145,000 in the previous calendar year, all catch-up contributions made at age 50 or older must be made to a Roth account in after-tax dollars. Individuals earning $145,000 or less, adjusted for inflation going forward, are exempt from this Roth requirement. Beginning in 2024, catch-up contributions to an IRA will be subject to cost-of-living adjustments (COLAs) and will increase with inflation from the current $1,000 limit.
- Starting in 2024, there will no longer be required minimum distributions for Roth 401(k)s and 403(b)s. Employers will be able to offer their employees the option of receiving matching contributions to Roth accounts, but it may take time for plan providers to offer this option and for payroll systems to be updated. Contributions to a Roth retirement plan are made on an after-tax basis, and the earnings on these contributions can grow tax-free.
Before the SECURE 2.0 bill, for those who own Roth 401(k)s, there was a simple solution for avoiding RMDs: roll the money into a Roth IRA, which has no RMDs for the original owner. If you are age 59.5 or older and have owned at least one Roth IRA for at least five years, the money rolled over to the Roth IRA can be withdrawn tax-free. The SECURE 2.0 bill eliminates the need to roll over funds from a Roth 401(k) to a Roth IRA. Instead, like Roth IRAs, Roth 401(k) accounts will not be subject to the RMD rules before the account holder dies (post-death minimum distribution rules, which also apply to Roth IRAs, still apply). Converting IRA money to a Roth IRA is a good strategy to start early, and you can spread out the conversion tax bill by converting small amounts over a number of years before you reach the age for RMDs.
If you are unable to reduce your required minimum distribution, you may be able to reduce the tax bill on the RMD by making and keeping track of nondeductible contributions to your traditional individual retirement accounts (by filing Form 8606 with your tax returns). In this case, a portion of the RMD can be considered as coming from those nondeductible contributions, which will be tax-free. For example, if your IRA holds $300,000 with $30,000 of nondeductible contributions, 10% of a distribution from the IRA will be tax-free. Each time you take a distribution, you will need to recalculate the tax-free portion until all the nondeductible contributions have been accounted for.
- For individuals who have reached age 70.5, qualified charitable distributions (QCDs) are a popular way to make charitable contributions (up to $100,000 annually) from pre-tax retirement accounts, which can reduce their current or future required minimum distribution (RMD) burden. Under the new legislation, the RMD age increases to 75, but the age threshold for QCDs remains at age 70.5.
- The legislation allows for transfers from 529 plans to Roth IRAs. After 15 years, the assets in a 529 plan can be rolled over to a Roth IRA for the beneficiary, subject to annual Roth contribution limits and an aggregate lifetime limit of $35,000. Rollovers cannot exceed the aggregate amount before the 5 years ending on the date of the distribution. The rollover is treated as a contribution towards the annual Roth IRA contribution limit.
The Roth IRA contribution income limits are waived for transfers from 529 plans, making them accessible to high-income 529 account owners and beneficiaries. This change provides a solution for individuals who may have concerns about having too much money in a 529 plan if their child receives a scholarship. It allows them to help their child fund a Roth IRA without paying income taxes and 10% penalties.
- Beginning in 2025, the SECURE 2.0 Act of 2022 will expand automatic enrollment in retirement plans, starting at a contribution rate of at least 3%. Automatic enrollment in 401(k) plans has been shown to increase participation. With some exceptions for small businesses, the bill requires 401(k) and 403(b) plans to automatically enroll eligible participants, who can choose to opt out of participation if they wish.
- The legislation allows employers to treat student loan payments as "elective deferrals" for matching purposes in workplace retirement accounts. This will allow student loan borrowers to benefit from an employer match even if they are unable to contribute to their own retirement plan.
- Starting in 2024, defined contribution retirement plans will be able to add an emergency savings account that is a designated Roth account that is eligible to accept participant contributions for non-highly compensated employees. The contribution will be limited to $2,500 annually (or lower, as set by the employer), and the first four withdrawals in a year will be tax-free and penalty-free. Depending on the rules of the plan, contributions may be eligible for an employer match.
Although SECURE 2.0 provides increased opportunities to save for retirement, it is important to note that everyone's financial situation is unique. It is always a good idea to consult with a financial advisor or tax professional to understand how the changes in SECURE 2.0 apply to your specific situation.
About the author: Echo Huang
Echo Huang, CFA, CFP®, CPA, left China at age 20 to cross the ocean with nothing but $800 and the hope of achieving the American Dream. Today, as founder and president of Echo Wealth Management, Echo helps the country's top executives and entrepreneurs take the complexity out of their finances, giving them the confidence to follow their dreams and achieve their goals. Her book Own Your Future, One Woman’s Story of Immigration and Financial Freedom aims to give you the tools and education to think properly about your money, to identify who should be on your financial team, and to offer insights into what each of them should deliver.