Staying informed about legislative changes is imperative to maintaining a dynamic financial plan. Remembering these changes is equally important. The Secure Act 2.0, a significant update to the original Secure Act of 2019, was signed into law in late 2022 with the aim of further strengthening retirement security for individuals and families. As we approach the midpoint of 2023, it is crucial to revisit some of the significant amendments introduced by Secure Act 2.0.
No One Will Start Required Minimum Distributions (RMDs) in 2023
Since the establishment of RMDs by the Tax Reform Act of 1986, individuals have been required to take distributions from their qualified retirement accounts once they reach a certain age. Originally, that age was 70 1/2. With the passage of the Secure Act in 2019, the age was pushed to 72. Now, under the Secure Act 2.0, individuals born between 1951 and 1959 can delay RMDs until age 73, and individuals born in 1960 and after can wait until age 75.
For the group of people who can delay taking RMDs until age 75, this means more time for their qualified retirement accounts to grow. Though a few years difference may not seem drastic, this could be a monumental benefit for some individuals.
Another noteworthy change to RMDs comes from the penalty assessed to individuals who fail to take their distributions. Before Secure Act 2.0, this penalty was a staggering 50% of the shortfall. The penalty has since been reduced to 25% of the shortfall and if the mistake is corrected in a timely manner, as per the IRS, it will only be 10%.
Elimination of RMDs for employer sponsored Roth Plans
Before Secure Act 2.0, individuals with plan Roth accounts (Roth 401(k) plans, Roth 403(b) plans, etc.) were required to take RMDs at age 72. Starting in 2024, this will no longer be the case as Secure Act 2.0 eliminates RMDs from plan Roth accounts.
The reasoning behind this legislation is straightforward. Roth IRAs did not have an RMD requirement and plan Roth accounts such as a Roth 401(k) did. Simply put, most people could get around taking RMDs from their Roth 401(k) by rolling it into a Roth IRA. Secure Act 2.0 leveled the playing field by eliminating RMD requirements from plan Roth accounts.
New Roth Option for Self-Employed Taxpayers
Another creation of the Secure Act 2.0 is the Roth SEP IRA. For self-employed individuals, a SEP IRA does not have the start-up and operating costs of a conventional retirement plan and allows for a contribution of up to 25 percent of each employee's pay.These are excellent tools for employers (especially self-employers) to provide a current year tax deduction and tax-deferred growth of assets until retirement.
For higher earners, a downside of the SEP IRA is that withdrawals made during retirement are taxable. The Roth SEP IRA offers a solution to these individuals by allowing a vessel that provides no current year tax deduction, but tax-free withdrawals during retirement. Establishing a Roth SEP IRA could be a very beneficial tool for self-employed individuals who expect to stay in a high tax bracket during retirement.
High Wage Earners Must Have Roth Catch-Up Contributions
Catch-up contributions are opportunities for individuals age 50 and older to make additional contributions to their employer sponsored plans and IRAs. For 2023, the catch-up contribution for individuals with 401(k)s, 403(b)s, 457(b)s, etc. is $7,500. Alongside the contribution limit of $22,500, individuals age 50 and older can make total contributions of $30,000 to their employer sponsored retirement plan.
Beginning in 2024, Secure Act 2.0 mandates a crucial change. Now, employees who earned wages exceeding $145,000 from their plan-sponsoring employer in the prior year must make their catch-up contributions on a Roth basis. In other words, higher earners will have their entire catch-up contribution made on a Roth, not pre-tax basis.
For a better understanding of how this works, consider Mary, a 51-year-old attorney, who will make $185,000 in salary in 2024. Throughout 2024, Mary takes full advantage of the IRS 401(k) limits and contributes $22,500 to her traditional 401(k) and an additional $7,500 as a catch-up contribution. Before Secure Act 2.0, Mary could have contributed all $30,000 on a pre-tax basis and received a $30,000 tax deduction for doing so. Now, Mary can still make her $22,500 contribution on a pre-tax basis, but the $7,500 catch-up contribution must be after-tax and go into a Roth account.
529 Plan to Roth IRA Transfers
One of the most notable provisions in Secure Act 2.0 that has drawn significant attention is the eligibility for 529 plans to be rolled into Roth IRAs. Typically, if an individual does not utilize a 529 plan and wishes to make nonqualified or noneducational distributions, they are subjected to federal income tax and a 10% penalty on the earnings associated with the distribution. However, this new provision within the Secure Act 2.0 presents an exciting opportunity for young individuals to bypass these penalties while simultaneously saving for their retirement.
This change does come with a few noteworthy limitations:
- The Roth IRA receiving the funds and the 529 plan beneficiary must be the same person.
- The 529 plan must have been held for the beneficiary for at least 15 years.
- The annual conversion limit is the Roth IRA contribution limit less any traditional IRA or Roth IRA contributions made by the individual for that same year.
- The maximum lifetime conversion limit is $35,000.
- Any 529 plan contribution made within the last 5 years is unable to be transferred to the Roth IRA .
These limitations should be carefully considered, as it may impact the overall financial planning and tax obligations of individuals and families.
The Secure Act 2.0 provided many significant updates, and this summary is not intended to be comprehensive. A summary of the complete provisions can be found at finance.senate.gov. It is crucial to seek guidance from professionals to gain a full understanding of how the specific implications of Secure Act 2.0 apply to your individual situation. By staying well-informed and adapting to these legislative changes, you can optimize your retirement planning strategies and set yourself on a path towards long-term financial well-being. Don't hesitate to reach out to us at Ullmann Wealth Partners for expert assistance and guidance.