What You Need to Know About SECURE Act 2.0

In this PFA Advisor Huddle, we break down key provisions of the Consolidated Appropriations Act of 2023. The legislation is also known as the SECURE Act 2.0 since it builds on the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019.

We assume you don’t have time or want to read the Act’s 4,000+ pages so we’ve summarized key changes going into effect over the next few years.

Rather watch video clips? Click on the headings below or visit our YouTube channel @penobscotfinancialadvisors219!

Required minimum distribution (RMD) age changes

The RMD age is changing again! Back when the original SECURE Act was signed, the RMD age was changed from 70 ½ to age 72. Well, that is changing again with the passage of SECURE Act 2.0. The new RMD age will be 73 for 2023 and increase again to age 75 in 2033.  

Folks still have until April 1st of the following year for their first RMD. This means anyone who turns 73 in 2023 will have until April 1, 2024, to take their RMD. Remember that if you do this, you will still need to take an RMD for 2024 by year end.  

Starting in 2024, all Roth 401(k)s will not require a RMD. Right now, a Roth IRA doesn’t require a RMD, but a Roth 401(k) would require a RMD. This led most people to roll their Roth 401(k) out to a Roth IRA, but now the Roth 401(k) won’t require the RMD.  

There have been a couple changes to the penalties that apply to missing a RMD. Today if you miss your RMD you are hit with a 50% penalty of the amount that needed to be withdrawn. That is being reduced to a 25% penalty and can fall down to as low as 10% if the taxpayer corrects the mistake in a timely manner (very vague on what would be considered timely). Taxpayers will still be able to submit an explanation in writing to why a RMD was missed, in hopes that the IRS waives the penalty all together.  

Soon, education assets may become retirement assets!

One part of the SECURE 2.0 bill adds meaningful flexibility to investors setting money aside in tax-deferred 529 plans.   

Flexibility already exists in many ways for people who are concerned about assets in 529 plans not being used for qualifying higher education expenses, and being taxed and penalized as a result.  These include a wide range of beneficiary changes allowed (up and down generations without limit and movable as far out as first cousins.). Also, since 529 assets don’t need to be distributed in any specified time period, a beneficiary who doesn’t use all their 529 assets for education might simply wait until they themselves have children and make their children beneficiaries!  Also, penalty free exemptions exist when the beneficiary receives a scholarship or attends a service academy.  In the event a taxable (non-qualifying) distribution DOES need to be made, it can be made payable to the beneficiary or the owner, whichever might have the better tax bracket. 

And with SECURE 2.0, another option is available.  529 assets can be CONVERTED to Roth IRAs! 

Now, if this sounds too good to be true, it may be.  There are a number of conditions that must be met, and these certainly narrow the usability of this option: 

• 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 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. 

This is all a slight improvement to the flexibility you have with 529 plans. There are potentially some planning opportunities that we aren’t clear on yet (Congress hasn’t clarified, for example, whether we need to reset the 15-year clock at the time of a beneficiary change.) 

Conceivably, a parent making a $35,000 contribution to their child’s 529 plan at least 5 years before the child starts working may, with an average rate of return of less than 8%, bestow a $1 million Roth IRA on that child, completely free of taxation.  A nice use of a small tax provision! 

Spouses have more flexibility in how to inherit money from one another 

Husbands and wives have always had more flexibility when it comes to inheriting retirement money from a deceased spouse than non-spousal beneficiaries.  SECURE 2.0 adds one more important choice! 

When one spouse dies, the surviving spouse can generally make decisions as to whether he or she wants to take or leave assets in their deceased spouse’s IRA.  This can be a helpful choice.  Let’s say, for example, that Mr. Potatohead is 75 years of age and his spouse, who survives him is 68 years old.   AT HIS current age, Mr. P is required to take annual minimum distributions (RMDs) from his retirement plan, paying taxes on the distributions.  As beneficiary of Mr. Potatohead’s IRA, however, Mrs. P. could decide to roll Mr. P’s IRA into an IRA of her own, and the assets will be treated as if Mr. P was Mrs. P.  The rollover is tax-free, assets continue to appreciate tax-deferred, and no required minimum distributions will be necessary until Mrs. P herself turns 72 (or 73 or 75, depending on her year of birth).  Once she starts to take the distributions, she will be taking them on her own (likely longer) life expectancy. 

But what if the roles were reversed?  What if Mrs. Potatohead is 75 and her decedent husband was 68?  Rolling his IRA into hers would mean that she would need to immediately start taking RMDs from the balance, since she is of that age.  If she left the assets in Mr. P’s IRA, she could continue to defer income and not take RMDs until Mr. P would have turned the age for RMDs.  (Albeit when she does start the distributions, they will be based on Mrs. P’s (likely shorter) life expectancy. 

SECURE 2.0 provides Mrs. P with one more option.  She can put herself in the shoes of her decedent husband, deferring RMDs until the age he would have been compelled to take them, and taking them over his (likely longer) life expectancy. 

A big change?  Maybe not – but it’s just one more way that, while the original SECURE Act made things much more challenging for non-spousal beneficiaries, SECURE 2.0 seems set on making them easier for spousal beneficiaries! 

Employer matches can go to Roth plans

Employees can now designate their employer matching contributions to their Roth 401(k), 403(b), 457(b), or TSP. Previously, matching contributions had to go to pre-tax accounts.

This option is only available if your employer’s matching dollars are not subject to a vesting schedule, meaning some or all of the match is forfeited if you separate from service before vesting.

Like other Roth account contributions, you will owe income tax on the year you receive the matching dollars. Consider splitting your match between pre-tax and Roth accounts if you sit at the top of your marginal tax bracket and want to remain there.

If your employer does not offer a Roth plan or matches are subject to a vesting schedule, you still get matching dollars but they’ll continue going to your pre-tax account.

No RMDs for designated Roth accounts

Currently, employer plan Roth accounts are treated like their pre-tax 401(k), 403(b), 457(b) and TSP counterparts when it comes to RMDs. That’s why retirees often opt to roll their employer Roth plans to a Roth IRA that does not require RMDs.

Starting in 2024, RMDs are not required for Roth employer plans. If you’ve been taking RMDs from your designated Roth accounts, you can suspend those in 2024.

It may still be prudent to roll the account to your Roth IRA. Consult with your PFA Advisor to find out if this matters for you.

Special catch-up limits for retirement plans & IRAs 

Individuals can make catch up contributions to IRAs when they are age 50 and older.  For many years, this limit has NOT been indexed to inflation and has been stuck at $1,000/year.  SECURE Act 2.0 changes this.  Starting in 2024, the age 50+ catch up limit will be indexed for inflation each year and it will be made in $100 increments. 

For retirement plans (401(k), 403(b), 457(b) etc…), SECURE Act 2.0 introduces some special catch-up limit adjustments for anyone aged 60 to 63.  These individuals will have their catch-up limits increased to the greater of $10,000 or 150% of the regular catch limit that exists in the future. Interestingly, the current catch-up limit for these plans is $7,500 and 150% of that is over $10,000 already, so it does not seem like the $10,000 floor will ever come into play.  Also note for these plans that SECURE Act 2.0 states that if an individual is making over $145,000 in wages, the catch-up contributions MUST go into ROTH. 

For SIMPLE IRA plans, the same age group (those aged 60-63) will have catch up limits increased to the greater of $5,000 or 150% of the regular SIMPLE IRA catch up limit that exists in the future. 

Qualified charitable contributions (QCDs) 

People who have reached age 70.5 can make contributions from their pre-tax retirement plans and IRAs directly to a charity. These distributions are not taxable, and they are an effective way to give for those people who are not itemizing and completely benefiting from their charitable giving. Since QCDs have been around, the limit on these distributions has been stuck at $100,000. SECURE Act 2.0 begins to index this limit for inflation starting in 2024. 

Employer matches for student loan payments

This is a fun, new provision. Starting in 2024, some student loan borrowers will no longer have to choose between paying their student loans and saving to an employer retirement plan to receive an employer match.

Employers will be allowed to make matching contributions to employee retirement savings accounts for amounts paid by participants towards their student debt. Borrowers will no longer miss out on the matching benefit due to their student loan expense, so long as employers choose to amend their plans to allow for the updated provision.

You can expect to see a lot of employers taking advantage of this opportunity to attract and retain employees. 

What has NOT changed

It’s also important to discuss what has NOT changed with SECURE 2.0: 

• No new limit on the use of the Back-Door Roth. This strategy is still a go for getting after-tax dollars into a Roth IRA, regardless of your income. 
• No new limitations on Roth conversions. Anyone can still do a Roth conversion, regardless of income. 
• RMDs are still solely based on age. There are no additional rules for large account balances. 
• The age at which you are allowed to make QCDs (70 1/2) has not changed. 
• There is still no clarification around the 10-Year Rule created by the original SECURE Act, which must be implemented for Non-Eligible Designated Beneficiaries of retirement accounts. This is an area where we were hoping to get some updates, since currently it is unclear if distributions are required for each of the 10 years or if accounts can simply be emptied in the 10^th year. This is a huge grey area for most people who inherited an IRA after 2019 from a non-spouse. We are expecting additional guidance on this topic before the end of the year!