In what is beginning to seem like an annual tradition, a bill with wide-ranging implications for taxes and retirement account strategies was hurriedly passed into law in the waning hours of 2022. Buried inside the massive 4,100-page, $1.7 trillion omnibus spending bill was a smaller retirement plan reform bill widely known as “SECURE Act 2.0”, in reference to the original SECURE Act, which was passed in the closing days of 2019. The original 2019 law made several changes to retirement account rules, including the repeal of the so-called “stretch IRA”, an increase in the age at which Required Minimum Distributions (RMDs) must begin, as well as changes to 529 plans, 401(k) plans, and more.
By comparison, SECURE Act 2.0 is relatively mild in its impact, but the sheer number of different provisions means that a significant number of individuals are likely to be affected in at least some way. As we usually do with bills like these, we’ll take some time to sift through the major provisions, in order to help sort out the various impacts (and opportunities) that the new law creates.
Changes to RMDs and catch-up contributions
One of SECURE 2.0’s headline changes is the further expansion of the age at which RMDs must begin. The 2019 Act increased RMD age from 70 ½ to 72, and SECURE 2.0 increases it again to 73 (effective immediately) and eventually to 75 (beginning in 2033). This change can offer significant flexibility for early retirees, allowing for greater ability to keep taxable income low. Managing income can help to minimize premiums for Medicare Part B & D, as well as increasing the opportunity to perform strategic Roth conversions in early retirement years. In addition to the RMD age expansion, SECURE 2.0 also decreases the penalty for individuals who do not meet their RMD for a given year. Previously, the penalty for any unmet RMD was 50% of the shortfall—under the new law, that penalty decreases to 25%, and it can be as low as 10% if the error is corrected “in a timely manner” (generally speaking, within a year).
There will also be several administrative changes to workplace retirement plans. Part-time workers will find it easier to become eligible to participate in 401(k) plans (workers with between 500 and 1,000 hours worked per year will become eligible after 2 years of service, instead of 3 years, beginning in 2025), which is again an expansion on the original SECURE Act. Employers will also now be required to auto-enroll all eligible employees in their plans, at a salary deferral of 3%. Employees will be allowed to opt out if they wish, and several exemptions apply—only newly-established plans will be subject to mandatory auto-enrollment, and many types of businesses will be exempt, especially smaller businesses.
Finally, there will be several changes to employer “matching” contributions and employee “catch-up” contributions. First, employers can now elect to make “matching” retirement contributions for employees who have made repayments to their student loan balances, essentially treating those loan repayments as if they were 401(k) savings. This provision is likely to be a popular tool for many employers, especially those looking to attract (and keep) younger talent.
There will also be an additional opportunity for older employees to make additional contributions to their 401(k) accounts. Currently, those age 50 and over are eligible to contribute an additional $7,500 per year in “catch-up” contributions, in addition to the regular $22,500 contribution limit. Beginning in 2025, workers aged 60 to 63 will also be eligible to make additional “catch-up” contributions, with their “catch-up” cap rising to at least $10,000 per year. However, there will be a caveat: for individuals with wages above $145,000 per year, any “catch-up” contribution will now be required to be directed to a Roth 401(k), and can no longer be put in a Traditional (tax-deferred) account. This limitation will apply to all employees age 50 and over, not just those eligible for the higher catch-up contributions.
Changes to Roth accounts
The catch-up contribution limitation mentioned above is only one of many SECURE 2.0 provisions that focuses on Roth accounts. In fact, SECURE 2.0 has a heavy focus on Roth accounts, indicating that the current legislative trend is favoring the Roth as a retirement option (perhaps because it accelerates the payment of taxes into the current year, helping to reduce budget deficits in the short-term).
First, a “fix” has been put in place that makes Roth 401(k) accounts function more like their Roth IRA cousins. Previously, Roth 401(k) funds were subject to RMDs (as if they were Traditional funds), even though Roth IRAs have no RMD requirements. SECURE 2.0 removes the RMD for Roth 401(k) balances, making the two accounts function similarly. Those RMDs could already be easily avoided using a rollover from the 401(k) to the IRA, but now such a step will not be purely necessary.
In addition, employer “matching” contributions are now permitted to be directed to the Roth 401(k) option—previously, employer matches could only be made to Traditional 401(k) accounts. Similarly, SEP and SIMPLE IRA plans will now be permitted to offer Roth options, which previously had been disallowed. Finally, there is a widely-reported provision that may now allow for unused 529 funds to be converted into Roth IRA funds, potentially helping to solve the problem of “overfunding” 529 accounts. There are, however, several strings attached—the 529 account must be in existence for at least 15 years, the Roth IRA receiving the funds must be in the name of the 529 beneficiary, any contributions made in the prior five years are ineligible to be transferred, and there is a lifetime transfer limit of just $35,000. Still, for those who are uneasy about funding 529 accounts, this could be a significant change on the margin.
Other considerations
In addition to the major provisions of SECURE 2.0, there is also a laundry list of minor provisions, many of which will only impact a small number of people. There will be an expansion of the “saver’s credit” (essentially a government-funded “match” for certain retirement plan contributions), but it will generally only apply to low-income taxpayers. There will also be additional “hardship distributions” from retirement plans that can be exempt from the 10% tax penalty, as well as certain emergency savings accounts that will be linked to 401(k) plans.
Also important is what was not included in the law—there will be no changes to any existing Roth strategies (like the backdoor Roth or mega-backdoor Roth), nor any limitations to standard Roth conversions. Income and contribution limits are largely unchanged, and provisions that could have forced distributions from retirement accounts that exceeded certain dollar values (“mega” IRAs) were also excluded. As usual, if you have questions about how this law may impact your retirement planning, we are happy to help.
