New Rules for Money in and Money out of Retirement Plans
Understanding the Impact of SECURE Act 2.0 of 2022
by Jay Heflin & Bob Schneeweis
The “SECURE ACT 2.0” was signed into law on December 29, 2022. It follows the SECURE Act of 2019 and is the second major legislation impacting qualified retirement plans since 2006. It consolidates three bills voted on over the course of the last year (Securing a Strong Retirement Act of 2022, Enhancing American Retirement Now Act, Retirement Improvement and Savings Enhancement to Supplement Healthy Investment of the Next Egg).
The legislation was designed to encourage businesses, especially small employers, to adopt retirement plans and help to close the gap to large employer plans. It also increases opportunities for individuals to save for emergencies and retirement, and to help individuals preserve their retirement savings.
SECURE 2.0 has a vast array of new provisions (more than 90) designed to help close existing gaps across the retirement system. We are going to focus on the provisions which are of the most interest to our clients, but our team is open to further questions about your specific needs.
Key Provisions of SECURE ACT 2.0
- When to start taking distributions from your IRA (and other qualified accounts). The original SECURE ACT raised it from age 70.5 to age 72, SECURE 2.0 Act increases the age at which individuals must begin taking RMDs (Required Minimum Distributions) from their retirement account from 72 to 73, starting on Jan. 1, 2023. The SECURE 2.0 Act will also eventually increase the RMD age to 75, beginning on Jan. 1, 2033.
- If you forget to take your RMD on time. The penalty is lowered to 25% (from 50%) and can be reduced to 10% if the IRA owner makes up the RMD in a timely manner. The law says this means the full amount is distributed by the earlier of the second year after the RMD was missed or before the IRS assesses a penalty. The IRS still can waive the lower penalty when a reasonable excuse is offered, but it’s not clear if the IRS will be as lenient now that the penalty is lower than 50%.
- Unused 529 college savings. Owners of 529 plans will be allowed to roll over funds to a Roth IRA of the beneficiary (beginning in 2024). There is a maximum $ 35,000-lifetime limit per beneficiary. It should be noted that the 529 plan will be subject to Roth IRA contribution limits, and in order to be eligible for the rollover, 529 plan account holders need to make sure their account is at least 15 years old and the Roth owner has includible compensation at least equal to the rollover. College is a major expense for all families, and expanding the use of 529 plans to allow for conversions to a Roth IRA down the road is a big positive. No need to worry about losing money not spent on education expenses.
- Larger IRA Contributions. Improvements to “Catch-Up” contributions reflect the reality that more people are working later and fewer have access to pensions. Secure Act 2.0 introduces a new category of catch-up contributions for 401K and employer-sponsored plans. Starting in 2025, there will be a new catch-up contribution limit for these plans: the greater of $10,000 or 150% of the standard catch-up contribution limit. For individuals not covered by these plans, the catch-up addition is $1,000 for individuals at least 50 years old. The standard catch-up limit for IRAs has been a fixed amount, but on Jan. 1, 2024, it will be indexed for inflation for Traditional and ROTH IRA contributions.
- Long-Term Care premiums before age 59 ½. The Secure Act 2.0 will let a client use up to $2,500 in individual retirement account or 401(k) plan account assets per year to pay for stand-alone long-term care insurance. A client can also use the distributions to pay for life insurance policies or annuity contracts that provide what the law classifies as high-quality sources of long-term care benefits. A client who uses the provision will have to include the distributions in taxable income but will not have to pay the extra 10% tax on early retirement asset withdrawals. For those in flood, or weather-damaged areas – Provisions for penalty-free early distributions of up to $22,000 for IRA owners who live in a “federally declared disaster area”, and they may repay the distribution within 3 years to avoid taxation.
- Provision for Terminal Illness. There are now penalty-free early distributions for IRA owners with a doctor’s certification of a terminal illness.
Much of the rest of SECURE 2.0 is focused on employer-sponsored retirement plans, including provisions that permit employers to add Emergency Savings accounts to their plans for participants to save up to $2,500 in after-tax ROTH contributions for emergency withdrawals. New plans must include automatic enrollment with initial contribution rates of at least 3% but not more than 10%. Starter 401k plans are encouraged for employers not currently offering a retirement plan with some coverage for the expense of setting up the plans.
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