The Tax Foundation released a fantastic list of notable state tax changes for 2023. It was so good, I wanted to post it here, rather than just tweeting it out, since not everyone uses Twitter. Here’s the link to the site, which includes personal income tax rate changes, corporate tax changes, sales and use tax changes, and a host of miscellaneous new and changed provisions.
Month: January 2023
SECURE 2.0 Act
In late December, as part of budget appropriations for 2023, Congress passed and President Biden signed into law, the SECURE 2.0 Act. For those interested in the full text, see Division T of HR 2617. It can be found on pages 2046-2404 of the 4,155 page document. SECURE 2.0 is an add-on to the original Setting Every Community Up for Retirement Enhancement (“SECURE”) Act of 2019, most of which went into effect in 2020. SECURE 2.0 is filled with a ton of tax, retirement, and other provisions, many of which are extremely complex and will require additional guidance from the IRS on implementation. Below are the provisions I noted that are most likely to impact some PWA clients, now, or in the future (I tried to sort these in order of most interest to least for the average client, so the more important ones are listed first. This makes the list NOT follow the sections of the bill at all).
- Rollover of unused 529 plans to Roth IRAs – SECURE 2.0 allows for penalty-free rollovers from a 529 plan to a Roth IRA for the beneficiary of the 529 under certain circumstances. The lifetime limit is $35k per beneficiary, but annually, can’t be more than what the beneficiary could contribute to a Roth IRA (that may or may not include the need to have earned income… we’ll need more guidance on that). The 529 account must have been open for at least 15 years to make such a transfer and the transferred amount must have been in the account for more than 5 years (i.e. you can’t contribute and then immediately convert… this is really intended for leftover education savings after school is complete). Interestingly, there are no income limits to making these rollover contributions, so we have another “backdoor Roth” type opportunity.
- RMD begin date – Required Minimum Distributions from pre-tax retirement plans must start in the year that a taxpayer turns 72 (up from 70.5 due to SECURE 1.0). SECURE 2.0 extends this to age 73 starting in 2023 and to 75 starting in 2033.
- Missed RMD penalty reduced – from 50% to 25%, or 10% if the correction occurs in a timely manner (generally, within 2 years). Starts in 2023.
- Additional 401k catch-up contribution – for those ages 60-63, the catch-up contribution amount is increased to $10k (from the current $7500) or 50% more than the regular catch-up contribution, whichever is greater, starting in 2025.
- Catch-up contributions must be Roth – Currently, catch-up contributions to a 401k/403b can be pre-tax or Roth as decided by the plan participant. Starting in 2024, all catch-up contributions must be Roth, unless the participant’s previous year compensation is less than $145k (indexed for inflation).
- Matching contributions can be Roth – Currently all 401k/403b employer matching is done on a pre-tax basis to a Traditional 401k. Starting in 2023, plans can allow participants to direct whether they want the match to be contributed to the Traditional or Roth 401k/403b. If Roth, the match will be considered taxable income in the year the contribution is made.
- Student loan payments will count for 401k matching purposes – when employers offer a 401k match, if the employee doesn’t contribute to the plan, they don’t get the match. SECURE 2.0 changes that by allowing employers to count student loan payments as contributions to 401ks for the purpose of calculating how much matching an employee will get. Starts in 2024. Another seemingly difficult one from an administration perspective. I’m sure there will be more guidance on how the employee proves the loan payment to the employer and by what deadline to receive the match.
- SIMPLE and SEP plans can be Roth – starting in 2023, both SIMPLEs and SEPs can allow Roth contributions (would need a SIMPLE Roth IRA and SEP Roth IRA, respectively.
- Use of 401k funds in Federally Declared Disasters – up to $22k can be withdrawn penalty-free (but not tax-free) from a 401k for a federally declared disaster. The amount is taxable over 3 years, to allow the impact to be spread rather than potentially bumping the taxpayer up in bracket in the year of the disaster. The amount can also be re-contributed within three years and then no tax is due. In addition, loans from 401ks get a boost if you live in a Federally declared disaster area. Instead of the max loan being 50% of the vested balance or $50k (whichever is less), it becomes 100% of the vested balance or $100k (whichever is less). Effective for disasters occurring after Jan 25, 2021.
- IRA Catch-Up – the extra amount that you can contribute to an IRA if you’re over age 50 will now be indexed to inflation (was previously a flat $1k). Starts in 2024.
- Qualifying longevity annuity contracts (QLACs) can be larger – the are annuities that start payment after age 72. Previously limited to 25% of account value or $125k max, up to $200k can now be purchased and is exempted from Required Minimum Distributions (RMD). Start is in 2023.
- Qualified Charitable Distribution (QCD) easing – SECURE 2.0 indexes the $100k annual QCD limit to inflation, and allows a one-time $50k QCD to a charitable gift annuity, charitable remainder unitrust, or charitable remainder annuity trust. Starts in 2023. Note, QCDs can still be made by those over 70.5 years of age, despite the RMD begin date being pushed back from the year you turn 70.5 to 72 (by SECURE 1.0) and now 73 or 75 (by SECURE 2.0).
- Roth 401k RMDs eliminated – While there has never been a Required Minimum Distribution for Roth IRAs, Roth 401ks did have an RMD. SECURE 2.0 eliminates this starting in 2024.
- Retirement plan distributions for Long-Term Care insurance – Up to $2500 can be distributed per year penalty-free (but not tax-free) to pay the premiums for LTCI. Starts in 2026.
- Penalty-free “emergency” distributions from 401ks – Can withdraw up to $1k per year as an emergency expense without penalty. Tax is due unless the amount is repaid within 3 years. No additional emergency withdrawals are allowed until the amount is paid back or the 3 years has passed. Starts in 2024.
- Emergency Savings Accounts – SECURE 2.0 allows (but does not require) employers to offer Emergency Savings Accounts to non-highly compensated employees, linked to their retirement plan. These would function like Roth 401k accounts (after-tax) with a max of up to $2500/yr in contributions, would qualify for matching, and would allow up to 4 penalty-free withdrawals per year. At termination, the remaining amount can be rolled to a Roth 401k or Roth IRA>
- 401k auto-enrollment – if you start a new job, you may find that more employers are auto-enrolling employees in their 401k, unless they opt out. SECURE 2.0 mandates this as part of new plan setups, with initial contributions ranging from 3-10% and auto-increase annually up to 10-15%. Starts in 2024.
- SIMPLE plan changes – contributions limits will increase by 10% starting in 2024. Additionally, employers contribute more to employee SIMPLE accounts (up to the lower of 10% of compensation or $5k).
- Nannie SEPs – Domestic employees can participate in Simplified Employee Pension (SEP) plans. Starts in 2023.
- Starter 401k plans – Employers without a 401k (or 403b) can sponsor a starter 401k (or safe-harbor 403b) that doesn’t require any onerous non-discrimination testing. Employees would be auto-enrolled and can contribute up to the maximum amount that would allowed to an IRA for the given year. Starts in 2024.
- Saver’s Credit becomes Saver’s Match – the current Saver’s credit provides a tax credit of 50% of the first $2k contributed to a retirement plan for low income individuals / families. SECURE 2.0 changes this to a Saver’s Match which is deposited into the saver’s retirement plan account (seems like a much more difficult plan from an administration standpoint, but perhaps it will provide a bit better incentive to contribute as the Saver’s Credit was not a popular program. Starts in 2027.
Q4 2022 Returns By Asset Class
This post contains the usual returns by asset class for this past quarter (by representative ETF), last year, last five years, last ten years, and since the covid low (3/23/2020). While there is still no predictive power in this data, I’ll continue to post this quarterly for those of you that are interested.
A few notes:
- Q4 was a strong quarter (even stronger if we could erase December) that ended a terrible year for everything other than commodities. Developed foreign markets led the way (+17%) as the US dollar finally cooled. Emerging market stocks, emerging market bonds, US small caps, and US large caps all had solid performance of +7-9%. High yield (junk) bonds returned +5% with real estate just below at +4.3%. Commodities ticked slightly higher (+2.4%) and after a miserable year, bonds crawled ahead as interest rates finally took a breather. Short-term corporate bonds were up 2.2% with the aggregate bond index up 1.6%.
- While many will remember 2022 as an excess of destruction in financial markets, it really was a destruction of excess. The areas that fared worst were those that saw substantial gains in previous years, leading to rich valuations by virtually every measure. I’ve mentioned Large Cap Tech multiple times in previous “market update” posts as an area of concern in an otherwise fairly priced market. 2022 brought it back to reality with the Nasdaq 100 falling more than 30% and individual well-known names falling much further. The ARK Innovation ETF (ARKK) closed the year down nearly 68%. The once-loved Tesla finished down 65%. Meme stocks like Gamestop (-50%) and AMC (-76%) also came back toward reality. And crypto, perhaps the most obvious representative of speculation, was also crushed with Bitcoin down 65%, Ethereum down 68%, and many of the smaller coins/tokens down substantially more. On the contrary, US Large Cap Value (perhaps the least representative of excess) held up quite well, down only 2.1% on the year. Destruction of excess is often a requirement of the start of a new bull market. Without a crystal ball, we can’t know when that will begin (or if it already has), but it would be very difficult to have one without cutting the excesses out of the market overall.
- 2022 was the worst year for the aggregate bond index in history, closing down 13%, after being down as much as 17% earlier in Q4. Bond prices move in the opposite direction from interest rates and with the Fed raising rates at a pace never before seen (started the year near 0% and ended near 4.5%!), in hopes of bringing inflation back toward their 2% target, bond prices tumbled. The shorter the term on the bond or bond fund, the less impact the increase in rates has though, so short-term bonds outperformed longer-term bonds. This should intuitively make sense… the shorter the time to maturity, the less time you have to wait to redeem your low-interest paying bonds and reinvest in new higher interest bonds. The longer the time to maturity, the longer you’re stuck with the low interest rates, so if you want to sell those bonds, no one will pay anywhere near your principal amount (i.e. the price falls). The good news is that we’ve gone from a world of negative and zero interest rates everywhere, to one where we can now get 3.4% in a bank account, 4.75% on a 1-year treasury note, over 5% on many high-quality corporate bonds.
- Commodities were the one bright spot in 2022, with the Bloomberg Commodity Index returning over 17%. Commodities still have a long way to go to catch up to other financial assets over the past 10 years though as you can see from the charts above. It feels like oil, gas, etc. are all high now, but remember that 10 years ago, oil was $120 vs. today’s ~$80.