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SECURE 2.0 Act

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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.

The SECURE Act & Tax Extenders

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Over the last week, Congress passed its Appropriations Act, designed to continue to fund the government. To it, they attached the SECURE Act (Setting Every Community Up for Retirement Enhancement) and the extension of multiple expired/expiring tax provisions, known as the “Tax Extenders”. The president is expected to sign the entire bill before departing for the holidays.

The SECURE Act modifies a number of qualified plan (401k, SIMPLE, SEP, etc.) and IRA/Roth IRA rules, along with a couple of 529 plan rules and the treatment of the “kiddie tax”. Below, I highlight the changes along with their likely impact on PWA clients. Virtually all of these changes take place as of 1/1/2020, but unlike the last few tax changes that passed in late December, there is no action that you need to take immediately. If you’re having trouble sleeping, you can read the Secure Act in its entirety on pages 1532-1656 of the Appropriations Act. There are only a few tax extenders that are likely to impact PWA clients. I’ve highlighted those below as well. For the full list, see pages 3-26 of the Division Q amendment to the Appropriations Act.

Secure Act Summary

First a little editorial… the name of the Act (Setting Every Community Up for Retirement Enhancement) and a lot of the press around it is completely misleading in my opinion. The Act’s changes to the retirement system are mostly minor positive tweaks with one somewhat concerning opening of Pandora’s high-cost-annuities-in-a-401k Box (more on that below). It is a far cry from the type of changes that would give everyone access to and the incentive to participate in a tax-advantaged retirement plan. The Act has been sold as “the”, or at least “an” answer to modern retirement issues, but it really doesn’t change a whole lot other than opening a new way for insurers to profit. Call me skeptical, but the insurance industry’s lobby game was strong on this one and when lobbyists step up to the plate in Washington, a home run is rarely a good thing for anyone other than their interest group. So, rather than reading this to see the multiple amazing ways that the Act will help you, please read it to get a sense for the minor positive changes and the couple of things to cautiously look out for in the future. Without further ado, the Secure Act:

· Eliminates a roadblock to Multiple Employer Plans (MEPs) that would allow two or more employers to join a pooled retirement plan, ideally expanding access to plans and reducing costs due to plan size. Pretty self-explanatory and nothing but positives here. Theoretically, this could allow anyone who works for a small business to have a 401k plan available, or a better 401k plan available in the future. Whether or not employers do band together to do this remains to be seen.

· Allows more part-time workers to participate in 401k plans. Specifically those who work 500-1000 hours per year, who were previously excluded from participation, will now be able to participate in the plans. That’s a clear positive for part-time workers and a slight negative for other workers who may see the increased costs to employers as a result of this change passed down to them in some form.

· Increases the business tax credit for new employer retirement plans to $5000 from $500 and adds a $500 credit for auto-enrollment feature. All good incentives that help motivate employers to create retirement plans and get their employees to participate. When compared to the cost of maintaining these plans though (esp. with any sort of matching or profit sharing), it’s honestly still chump change.

· Tweaks the Safe Harbor 401k rules to allow for a higher default employee contribution % while removing notification requirements for plans that make non-elective contributions. Employers can now auto-enroll employees with as much as a 15% contribution level (up from 10%) or with an automatic annual escalation to 15% max. Employees can still opt out though.

· Allows a new exception from the 10% early distribution penalty from a retirement plan for childbirth/adoption within one year after birth, up to a max of $5k per parent. Repayment is allowed to certain types of plans, though the rules are unclear. The increased flexibility is great and maybe more people will participate in employer retirement plans if they can get money back out of them for events like this. But generally, giving people the ability to raid retirement savings for non-retirement reasons isn’t setting anyone up for retirement.

· Eliminates the use of 401k loan “credit card” arrangements. Did you know that some plans adopted provisions that let an employee take out a 401k loan credit card that they could use for any purpose up to the loan limit? That’s not setting anyone up for success in retirement. There are already well-established reasons that loans can be permitted and formal arrangements to make sure participants are taking loans for those reasons only, and are aware of the terrible tax and penalty implications of defaulting on those loans.

· Requires plan administrators to include on quarterly statements an estimate of lifetime income that could be produced at retirement age based on current 401k balance. In other words, if you used your lump sum 401k balance to purchase a straight annuity (series of monthly payments for your life), how much could you expect each month in retirement? I think framing the question in this way is helpful in leading people to realize they may need to save more (or less) based on where they stand.

· Extends the date by which a retirement plan needs to be in place for a tax year from 12/31 of that tax year to the filing deadline of the tax return (plus extensions). This is helpful if you started self-employment or a small business and don’t realize you could benefit from setting up a retirement plan until you prepare your taxes, only to find out that you previously had to open most retirement plans by 12/31 to make a difference. Now you can see the benefit in real numbers and make the decision to open and fund the plan at tax time.

· Allows for portability of lifetime income options in a retirement plan. If the plan decides to eliminate a lifetime income option that was offered, employees enrolled in that option would be allowed to take an in-service withdrawal either by a direct rollover to an IRA or retirement plan or by a distribution to the employee. This is a necessary precursor for the next bullet.

· Provides a fiduciary safe harbor for including lifetime income options using annuities. As long as the cost is “reasonable” and the insurer is thought to be financially capable of satisfying its obligations, the plan sponsor will not be held to the same standards as they are with the selection of other investments in the plan as set forth by the Employee Retirement Income Security Act of 1974 (ERISA). This is the provision that drove the insurance industry lobbying for the SECURE Act. It essentially allows employers (and those they hire to select 401k options) to include annuities in the plan. This is not inherently bad. Some annuities, especially annuities that convert a lump sum into an immediate or future monthly cash flow stream for life, make a lot of sense from some people. But there are also terrible annuity products with monstrous fees that take advantage of consumers with overcomplicated promises dressed up as “guaranteed lifetime income” that really make no sense for anyone, especially not inside an already tax-deferred retirement plan. Now, plan sponsors can be talked into including these options by insurers (who kick back commissions to the plan administrator) and will no longer be held to the same standard as they are for selecting mutual funds. For PWA clients, this isn’t an issue. If you have a new fabulous “guaranteed lifetime income” option in your 401k at some point in the future, we’ll evaluate it like any other option and will likely come to the conclusion that it doesn’t make sense. For those who don’t have an advisor looking out for them as a fiduciary, I fear this new ERISA exclusion is opening up Pandora’s Box just when we’re really starting to get plan fees and mutual fund fees down to something reasonable. I hope I’m wrong.

· Eliminates the maximum age for making an IRA contribution (which used to be 70). This is great as people are generally working longer and if they want to keep saving for retirement past 70, it allows them to do so. But, generally speaking, those who are working past 70 and contributing to their retirement past age 70 aren’t the people who have a retirement savings issue. So, it’s a nice provision, but not sure it really helps a whole lot.

· Changes the Required Minimum Distribution (RMD) starting age to 72 from 70.5 for pre-tax retirement plans (401ks, IRAs, etc.). A nice add, with people living longer, to not have to start withdrawing from their pre-tax money and therefore paying tax for an extra 1-2 years. Not a huge change, but it will have some impact for those that can rely on other sources of money from retirement to age 72 and can use that timeframe to tax-optimize their withdrawals over life (Roth conversions, gain harvesting, minimizing tax on social security income, minimizing Medicare IRMAA surcharges, etc.).

· Ends the stretch IRA. This provision will force inherited IRAs to be liquidated over 10 years in most circumstances, rather than over the lifetime of the person who inherits the account. No RMDs during the first 9 years. You just need to liquidate by end of year 10. Exceptions: surviving spouse, disabled, chronically ill, not more than 10 years younger than the deceased owner, and minor children of the deceased (until they reach the Age of Majority). This is a big negative for most who stand to inherit a 401k or IRA, and that’s intended since this provision is the primary “pay-for” of the bill in its ability to raise tax revenue. It stinks, but it’s hard to argue with it. Deceased people don’t need retirement accounts and therefore the tax benefits that go along with them don’t make a ton of sense for those who inherit them. I’m in the minority of advisors in admitting this, but the change seems fair to me… maybe even generous in giving 10 years. This one has major estate planning implications. If one leaves their retirement accounts to a trust that is directed to pay out only the RMD each year to the trust beneficiary (to minimize tax over their lifetime under the old rules), that trust won’t pay anything out for 9 years and then will pay the entire lump sum in year 10, or worse, will retain it and pay tax at trust rates. Estate plans and the wording of such trusts need to be re-evaluated and potentially re-written. If you have such a trust, or have one that will be created at your death by your will (testamentary trust), and your estate attorney doesn’t contact you shortly, you’ll need to reach out to him or her and evaluate if any changes are necessary.

· Add a new provision that up to $10k (lifetime) can be used from a 529 to pay off student debt without Federal tax / penalty. Another $10k to pay off a sibling’s student debt. State rules differ and will likely follow the same path as they followed on the addition of K-12 private school tuition. Sounds wonderful, but are there really a lot of people who have extra 529 money lying around to pay down their or a sibling’s student loans? It also doesn’t make sense to set up a 529 for this purpose (unless it allows you to game the state tax deduction rules). It would make more sense to just pay down the debt, not contribute to a 529 and hope it grows while the student loans continue to accrue interest at the same time.

· Reverses the Kiddie Tax changes made by TCJA which taxed investment income of minors at estate & trusts tax rates instead of parent rates. Back to parent rates now. This one has nothing to do with retirement. There was just a lot of pushback especially when people realized the Kiddie Tax applies to Military Survivor’s Benefits and the TCJA exposed much more of that to higher tax. Now it’s “fixed” back to the old rules.

Relevant Tax Extenders

· The deduction for mortgage insurance (PMI) expenses returns for those who itemize.

· The threshold to deduct medical expenses for those who itemize is 7.5% of adjusted gross income (down from 10% without the extenders).

· The qualified tuition deduction, which doesn’t require itemizing, is back (max $4k, income restrictions apply as before).

All of the above tax extenders apply for tax years 2019 and 2020. They expire again for 2021 unless further extended by future legislation.