#SECUREACT2.0

Approximately 78% of people who work for companies with fewer than 10 employees and about 65% of those who work for companies with 10 to 24 employees do not have access to a retirement plan at work.(1) That’s unfortunate, because workers with a retirement plan are far more likely to save for retirement than those without a plan. In 2022, 62% of those without a retirement plan had accumulated less than $1,000 for retirement, compared with 71% of those with a plan who had saved at least $50,000. More than four in 10 workers with access to a work-based plan had amassed a quarter million dollars or more.(2)

In December 2022, Congress aimed to address this issue (among others) by passing legislation that will help small employers more efficiently and cost-effectively offer retirement plans to their workforces, while providing incentives to help improve participation rates among lower-income workers. The SECURE 2.0 Act of 2022 — so named because it builds upon the original Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in 2019 — is a sweeping set of provisions designed to improve the nation’s retirement-planning health. Here is a brief look at some of the tax perks, rule changes, and incentives included in the legislation.

Tax Perks for Employers in 2023

Perhaps most appealing to small business owners, the Act enhances the tax credits associated with adopting new retirement plans, beginning in 2023.

For employers with 50 employees or less, the pension plan start-up tax credit increases from 50% of qualified start-up costs to 100%. Employers with 51 to 100 employees will still be eligible for the 50% credit. In either case, the credit maximum is $5,000 per year (based on the number of employees) for the first three years the plan is in effect.

In addition, the Act offers a tax credit for employer contributions to employee accounts for the first five tax years of the plan’s existence. The amount of the credit is a maximum of $1,000 for each participant earning not more than $100,000 (adjusted for inflation) in income. Each year, a specific percentage applies. In years one and two, employers receive 100% of the credit; in year three, 75%; in year four, 50%; and in year five, 25%. The amount of the credit is reduced for employers with 51 to 100 employees. No credit is allowed for employers with more than 100 workers.

Rule Changes and Relevant Years

In 2024, employers will be able to adopt a deferral-only starter 401(k) or safe-harbor 403(b) plan, which are designed to be lower cost and easier to administer than traditional plans. Both plan types have auto-enrollment features and accept employee contributions only. Employees are enrolled at minimum contribution rates of 3%, not to exceed 15%, and may opt out. The plans may accept up to $6,000 per participant annually ($7,000 for those 50 and older), indexed for inflation.

SIMPLE plans may benefit from two new contribution rules. First, employers may make nonelective contributions to employee accounts up to 10% of compensation or $5,000. Second, the annual contribution limits (standard and catch-up) for employers with no more than 25 employees will increase by 10%, rather than the limit that would otherwise apply. An employer with 26 to 100 employees would be permitted to allow higher contributions if the employer makes either a matching contribution on the first 4% of compensation or a 3% nonelective contribution to all participants, whether or not they contribute. These changes also take effect in 2024.

Beginning in 2025, 401(k) and 403(b) plans will generally be required to automatically enroll eligible employees and automatically increase their contribution rates every year, unless they opt out. Employees will be enrolled at a minimum contribution rate of 3% of income, and rates will increase each year by 1% until they reach at least 10% (but not more than 15%). Not all plans will be subject to this new provision. Exceptions include those in existence prior to December 29, 2022; those sponsored by organizations less than three years old or employing 10 or fewer workers; governmental and church plans; and SIMPLE 401(k) plans.

Incentives for Participation

SECURE 2.0 drafters were creative in finding ways to encourage workers, particularly those with lower incomes, to take advantage of their plans. For example, effective immediately, employers may choose to offer small-value financial incentives, such as gift cards, for joining a plan. Beginning in 2024, employers may provide a matching contribution on employee student loan payments, which should help encourage younger workers to plan for their future. Also in 2024, workers will be able to withdraw up to $1,000 a year to cover unforeseeable or immediate emergencies without having to pay a 10% early distribution penalty, which should help address the fear of locking up retirement-plan contributions for many years. Employees will have up to three years to repay the emergency distributions and will not be able to take a second emergency distribution during this three-year period unless the first has been reimbursed.

Source:

1) AARP, July 2022

2) Employee Benefit Research Institute, 2022

Prepared by Broadridge. Edited by BFSG. Copyright 2023.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

The SECURE 2.0 Act, passed as part of an omnibus spending bill in December 2022, added new exceptions to the 10% federal income tax penalty for early withdrawals from tax-advantaged retirement accounts. The Act also expanded an existing exception that applies specifically to employer plans. These exceptions are often called 72(t) exceptions, because they are listed in Section 72(t) of the Internal Revenue Code.

The 10% penalty tax generally applies to withdrawals prior to age 59½ from IRAs, employer-sponsored plans [such as 401(k) and 403(b) plans], and traditional pension plans, unless an exception applies. The penalty is assessed on top of ordinary income taxes.

New exceptions

Here are the new exceptions with their effective dates. Withdrawals covered by these exceptions can be repaid within three years to an eligible retirement plan. If repayment is made after the year of the distribution, an amended return would have to be filed to obtain a refund of any taxes paid.

• Disaster relief — up to $22,000 for expenses related to a federally declared disaster if the distribution is made within 180 days of the disaster occurring; included in gross income equally over three years, beginning with the year of distribution, unless the taxpayer elects to report the full amount in the year of distribution (effective for disasters on or after January 26, 2021)
• Terminal illness — defined as a condition that will cause death within seven years as certified by a physician (effective 2023)
• Emergency expenses — one distribution per calendar year of up to $1,000 for personal or family emergency expenses to meet unforeseeable or immediate financial needs; no further emergency distributions are allowed during the three-year repayment period unless the funds are repaid, or new contributions are at least equal to the withdrawal (effective 2024)
• Domestic abuse — the lesser of $10,000 (indexed for inflation in future years) or 50% of the account value for an account holder who certifies that he or she has been the victim of domestic abuse (physical, psychological, sexual, emotional, or economic abuse) during the preceding one-year period (effective 2024)

Expanded exception for employer accounts

The 10% penalty does not apply for distributions from an employer plan to an employee who leaves a job after age 55, or age 50 for qualified public safety employees. SECURE 2.0 extended the exception to public safety officers with at least 25 years of service with the employer sponsoring the plan, regardless of age, as well as to state and local corrections officers and private-sector firefighters.

Previously established exceptions

These exceptions to the 10% early withdrawal penalty were in effect prior to the SECURE 2.0 Act. They cannot be repaid unless indicated. Exceptions apply to distributions relating to:

• Death or permanent disability of the account owner
• A series of substantially equal periodic payments for the life of the account holder or the joint lives of the account holder and designated beneficiary
• Unreimbursed medical expenses that exceed 7.5% of adjusted gross income
• Up to $5,000 for each spouse (from individual accounts) for expenses related to the birth or adoption of a child; can be repaid within three years to an eligible retirement plan
• Distributions taken by an account holder on active military reserve duty; can be repaid up to two years after end of active duty to an individual retirement plan
• Distributions due to an IRS levy on the account
• (IRA only) Up to $10,000 lifetime for a first-time homebuyer to buy, build, or improve a home
• (IRA only) Health insurance premiums if unemployed
• (IRA only) Qualified higher education expenses

These exceptions could be helpful if you are forced to tap your retirement account prior to age 59½. However, keep in mind that the greatest penalty for early withdrawal from retirement savings may be the loss of future earnings on those savings. Some employer plans allow loans that might be a better solution than an early withdrawal.

Retirement account withdrawals can have complex tax consequences. Consult your tax professional before taking specific action.

Prepared by Broadridge. Edited by BFSG. Copyright 2023.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Henry VanBuskirk, CFP®, Wealth Manager

“Who can it be knocking at my door?” It’s the Men at Work and Women at Work in Congress(¹) with new retirement legislation, SECURE Act 2.0. While this new legislation has many positive changes, many of those changes come with added complexity to how the Traditional IRA and Roth IRA contribution limits and catch-up contribution amounts are calculated. For example, the $1,000 catch-up contribution amount for persons aged 50 and older will now be indexed for inflation starting in the 2024 tax year. Further, persons aged 60-63 have an even higher catch-up contribution amount, and then persons aged 64 and older revert back to the $1,000 catch-up contribution amount indexed for inflation rule. The exact wording in the SECURE 2.0 Act is in Sections 108-109 and reads as follows:

Those familiar with the Medicare prescription drug coverage gap usually referred to as the “Medicare Part D donut hole”, know that coverage starts out good, then not so good, and then goes back to being good again. The new catch-up contribution rules in SECURE Act 2.0 for persons aged 50 and older give us a “Reverse Donut Hole”, where catch-up contributions to your Traditional IRA or Roth IRA start off okay, then really good, then go back to being okay. As I’m writing this and thinking through it, a reverse donut hole doesn’t make much sense, so I’m just going to call this catch-up contribution phenomenon created by Congress a donut with no hole. A wise man once said that “…A donut with no hole is a Danish”(²⁾.

Whether you are Danish American, Asian American, African American, or prefer not to specify, chances are you probably want to maximize the potential of your Traditional IRA and/or Roth IRA accounts throughout your lifetime. You also most likely want to also take advantage of the new contribution limits applied by Congress.

The advice that’s generally given is that lower-income earners should contribute to a Roth IRA and higher-income earners should contribute to a Traditional IRA regardless of whether or not that Traditional IRA contribution is deductible or not. However, there is no catch-all solution to this catch-up contribution question for higher-income earners. Our team of CFP® professionals at BFSG can help answer that question for you through a customized financial plan.

If you are a high-income earner that cannot take a deduction on a Traditional IRA contribution and cannot contribute to a Roth IRA (read here for current phaseouts), it may be worth considering a Backdoor Roth IRA strategy. I will illustrate how this strategy works through a case study.

Case Study

Ray Barone (age 40) is a sportswriter for a local Long Island paper making $80,000 per year and is married to Debra Barone (age 40), a homemaker that takes care of their three children. Ray has a Traditional 401(k) at work that he contributes to and does not contribute to any other retirement accounts. Debra does not have any retirement accounts that she contributes to and believes that she is not eligible to contribute to a Traditional IRA or Roth IRA since she doesn’t have any earned income. Ray gets an unexpected call from Sports Illustrated saying that they loved reading his article on the career of retired New York Mets baseball player, Art Shamsky, and offered Ray a job as their Editor in Chief. His salary at Sports Illustrated would be $400,000 per year and full benefits, including a 401(k) plan. Ray almost fell out of his chair when he heard this news since he knew it would mean a significant increase in pay. Ray then asked if he could take time to discuss this job offer with his family and call them back in the morning.

Ray then proceeds to tell Debra, cynical brother Robert, and doting parents Frank and Marie the news and asks what they all think. They have the following conversation:

Debra: “I think this is a great opportunity, go for it, Ray!”

Frank: “Congratulations son, I say take the job.”

Marie: “This is great, Ray! I always knew that one of my sons would be successful!”

Robert: [With a long sigh] “Everybody Loves Raymond.”(³)

Marie: “Robert! Don’t be jealous of Ray’s talent.”

Robert: [Nefariously] “Sorry Ray, I’m happy for you. I really am. Just remember, the higher up the corporate ladder you climb, the further down you have to fall.”

Frank: “Robert, don’t be a jerk to Ray! Maybe I should climb up that corporate ladder and knock some sense into that big head of yours.”

Robert: “Please forgive me, King Ray. I didn’t mean to upset your loyal subjects.”

Ray: “Stop it, everyone! I’ll call Sports Illustrated in the morning and accept their job offer.”

Ray accepts the new job offer but is nervous about making sure his wife and kids have a prosperous future. After Ray starts his new job, Ray and Debra then decide to meet with their advisor, Phil Rosenthal, to have him run a financial plan for them. Ray and Debra’s main goal is to have the greatest possible account value in their retirement accounts so that they can pass on a legacy to their kids. They also know that they need to make sure that Ray continues to contribute to his 401(k) at work.

The Meeting

The first thing Phil recommends is for Ray to maximize his 401(k) contributions at work, which was not a surprise to hear from Ray and Debra. Phil then recommends that Debra start to contribute to a Traditional IRA and make the maximum contribution each year that Ray has earned income. This confuses Debra since she believes that since she has no earned income of her own, she cannot contribute to a Traditional IRA or a Roth IRA. Phil then exclaims, “A non-earning spouse can contribute to a Traditional IRA or Roth IRA as long as the other spouse has earned income.”(⁴⁾ Debra thinks to herself that this is great since with the extra money that Ray is earning, they will be able to afford to contribute to a Traditional IRA for her and Debra asks Phil to run an analysis of what the account could be at her age 100 assuming that she only takes the Required Minimum Distributions (RMDs) in her account and that because of SECURE Act 2.0, her starting age to take RMDs will be age 75. Ray wants to retire at 65 and Ray and Debra want to see the analysis run until their age 100. Phil then proceeds to run the analysis with the following assumptions:

Here is a summary of the results of that analysis based on the assumptions above:

• Total RMDs throughout Debra’s lifetime: $1,087,987.46
• Total Tax on RMDs: $335,644.13

While Phil was running the analysis, Debra reads on the IRS website that they would not be able to take a tax deduction for the contributed amount to her Traditional IRA because Ray makes too much money and also is covered by a 401(k) plan at his work. This leads to the following conversation:

Debra: “Why would anyone contribute to a Traditional IRA now, not be able to deduct the contributed amount, and then pay taxes on their RMDs later in life? I don’t understand the purpose of a nondeductible Traditional IRA.”

Phil: “That’s a great point, Debra. I do recommend contributing to a tax-advantaged account like a Traditional IRA or Roth IRA since the assets in the account will grow tax-deferred. Assets in nonqualified accounts do not grow tax-deferred and taxes could be owed on any dividends, interest, or capital gains earned in the account. The main difference between the Traditional IRA and how you would be able to fund a Roth IRA, you either pay the taxes later in the case of a Traditional IRA or pay taxes now, in the case of a Backdoor Roth IRA strategy. For you and Ray, a Backdoor Roth IRA strategy would be more beneficial to you both in the long run.”

Ray: “What is this Backdoor Roth IRA strategy?”

Phil: “The strategy would be that Debra would contribute to a nondeductible Traditional IRA. She would then immediately convert any amount into a Roth IRA and would repeat this process each year until you retire at 65.”

Ray: “What do you mean by, convert to a Roth IRA?”

Phil: “You establish a Roth IRA and transfer funds from the Traditional IRA. Any funds that are transferred from the Traditional IRA to the Roth IRA are taxable to you as ordinary income. After the funds are in the Roth IRA, they will grow tax-free, and distributions are tax-free as long as the account has been established for 5 years and you are at least age 59.5. A Roth IRA also does not have Required Minimum Distributions.”

Debra: “According to the IRS website, Ray also makes too much money to contribute to a Roth IRA. We can’t do what you are suggesting, Phil.”

Phil: “You are right in that you cannot contribute to a Roth IRA. However, the IRS does allow you to convert existing assets in a Traditional IRA to a Roth IRA. This is referred to as a Backdoor Roth IRA since you have to go through this extra hoop to fund a Roth IRA account because you are above the Roth IRA contribution limit.”

Phil: “What is going on mechanically is you are making after-tax contributions. Instead of receiving a tax deduction for the contribution, your adjusted gross income will stay the same as if you were to never take a tax deduction on the converted amount. You aren’t paying taxes on that nondeductible contribution itself. For example, if a married couple is in the 35% tax bracket with an AGI of $500,000 and decides to make a nondeductible contribution of $5,000 their AGI would still be $5,000. If they could receive a deduction, their AGI could be reduced to $495,000 and their tax bill would be reduced by $1,750. The “tax due from the backdoor Roth” would be this $1,750.”

Debra: “Can you show us the same analysis, but with this Backdoor Roth Strategy?”

Phil: “I’d be happy to.”

Phil then proceeds to run the analysis on the Backdoor Roth Strategy and uses the following assumptions:

The analysis using the assumptions above concluded that the total tax on Roth conversions would be $88,560.43.

Here are a couple of conclusions that we can draw from this analysis:

1. Since Debra would not be subjected to RMDs in a Roth IRA, she would not need to pay taxes on those distributions. That difference in tax savings over their lifetimes is $247,083.70. This is the difference between the total taxes for the Traditional IRA of $335,644.13 and the total taxes for the Backdoor Roth Strategy of $88,560.43.
2. If Ray and Debra decide not to do the Backdoor Roth strategy and did not need the funds from the RMD to live on, they could always reinvest those proceeds in a nonqualified investment account. The nonqualified investment account could grow, and taxes could be owed on any dividends, interest, or capital gains earned on that account. If they needed the funds from the RMDs to live on, they would still owe taxes regardless because they are required to take RMDs on a Traditional IRA.
3. With the Roth IRA strategy, they are able to keep it in a tax-free bucket and not be subjected to RMDs. If they need cash from the Roth IRA to live on in retirement, distributions would be tax-free.
4. Another key factor to consider is that any amount still in the Traditional IRA or Roth IRA at Ray and Debra’s passing would go to their children. Their children would be subjected to the inherited IRA and inherited Roth IRA rules, which declare as of SECURE Act 2.0’s passing, that inherited IRA and inherited Roth IRA accounts are subjected to RMDs on the beneficiary’s life and that the inherited IRA or inherited Roth IRA account must be depleted within 10 years of the original depositor’s death. Inherited IRA distributions are taxable at ordinary income and inherited Roth IRA distributions are tax-free. Not only do Ray and Debra get to enjoy tax-free growth and distributions with a Roth IRA in retirement, but their kids would as well.

Debra and Ray are delighted by the analysis and eager to start the Backdoor Roth Strategy. They proceed to thank Phil for his work and proceed to end the meeting. The next day at work, Ray then thinks about his own 401(k) and if there are additional long-term planning opportunities that they can do. He believes that his plan at work will start to offer employer-matching Roth contributions and not require RMDs from Roth 401(k)s because of the new SECURE Act 2.0 legislation. His thinking comes from the following two sections in the SECURE Act 2.0:

Ray then proceeds to call Phil and ask about this. Phil states, “There might be a financial planning opportunity for you and Debra with a Mega Backdoor Roth strategy. A Mega Backdoor Roth Strategy works similarly to the regular Backdoor Roth Strategy. I am happy to run the numbers for you.” Ray declines since he believes it’s too premature to run the numbers since his company has yet to amend its current 401(k) plan and may not offer matching Roth contributions⁽⁵). Ray feels content for now with Phil’s answer and believes that his financial plan is solid.

Pro-Rata Rule

You may be asking yourself, what if I want to implement a Backdoor Roth strategy or Mega Backdoor Roth Strategy and my existing IRA has some deductible contributions and some nondeductible contributions? In that case, we would need to account for the pro-rata rule. To illustrate the pro-rata rule for an IRA and for a 401(k), we have the following two examples.

IRA: Tom has an IRA worth $100,000 with $30,000 from nondeductible contributions and $70,000 from deductible contributions. If Tom wants to implement a Backdoor Roth Strategy and convert $10,000 from his IRA to a Roth IRA, $3,000 of that converted amount is from nondeductible contributions and $7,000 would be from deductible contributions. Tom would then need to pay tax at ordinary income rates on $7,000 of the $10,000 total converted amount.

This rule is in place so that people implementing Backdoor Roth or Mega Backdoor Roth Strategies aren’t able to pick and choose what converted amounts get taxed and what converted amounts don’t. You will need to make sure to track any nondeductible contributions with the IRS Form 8606 and we strongly recommend working with a trusted tax professional when implementing a Backdoor Roth or Mega Backdoor Roth Strategy.

Conclusion

After reading through this article, you may be thinking why Congress adjusted the catch-up contributions the way they did, why they increased the RMD age to 73 for persons that will be 73 before 01/01/2033 and age 75 for persons that will be 75 after 01/01/2033, or why they had Roth 401(k) RMDs before but now they are getting rid of them. If you are upset about these changes that Congress made, you are free to fill in the following blanks to blame Politician _______ from the ________ Political Party who has Machiavellian intentions to do _________. We aren’t here to judge why Congress does what they do. We just work with the facts that we’re given and plan accordingly. What we do know is that even after the new SECURE Act 2.0, the Backdoor Roth strategy is still available. It may be more beneficial now than ever to consider a Backdoor Roth strategy if your situation is similar to what was described in this article.

Our team of Certified Financial Planners work with you to craft your comprehensive financial plan to understand whether or not a Backdoor Roth strategy is right for you. Please feel free to reach out to us at financialplanning@bfsg.com or 714-282-1566 and let us know how we can be of help. Thank you.

Footnotes:

1. From the ‘80s band, Men at Work, and their song, “Who can it be now?”
2. That great philosopher was Chevy Chase in the movie Caddyshack: https://www.imdb.com/title/tt0080487/.
3. The characters in the case study are from the sitcom, “Everybody Loves Raymond”: https://www.imdb.com/title/tt0115167/.
4. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits
5. If you are interested in learning more about a Mega Backdoor Roth strategy and how it impacts your financial plan, our team of CFP® professionals are happy to analyze how this strategy affects your long-term financial goals.

References:

1. https://www.finance.senate.gov/imo/media/doc/Secure%202.0_Section%20by%20Section%20Summary%2012-19-22%20FINAL.pdf
2. https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2023
3. https://www.irs.gov/retirement-plans/2023-ira-deduction-limits-effect-of-modified-agi-on-deduction-if-you-are-covered-by-a-retirement-plan-at-work
4. https://www.medicare.gov/drug-coverage-part-d/costs-for-medicare-drug-coverage/costs-in-the-coverage-gap

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Please Note: The above projections are based upon historical data and should not be construed or relied upon as an absolute probability that a different result (positive or negative) cannot or will not occur. To the contrary, different results could occur at any specific point in time or over any specific time period. The purpose of the projections is to provide a guideline to help determine which scenario best meets the client’s current and/or current anticipated financial situation and investment objectives, with the understanding that either is subject to change, in which event the client should immediately notify BFSG so that the above analysis can be repeated.

The SECURE 2.0 legislation included in the $1.7 trillion appropriations bill passed late last year builds on changes established by the original Setting Every Community Up for Retirement Enhancement Act (SECURE 1.0) enacted in 2019. SECURE 2.0 includes significant changes to the rules that apply to required minimum distributions from IRAs and employer retirement plans. Here’s what you need to know.

What Are Required Minimum Distributions (RMDs)?

Required minimum distributions, sometimes referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer retirement plans after you reach a certain age, or in some cases, retire. You can withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal tax penalty.

These lifetime distribution rules apply to traditional IRAs, Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs, as well as qualified pension plans, qualified stock bonus plans, and qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also generally subject to these rules. If you are uncertain whether the RMD rules apply to your employer plan, you should consult your plan administrator, a tax professional, or your financial adviser.

Here is a brief overview of the top five ways that the new legislation changes the RMD rules.

1. Applicable Age for RMDs Increased

Prior to passage of the SECURE 1.0 legislation in 2019, RMDs were generally required to start after reaching age 70½. The 2019 legislation changed the required starting age to 72 for those who had not yet reached age 70½ before January 1, 2020.

SECURE 2.0 raises the trigger age for required minimum distributions to age 73 for those who reach age 72 after 2022. It increases the age again, to age 75, starting in 2033. So, here’s when you have to start taking RMDs based on your date of birth:

Your first required minimum distribution is for the year that you reach the age specified in the chart, and generally must be taken by April 1 of the year following the year that you reached that age. Subsequent required distributions must be taken by the end of each calendar year (so if you wait until April 1 of the year after you attain your required beginning age, you’ll have to take two required distributions during that calendar year). If you continue working past your required beginning age, you may delay RMDs from your current employer’s retirement plan until after you retire.

2. RMD Penalty Tax Decreased

The penalty for failing to take a required minimum distribution is steep — historically, a 50% excise tax on the amount by which you fell short of the required distribution amount.

SECURE 2.0 reduces the RMD tax penalty to 25% of the shortfall, effective this year (still steep, but better than 50%).

Also, effective this year, the Act establishes a two-year period to correct a failure to take a timely RMD distribution, with a resulting reduction in the tax penalty to 10%. Basically, if you self-correct the error by withdrawing the required funds and filing a return reflecting the tax during that two-year period, you can qualify for the lower penalty tax rate.

3. Lifetime Required Minimum Distributions from Roth Employer Accounts Eliminated

Roth IRAs have never been subject to lifetime Required Minimum Distributions. That is, a Roth IRA owner does not have to take RMDs from the Roth IRA while he or she is alive. Distributions to beneficiaries are required after the Roth IRA owner’s death, however.

The same has not been true for Roth employer plan accounts, including Roth 401(k) and Roth 403(b) accounts. Plan participants have been required to take minimum distributions from these accounts upon reaching their RMD age or avoid the requirement by rolling over the funds in the Roth employer plan account to a Roth IRA.

Beginning in 2024, the SECURE 2.0 legislation eliminates the lifetime RMD requirements for all Roth employer plan account participants, even those participants who had already commenced lifetime RMDs. Any lifetime RMD from a Roth employer account attributable to 2023, but payable in 2024, is still required.

4. Additional Option for Spouse Beneficiaries of Employer Plans

The SECURE 2.0 legislation provides that, beginning in 2024, when a participant has designated his or her spouse as the sole beneficiary of an employer plan, a special option is available if the participant dies before required minimum distributions have commenced.

This provision will permit a surviving spouse to elect to be treated as the employee, similar to the already existing provision that allows a surviving spouse who is the sole designated beneficiary of an inherited IRA to elect to be treated as the IRA owner. This will generally allow a surviving spouse the option to delay the start of required minimum distributions until the deceased employee would have reached the appropriate RMD age, or until the surviving spouse reaches the appropriate RMD age, whichever is more beneficial. This will also generally allow the surviving spouse to utilize a more favorable RMD life expectancy table to calculate distribution amounts.

5. New Flexibility Regarding Annuity Options

Starting in 2023, the SECURE 2.0 legislation makes specific changes to the required minimum distribution rules that allow for some additional flexibility for annuities held within qualified employer retirement plans and IRAs. Allowable options may include:

• Annuity payments that increase by a constant percentage, provided certain requirements are met
• Lump-sum payment options that shorten the annuity payment period
• Acceleration of annuity payments payable over the ensuing 12 months
• Payments in the nature of dividends
• A final payment upon death that does not exceed premiums paid less total distributions made

It is important to understand that purchasing an annuity in an IRA or an employer-sponsored retirement plan provides no additional tax benefits beyond those available through the tax-deferred retirement plan. Qualified annuities are typically purchased with pre-tax money, so withdrawals are fully taxable as ordinary income, and withdrawals prior to age 59½ may be subject to a 10% federal tax penalty.

These are just a few of the many provisions in the SECURE 2.0 legislation. The rules regarding required minimum distributions are complicated. While the changes described here provide significant benefit to individuals, the rules remain difficult to navigate, and you should consult with a tax professional or your financial adviser to discuss your individual situation.

Footnotes:

1. A technical correction is needed to clarify the transition from age 73 to age 75 for purposes of the required minimum distribution rule. As currently written, it is unclear what the correct starting age is for an individual born in 1959 who reaches age 73 in the year 2032.

Prepared by Broadridge. Edited by BFSG. Copyright 2023.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.