By Carl Hollister, President L.M. Kohn and Company, and Garry Kohn, CFP®, President Kohn Wealth Management Advisors
On December 23, 2022, the U.S. House of Representatives passed the Consolidated Appropriations Act of 2023, which includes the much-anticipated second iteration of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. SECURE Act 2.0, as it’s come to be known, is one of the most comprehensive retirement plan changes in many years. And advisors need to be familiar with the changes contained in this legislation to be able to better serve their clients. In this article, we’ll discuss a few of these takeaways and what they mean for advisors’ customers.
Required Minimum Distributions (RMDs)
The updates contained within SECURE Act 2.0 have many implications for those reaching retirement age, most notably continuing to raise the age for RMDs beyond what the original SECURE Act outlined from 72 to 73 for individuals born between 1951 and 1959, and age 75 for those born in and after 1960.
As it stands today, penalties for missing an RMD are 50% of the RMD amount. For example, if a client is required to take a $10,000 RMD and misses it, they will be required instead to take out $15,000. Under SECURE Act 2.0, this penalty is reduced to 25%. And provided that it’s rectified within a correction window before tax time (April 15), the penalty is further reduced to 10%. However, clients cannot file an extension on their tax deadline to get more time.
Implications on 529 Plans and Student Loans
Historically, a big objection to the 529 tax-advantaged education savings plan has been the difficulty in recouping contributions to the plan if the beneficiary does not go to college or does not use all of the funds for educational purposes. Beginning January 1, 2024, the SECURE Act 2.0 will allow for the 529 funds to be rolled over into a Roth IRA in the beneficiary’s name. To do this, several conditions must be met. First, the Roth IRA receiving the rollover funds has to be in the same name as the beneficiary of the 529 plan. The 529 plan must have been maintained for at least 15 years. Any contributions to the 529 plan made in the last five years (as well as any earnings on those contributions) are ineligible to be moved to the Roth IRA. There is also an annual limit, currently $6,500 for those under 50 years of age, which counts toward the beneficiary’s total annual contribution limits for that account, and a lifetime maximum of $35,000. Lastly, the beneficiary has to have earned income for 529 funds to be rolled into their Roth IRA.
There are a number of advantages of 529 plan-to-Roth IRA transfers compared to regular Roth IRA contributions. Specifically, while individuals are prohibited from making regular Roth IRA contributions once they’ve hit their Modified Adjusted Gross Income threshold, the SECURE Act 2.0-authorized transfers of funds from 529 plans to Roth IRAs will not be subject to the same limitations. This is a good opportunity for clients of high net worth to start up a retirement plan for their children or grandchildren.
Concerning student loans, there are also some opportunities for employers who have staff members with student loan debt. SECURE Act 2.0 gives these employers an option to treat employees’ payments to their qualified student loans as contributions to a retirement plan and qualify for a retirement plan match if they offer this benefit. To qualify, employers should confirm that the vesting and matching schedules are the same as if the employees’ student loan payments had been salary deferrals. This gives the employer some tax benefits while also allowing them to offer an attractive benefit for their employees.
It’s important to note that there are still a lot of details left “up in the air” by the current legislation on these new policies for 529 plans and student loans. For example, concerning the 15-year minimum before assets contributed to a 529 plan can be moved to a Roth IRA; how is this affected if the owner of the plan changes the beneficiary? Does the 15-year period reset, or retain the original start date? Additional clarification from the government is required to clear up these details.
In what has been interpreted by some as a significant technical error, SECURE Act 2.0 Section 603 mandates that for high-wage earners making $145,000 or more per year, catch-up contributions must be paid on an after-tax, Roth basis. This applies to catch-up contributions to 401(k), 403(b) and 457 plans, but not to catch-up contributions for IRAs.
However, the specific language used by this provision appears to create a number of loopholes for some clients. First, it says that the Roth restriction only applies to those whose “wages” exceed $145,000, appearing to allow self-employed workers to continue to have the opportunity to make pre-tax catch-up contributions, even if they earn more than $145,000. Additionally, the language states that the Roth restriction applies to wages paid to the individual in “the preceding calendar year from the employer sponsoring the plan.” Therefore, if an individual (50 years of age or older) earning $145,000/ year or more with employer A would change jobs midyear to employer B (also earning $145,000/ year or more), they could technically contribute to the new employer’s retirement fund because they had not yet earned the cutoff limit of $145,000 during that calendar year.
The implications of Section 603 have many custodians scrambling to set up custody Roth options to accept these after-tax catch-up contributions. Technically speaking, the IRS hasn’t provided enough guidance through the Department of Labor to allow the development of prototype accounts. And according to the law, if an employer’s plan includes employees who are eligible to make catch-up contributions and who earned above the $145,000 limit the previous year, and if the plan does not include a Roth catch-up contribution option, then no one on the plan is allowed to make catch-up contributions regardless of the amount they earned the previous year.
Currently, for those individuals over the age of 50, catch-up contributions up to $7,500 for qualified plans and $3,500 for Simple IRA plans are allowed. Qualified plan catch-up provisions will be indexed to inflation beginning in 2026, and catch-up contributions to IRAs will be indexed to inflation beginning in 2024. Starting in 2025, those aged 60-63 will have the ability to catch up the greater of $10,000 or 50% more than the regular catch-up contribution limit (currently $7,500). This provision reverts to the pre-SECURE Act limits at age 64. But again, these contributions are required to be made to a Roth side of the individual’s retirement plan.
Retirement Plan Inheritance Rules
SECURE Act 2.0 extends the number of options for surviving spouses who have inherited a retirement account by introducing an irrevocable election for the surviving spouse to be treated as the deceased spouse. This is of considerable value for an older spouse whose younger spouse passes before them, because it would delay RMDs for the surviving spouse until the deceased spouse would have reached the age at which RMDs begin.
If both spouses die, the beneficiary of the retirement account has a 10-year limit to take the funds from the account. This 10-year period is calculated from the date of death, and not the date the IRA was established. This is a departure from the current rules, as previously it was common for higher earners to create a conduit trust to ensure the beneficiary didn’t spend down their inheritance too quickly. SECURE Act 2.0 changes this, requiring these trusts to adhere to the 10-year rule.
Additionally, these withdrawals are not treated like RMDs and there is no requirement to take a distribution every year.
With these new rules at heart, advisors should look at their clients’ beneficiary designations and make any changes necessary while the client is still alive. Beneficiary designations become irrevocable upon the death of the client.
Qualified Charitable Contributions (QCDs)
One additional consideration from SECURE Act 2.0 is a change to Qualified Charitable Distributions from an IRA or other retirement plan. Where previously individuals of RMD age were allowed to give QCDs up to their RMD amount that year to qualifying charities, now it’s a maximum amount of $100,000 donation (indexed to inflation) made directly from the custodian to the charity. This is especially important for clients on Medicare, since Medicare is based on the client’s gross income. There’s an opportunity here for clients to take money from their account and give it to a charity of their choice, without having to pay taxes on the money or affecting their Medicare premium.
As you can see, there is still a lot to be clarified in the details of SECURE Act 2.0. Expect more takeaways from the thought leaders at L.M. Kohn as this legislation develops.
For more information on SECURE Act 2.0 and what advisors need to know, contact us.