Back in April of 2022, I wrote about the successor to the Setting Every Community Up for Retirement Enhancement (SECURE) Act which was passed in 2019. A package of legislation which has been dubbed the SECURE Act 2.0. As I write this at the end of 2022, the act has been passed by Congress and brings some changes both expected and unexpected. Among the expected changes are the prolonging of required minimum distributions to age 73, increasing catch up contributions for those over 60, and adding the ability for employers to make Roth matching contributions to their employee’s retirement accounts. You can find my previous blog post here but I would encourage you to check out this article which explains each of those changes in their final form[i][ii]. However, some changes were less talked about earlier in the year but no less impactful. Today, let’s take a look at some of the other highlights from the new law of the land.
As I mentioned in my prior post on the subject, the SECURE Act 2.0 fixes a problem with Roth 401(k) contributions by allowing employers to make their matching contributions on a Roth basis as well. However, the act also cleans up another issue in regards to required minimum distributions or RMD’s. Current tax law says that required minimum distributions must be taken from a 401(k) regardless of whether the employee’s contributions are tax deferred or Roth. This differs from IRAs where only traditional IRAs require RMD’s and Roth IRA’s do not. The SECURE Act 2.0 fixes this issue but excluding Roth 401(k) balances from the requirement of RMD’s (starting in 2024). This is good news for plan participants who want to keep their money invested into their 70s. It also incentivizes employees to keep their money in the plan rather than rolling it over to a Roth IRA as is currently the trend. Notably, the new rule will apply even if you have already begun taking RMDs[iii]
529 Roth Transfers
As I mentioned before, SECURE Act 2.0 isn’t actually a stand-alone bill but rather a package of bills and proposals. One such bill was originally called the College Savings Recovery Act and was introduced in the Senate back in June of 2022. I wrote about that bill on our blog in July and you can find that post here[iv]. Safe to say, at the time I had some questions about the bill particularly as it relates to 529 plans being used in ways that they were not intended to be used. Thankfully, the final draft of the bill cleared up many of those questions.
The bill addresses a long-standing problem as it relates to 529 plans: what if I don’t use all of the account for my children’s education and I don’t have anyone to pass the account along to? The bill fixes this problem by allowing the remaining balance in a 529 plan to be transferred to a Roth IRA, however there are some ground rules. Beginning in 2024, 529 balances will be eligible for transfer into a Roth IRA as long as the owner of the Roth IRA is also the beneficiary of the 529. The 529 also needs to have been open for at least 15 years. This removes the potential tax loop hole of parents funding a 529 plan tax deferred only to then turn around and convert it to a Roth for their own benefit. Basically, if you establish an account for benefit of your child, it must remain the benefit of your child or else you will pay a penalty. This presents a fantastic opportunity for parents to pay for their children’s education with the added benefit of helping them start a Roth IRA should there be money left over! Roth transfers will be limited to the annual IRA contribution limits up to a lifetime max of $35,000 and the last 5 years of contributions and earnings are not eligible for transfer.
Retirement plans are meant for a singular purpose, that is, for retirement. The Federal government allows certain tax advantages in the hopes that this will incentivize the American public to save for their own retirement and thus to not be a drain on the economy in the latter years of their life (that might sound cynical but it’s the truth 😊). That said, in exchange for these tax benefits, the government imposes a penalty (usually 10%) on withdrawals before age 59 ½. In recent years however, exceptions have been added that make it easier to take early withdrawals while also avoiding the penalty. This started with the original SECURE Act which was followed by the COVID era CARES Act. The 2.0 version of that prior legislation adds even more exceptions to the early withdrawal penalties rule.
New exceptions to the penalty include those who are suffering from terminal illness or domestic abuse (with some limitations). There is also a carve out for those who are paying for long term care insurance using their IRA funds (again, with limitations). But perhaps the most intriguing new exception to the penalty is for “emergency withdrawals”. What makes this exception unique is that the wording is extremely broad stating that someone is eligible if they experience, “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.” To counter this broad definition of “emergency”, this type of penalty-free withdrawal will be limited to one $1,000 distribution per calendar year. Additional emergency withdrawals will not be eligible for penalty exception until the last withdrawal is paid back into the account, regular deferrals into the account since the distribution equal the amount of that distribution, or 3 years have passed from the last emergency withdrawal.
All of these changes can be overwhelming and complicated (we are still sorting through them ourselves!). If you have questions, I encourage you to reach out to us. I also recommend checking out this blog post from a well-respected financial advisor website which lays out all of the details in all of their nerdy glory! Thanks for reading this week’s post and cheers to another year of “A Wing and a Plan”!
Investing involves risks including possible loss of principal. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Content in this material is for general information only and not intended to provide specific advice or recommendations, or a substitute for specific individualized tax or legal advice.