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Canopy Commentary - SECURE Act 2.0

Canopy Commentary - SECURE Act 2.0

January 04, 2023

Raise your hand if you think Congress should get out of the habit of passing tax legislation hours before the end of the year, leaving the professionals with no time to plan for it.  In the waning days of 2022, Congress passed the Consolidated Appropriations Act of 2023, which authorizes roughly a year of federal spending ($1.7 trillion worth) and includes what has been referred to as SECURE Act 2.0, with several provisions that may be of interest to financial consumers.

One provision of interest to many retirees is a small push-back of the age when required minimum distributions (RMDs) from retirement accounts such as IRAs begin.  Previously, distributions were first required in the year that the account owner reached age 72, and the distributions would be an increasing percentage of the retirement assets for each subsequent year.

The new law has moved the RMD age from 72 to 73 for anyone who reaches age 72 in 2023 or thereafter.  Furthermore, anyone who reaches age 74 after December 31, 2032 will have RMDs begin at age 75.  SECURE 2.0 has no impact on those who are already subject to RMDs (those who turned 72 prior to 2023); they must continue to follow the same formula.

One of the most draconian penalties in the tax code applies if someone fails to satisfy their full RMD in any tax year; the IRS penalty is an excise tax equal to 50% of the required amount that was not distributed.  In the new bill, Congress reduced that excise tax to 25%, and further reduced it to 10% if the account owner catches and corrects the distribution before the next tax return is due or before the IRS sends a demand letter.

Beyond that, there are several of what Congress must believe are enhancements to the existing panoply of retirement plan options.  Previously, participants in an employer-sponsored Roth retirement account (such as a Roth 401k) were subject to RMDs; now they are not—which levels the playing field with Roth IRAs, which were never subject to RMDs.  The bill would allow employers to offer Roth versions of SIMPLE and SEP plans as well; previously those plans could only include pre-tax funds.  Employers will now be permitted to deposit matching contributions into these Roth accounts, which would be included in the employee’s taxable income in the year of the contribution.

Also, a provision would allow employers to make matching contributions to a 401(k), 403(b) or SIMPLE IRA plan for qualified student loan payments—that is, payment on the debt incurred for higher education purposes.

Speaking of higher education, people with funds in a state-sponsored 529 college savings plan are now able to transfer excess funds into a Roth IRA, up to a maximum of $35,000.  The bill requires that the Roth IRA receiving the funds be in the name of the beneficiary of the 529 plan, and the 529 account must have been in existence for 15 years or longer.  Any contributions made in the most recent five years, and earnings on those contributions, are not eligible for this transfer. 

People over age 50 have been able to make an additional $1,000 contribution to their IRA or Roth IRA, known as a catch-up contribution.  But that amount has never been indexed to inflation.  Now, starting next year, the catch-up contribution limit will be indexed to inflation, in increments of $100.  Meanwhile, starting in 2025, participants aged 60-63 will be permitted to make catch-up contributions of $10,000 (up from the current $7,500) in their 401(k) plan, or $5,000 if they are participants in a SIMPLE plan.

Beyond that, the bill provides for various new exceptions to the 10% penalty tax imposed on withdrawals from retirement accounts before age 59 1/2, and it creates a new type of ‘Emergency Savings Account’ that employers could set up for plan participants who do not own more than a 5% interest in their employer or receive more than $135,000 in compensation.  The employees can make tax-deductible cash contributions until the account reaches $2,500, and the funds grow tax-free thereafter.  The idea is that this money will be used whenever the family faces an emergency.

Two areas where many people expected changes did not occur.  The federal estate tax exemption was not reduced (with inflation indexing, it will be $12,920,000 in 2023; double that amount for married couples), and so-called ‘back-door’ Roth contributions were not eliminated.

If Congress must put tax legislation on the books in the waning minutes of the year, at least we can be grateful that most of the provisions are positive ones, and that they don’t require an end-of-the-year planning scramble.  (You can put your hand down now.)