Significant Retirement Planning Opportunities in SECURE 2.0 Act
Signed into law December 29, 2022, the SECURE 2.0 Act is a major piece of legislation – and a follow up to the 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act. Certain provisions of the 2019 SECURE Act were previously addressed in this earlier blog: Tax Update: New Proposed Rules Affecting Required Minimum Distributions.
The following is a summary of some of the more significant provisions of the SECURE 2.0 Act (“the Act”):
Provisions benefiting individualsTax-free rollovers from 529 accounts to Roth IRAs. After 2023, the Act permits beneficiaries of 529 college savings accounts to make up to $35,000 over their lifetime of direct trustee-to-trustee rollovers from a 529 account to their Roth IRA without tax or penalty. The 529 account must have been open for more than 15 years, and the rollover is limited to the amount contributed to the 529 account (and its earnings) more than five years earlier. Rollovers are subject to the Roth IRA annual contribution limits, but they are not limited based on the taxpayer's AGI.
Age increased for required minimum distributions (RMDs). Under the Act, the age used to determine required distribution beginning dates for IRA owners, retired employer plan members, and active-employee 5%-owners increases, in two stages, from the current age of 72 to age 73 for those who turn age 72 after 2022, and to age 75 for those who attain age 74 in 2032.
- This is a change in the RMD rules from information outlined in the aforementioned blog.
- Planning caution – Taking advantage of the Act provisions could mean having to withdraw a larger amount later, and possibly having to pay more in taxes when you start your RMDs. There may also be negative tax effects on non-spousal beneficiaries.
More penalty-free withdrawals permitted. The Act includes several changes regarding retirement plan early withdrawals and related penalties as follows:
- After 2023, there is a new exception to the 10% pre-age-59½ penalty tax: One distribution per year of up to $1,000 used for emergency expenses to meet unforeseeable or immediate financial needs relating to personal or family emergencies. The taxpayer has the option to repay the distribution within three years. No other emergency distributions are permissible during the three-year period unless repayment occurs.
- Similarly, plans may permit participants that self-certify having experienced domestic abuse to withdraw the lesser of $10,000, indexed for inflation, or 50% of their account without incurring the 10% tax on early distributions. The participant can repay the withdrawn money from the retirement plan over three years and get a refund of income taxes on money that is repaid. Also, the additional 10% early distribution tax no longer applies to distributions to terminally ill individuals.
- Beginning December 29, 2025, retirement plans may make penalty-free distributions of up to $2,500 per year for payment of premiums for high quality coverage under certain long term care insurance contracts.
- Retroactive for disasters occurring after January 25, 2021, penalty-free distributions of up to $22,000 may be made from employer retirement plans or IRAs for affected individuals. Regular tax on the distributions is considered as gross income over three years. Distributions can be repaid to a tax preferred retirement account. Additionally, amounts distributed prior to the disaster to purchase a home can be recontributed, and an employer may provide for a larger amount to be borrowed from a plan by affected individuals and for additional time for repayment of plan loans owed by affected individuals.
- The Act also contains an emergency savings provision that allows employers to offer non-highly compensated employees emergency savings accounts linked to individual account plans that automatically opt employees into these accounts at no more than 3% of their salary, capped at a maximum of $2,500. Employees can withdraw up to $1,000 once per year for personal or family emergencies without certain tax consequences.
- The Act specifies that earnings attributable to excess IRA contributions that are returned by the taxpayer's tax return due date (including extensions) are exempt from the 10% early withdrawal tax. The taxpayer must not claim a deduction for the distributed excess contribution. This applies to any determination of, or affecting, liability for taxes, interest, or penalties made on or after December 29, 2022.
Favorable surviving spouse election. For plan years after 2023, the surviving sole spousal designated beneficiary of an employee who dies before RMDs have begun under an employer qualified retirement plan may elect to be treated as if the surviving spouse were the employee for purposes of the required minimum distribution rules. If the election is made, distributions need not begin until the employee would have had to start them.
- This provision allows a designated spousal beneficiary to receive a similar distribution period for lifetime distributions under an employer plan as is permitted if the surviving spouse rolled the amount into an IRA.
- The IRS will prescribe the time and manner of the election, which, once made, may not be revoked without IRS consent.
Retirement Plan and Small Business ProvisionsAutomatic salary deferral enrollment. For plan years beginning after 2024, the Act provides that a plan that permits salary deferrals generally will not be treated as a qualified cash or deferred arrangement or annuity contract unless it includes an automatic contribution arrangement (EACA) that satisfies these requirements:
- it must allow permissible withdrawals within 90 days after the first elective contribution,
- automatic contributions must be 3% to 10% during a participant's first participation year, unless the participant elects out, automatically increasing by one percentage point each year to between 10% and 15% (but no more than 10% for plan years ending before 2025 for any non-"safe harbor" plan); and
- if the participant makes no investment election, automatically contributed amounts must be invested in accordance with DOL default investment rules.
New "starter” 401(k) plans. The Act establishes two new kinds of retirement plan designs for plan years beginning after 2023, which smaller employers may be inclined to offer to employees due to their eased costs and administrative burdens:
- a new type of section 401(k) plan called a starter 401(k) deferral-only arrangement, which is a cash or deferred arrangement maintained by an eligible employer that automatically satisfies the actual deferral percentage (ADP) nondiscrimination test. An employer can generally offer this type of plan only if it maintains no other plan in that year. All employees who meet the plan's age and service requirements must be eligible to participate.
The contribution percentage must be from 3% to 15%, applied uniformly. Employees may elect out or choose to contribute at a different level. No matching or nonelective contributions are permitted. Employee elective contributions for a calendar year may not exceed $6,000, adjusted for inflation, but catch-up contributions of up to $1,000, inflation indexed, are permitted for employees who are age 50 and over.
- a new type of 403(b) plan called a safe harbor deferral-only plan, for which requirements like those described for starter 401(k) deferral-only arrangements apply.
Change in tax treatment of catch-up contributions for high-income individuals. For tax years beginning after 2023, individuals whose wages for the preceding calendar year exceed $145,000 (indexed for inflation) are subject to mandatory Roth tax treatment on their catch-up contributions (i.e., only the “regular” contribution limit is allowed to be made on a pre-tax basis). Employers must include and account for designated Roth contributions for these employees, even if the plan does not provide participants with the opportunity to make designated Roth contributions. This rule does not apply to simplified employee pensions under IRC Sec 408(k) or to SIMPLE IRAs under IRC Section 408(p).
Contribution changes for SIMPLE plans. Employers with SIMPLE plans currently must either make contributions for employees of 2% of compensation or match employee elective deferral contributions up to 3%. For tax years beginning after 2023, the Act permits an employer to make additional contributions to each employee of the plan in a uniform manner, of up to the lesser of up to 10% of compensation or $5,000 (indexed).
For employers with no more than 25 employees, the Act increases the SIMPLE annual deferral limit and the catch-up contribution at age 50 by 10%, compared to the limit that would otherwise apply in the first year this change is effective (tax years after 2023). Employers with 26 to 100 employees could provide for higher deferral limits, but only if they either provide a 4% match or a 3% employer contribution. Similar changes to the contribution limits also apply for SIMPLE 401(k) plans.
Bigger tax credit for start-up retirement plans. The Act improves the small employer pension plan start-up cost credit in three ways for tax years starting after 2022.
- First, it makes the credit equal to the full amount of creditable plan start-up costs for employers with 50 or fewer employees (up to an annual cap). Previously only 50% of costs were allowed. The law remains unchanged for employers with 51 to 100 employees).
- Also, retroactive to tax years beginning after December 31, 2019, the Act fixed a technical glitch that prevented employers who joined multi-employer plans that were in existence for more than three years from claiming the start-up cost credit. Employers that joined a pre-existing multi-employer plan in 2020 or 2021 should contact their tax advisor regarding filing amended returns to claim the credit.
- Perhaps the biggest change is that certain employer contributions for a plan's first five years now may qualify for the credit. The credit is increased by a percentage of employer contributions, up to a per-employee cap of $1,000: It is 100% in the plan's first and second tax years, 75% in the third year, 50% in the fourth, and 25% in the fifth. For employers with between 51 and 100 employees, the contribution portion of the credit is reduced by 2% times the number of employees above 50.
- In addition, no employer contribution credit is allowed for contributions for employees who make more than $100,000 (adjusted for inflation after 2023). The credit for employer contributions also is not available for elective deferrals or contributions to a defined benefit pension plan.
Plan amendments may be required. Most retirement plans will need to be amended to comply with some of the provisions of the Act. The deadline for plan amendments made under the Act or any related IRS or DOL regulation is the end of the first plan year beginning on or after January 1, 2025 (2027 for governmental and collectively bargained plans). In the interim, a plan that operates as if a retroactive amendment were already in effect generally will not be treated as violating the anti-cutback rules.
This article summarizes several of the more than 90 retirement plan provisions included in the SECURE 2.0 Act. Please contact your Herbein tax advisor to further discuss these items, or other aspects of the Act that may affect retirement planning for you or your small business.
Article Contributed by Deane Markle