TRICKS OF THE TRADE
Summary of SECURE 2.0 Bill
Prepared by: Michael Menninger, CFP®
The SECURE Act 2.0 is part of the spending bill released on December 19, 2022 and signed into law on December 29, 2022. During the past year we have heard a lot about SECURE 2.0 and were unsure if it would be passed this year. For the most part, SECURE 2.0 builds on the work of the SECURE Act of 2019 which expanded access to employer retirement plans and encouraged employee use of the plans.
Before launching into the rule changes, I would like to answer the question that is frequently asked regarding law changes, “Is this permanent?” Well, the answer is “yes” it is permanent, until they change it. In other words, “no”, they aren’t permanent.
1. RMD Age – The age in which IRA owners must begin withdrawing from their accounts (RMD, or Required Minimum Distributions) has changed from age 72 to 73 beginning in 2023. As one may recall, the RMD age was just changed from 70.5 to 72 in 2020. The rule also states that the RMD age will go to age 75 in year 2033. In addition to the age change, the IRS penalty for not taking the RMD has been reduced from 50% to 25%.
Our Take: The gov’t is implying that people are living longer, so the RMD beginning age should be extended accordingly. However, the IRS will eventually need to raise taxes in order to make up for the budget deficit and mounting debt, so they are losing this source of tax revenue. In our experience, people who need their retirement accounts as a source of income are already taking it, so the RMD mostly applies to those who don’t need the money. If so, then why delay the taxation of those monies? As for the tax penalty, we always believed that 50% was excessive.
2. Automatic Enrollment - For plans starting after January 1, 2025, employees must be automatically enrolled at a 3% (pre-tax) deferral rate with a required feature that escalates automatically enrolled employees by 1% each year, up to a 10% cap. Small businesses with 10 or fewer employees, churches, governmental employers and employers that have been in business for less than three years are excluded.
Our Take: This is a great idea to encourage new employees to contribute to their retirement plan at work. However, we understand that they still have the opportunity to reduce it to 0% if they choose.
3. Catch Up Contributions – Beginning Jan 1, 2024, catch-up contributions must be made as Roth (after-tax) contributions for any participant who earns more than $145,000 (as indexed). For participants between the ages of 60-63, the catch-up limit is increased to the greater of $10,000 or 50% more than the regular catch-up amount. These amounts will be indexed for inflation after 2025 and this provision is effective for tax years beginning in 2025.
Our Take: This represents two independent concepts. The first concept is to make the catchup contribution after tax, which limits the amount of tax-deductible contributions to a retirement plan for higher earners. This is consistent with the comment above that the IRS needs to increase its revenue. The second part is that the catchup limit goes up between ages 60 – 63. That is great, but why limit to only those few years? The concept of the catchup contribution is terrific, as it allows participants over age 50 to contribute more to their retirement plan to make up for lost time. This is common, because many workers weren’t contributing enough to their retirement plans while their cost of living was higher during child-raising years. So, if they are allowing an even greater catch up limit, why for only a few years?
4. Start Up Credit Increased - The credit has increased from 50% of administrative costs up to $5,000 to 100% for employers that have 50 or fewer employees, with a per employee cap of $1,000. The credit phases out for employers with 51 to 100 employees. This is effective for plan years beginning January 1, 2023.
Our Take: We love this, as it provides an increased incentive for small employers to start a new retirement plan for their employees. In the past, it was cost prohibitive for many employers to start a plan, and this makes it nearly cost-free to do so, except if the employer chooses to make matching or non-elective contributions.
5. Student Loan Payments Treated as Deferrals – For employees making student loan payments, they can be treated as deferrals to their retirement plan, enabling them to receive their company match.
Our Take: In short, this was designed for those workers (usually younger) who are burdened with student loan payments and are inhibited in making deferrals to their retirement plan because of those loan payments. We like the idea, but wonder how this will be administered and tracked by the employer.
6. Employer Match May Be Treated as Roth Contributions - This is optional and permitted for 401(k), 403(b) and governmental 457(b) plans. This is effective immediately and the plan would have to permit this.
Our Take: This is our favorite change, but we have not seen specifics regarding its implementation and administration. We have been preaching for years that under current and projected tax laws, a vast majority of workers are in a lower marginal tax bracket today than they will be in retirement, suggesting they should be taking advantage of Roth contributions whenever possible. Unfortunately, the employee had no control over the company matching contributions until now.
The uncertainty lies in the administration of this program. We surmise that if the employer matches with post-tax dollars, they will still get the deduction, so the employee will be responsible for the tax on those dollars. Will it raise their income tax withholding each pay, or will they be subject to a surprise when they file taxes in April? We believe the former, which means that the payroll companies will need to make adjustments as well. The next question is what happens if the matching contributions aren’t fully vested, and the employee terminates employment? Again, this was not addressed, but we suspect that the employee will get a tax deduction for any unvested dollars (their after-tax cost basis) forfeited back to the plan. More administration for the employer and plan sponsor, but a great idea nevertheless.
If the employer adopts this option, it will require them to make changes to the Plan Document, which usually will cost some money. We encourage employers to review their plan document and make all the changes at once, because there is typically one cost for doing so, regardless of the number of changes. If so, then the employer should adopt the Roth component, as well as the ability for the employee to convert to Roth inside the plan. This has little to no cost to the employer, but provides a tremendous benefit to some employees who choose to take advantage of these features.
7. Saver’s Match - Currently there is a credit for employees who make contributions to a retirement plan based on their income. The credit is being changed from a tax refund to a federal matching contribution that must be paid into a taxpayer’s IRA or retirement plan.
Our Take: This is a little-known rule, mainly because it doesn’t apply to very many people, particularly under the current tax code with such a large standard deduction. There is a very narrow range of income for this to make practical sense, but we have recommended it before. In that narrow range, one could contribute $2,000 to a Roth IRA and get a $1,000 tax credit for doing so. They could immediately withdraw their $2,000 and walk away with a $1,000 IRS tax credit. The same applies now, but the gov’t would make a matching contribution to that plan instead of a tax credit when filing taxes. We have no idea how the gov’t will administer this program, nor do we understand why the gov’t enacted this change. But again, this affects so few people, it’s not worth getting excited about.
8. Emergency Savings Account - Optional emergency savings accounts up to $2,500 for non-highly compensated employees. Contributions are treated as Roth deferrals, eligible for matching contributions, and distributions are treated as qualified distributions so that earnings are non-taxable.
Our Take: This is a nice feature, but also makes it too easy for some participants to withdraw from their retirement account. There was also no mention as to whether the employee could return the money back to the plan, and during what period of time.
There are many more feature to the SECURE 2.0 bill. We are still analyzing the bill but there are many key features that will require explanation regarding their execution. There is still much more information to come from the IRS and Department of Labor. Overall, we think SECURE 2.0 will help participants and employers save for retirement, which will help them to fulfill life.
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