In late 2022, the retirement planning landscape underwent a significant shift with President Biden’s enactment of the SECURE 2.0 Act. Building on the foundation of the 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act, this new legislation introduces pivotal changes aimed at making retirement savings more accessible and beneficial for Americans.
From increased flexibility in managing retirement funds to expanded saving opportunities, the SECURE 2.0 Act is a game-changer for both retirees and those nearing retirement. In this article, we’ll explore these essential updates and how they can positively shape your retirement planning strategy.
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Addressing the Retirement Savings Crisis: The Role of the SECURE Act & SECURE 2.0
A variety of factors, including the shift from employer-sponsored defined-benefit pension plans to defined-contribution plans, lower savings rates, and longer lifespans are driving a retirement savings crisis in the United States. The convergence of these factors has created a precarious situation where a significant portion of the population feels financially unprepared for retirement.
In fact, more than half of American workers say they’re behind on their retirement savings, and 37% feel “significantly behind,” according to a 2023 Bankrate survey.
The SECURE Act and its subsequent enhancement, SECURE 2.0, aim to address these issues by making retirement savings accounts more accessible to American workers and providing incentives to save. By providing a framework that encourages saving and offers strategic tax planning opportunities, these twin pillars of legislation serve as a vital toolkit for enhancing the financial security of retirees and those preparing for retirement.
SECURE 2.0 Act: Notable Provisions
The SECURE 2.0 Act makes various changes to the rules governing 401(k) plans and Individual Retirement Accounts (IRAs), including adjustments to withdrawal requirements and contribution limits. Here are some of the key provisions affecting retirees and those nearing retirement.
#1: Raised Starting Age for Required Minimum Distributions (RMDs)
One of the most notable aspects of the SECURE 2.0 Act is that it modifies the age threshold for when individuals must begin withdrawing funds from their tax-deferred retirement accounts, such as 401(k)s, 403(b)s, and traditional IRAs.
The original SECURE Act raised the starting age for RMDs from 70½ to 72. However, SECURE 2.0 goes a step further by increasing the RMD age to 73 beginning in 2023 and will increase it again to age 75 starting on January 1, 2033.
By raising the RMD age, retirees can take a more tailored approach to financial planning in their later years. Implications of this change include:
- Extended Investment Horizon. The delay in the RMD start age allows retirement savings to continue to grow tax-deferred, benefiting from the power of compounding for an additional year or more.
- Enhanced Flexibility and Tax Management. This provision gives retirees greater latitude in deciding when and how to withdraw from their retirement accounts, allowing for more time to plan for tax-efficient withdrawals.
- Impact on Social Security and Medicare. By delaying RMDs, retirees might be able to manage their income levels more effectively, potentially reducing the taxation of Social Security benefits and lowering Medicare Part B and D premiums.
- Longer Window for Roth Conversions. Taking RMDs at a later age may provide more time for strategic Roth IRA conversions, a process that involves shifting funds from a tax-deferred retirement account such as a traditional IRA to a Roth IRA.
The SECURE 2.0 Act also reduces the penalty for not taking an RMD from 50% to 25% of the RMD not taken, and 10% if the individual corrects the error within two years. Furthermore, it eliminates RMDS during a participant’s lifetime for Roth 401(k) accounts.
#2: Enhanced Catch-Up Contribution Limits
The SECURE 2.0 Act recognizes the need for individuals, especially those nearing retirement age, to have the opportunity to enhance their retirement savings. To address this, the new law includes provisions to increase the catch-up contribution limits for individuals aged 50 and over.
In 2023, the catch-up contribution limit is $7,500 for most workplace retirement plans. Starting in 2025, SECURE 2.0 raises the annual limit for those aged 60 to 63 to $10,000, indexed for inflation.
This provision may have the following implications for those nearing retirement:
- Incentive to Save More. By allowing higher catch-up contributions, the SECURE 2.0 Act incentivizes individuals to save more during their peak earning years.
- Reduced Taxable Income. Making larger catch-up contributions can also help reduce taxable income for the year, potentially resulting in immediate tax benefits. This can be a strategic move for those in higher tax brackets looking to minimize their tax bill.
- Compensation for Retirement Shortfalls. For those who may not have been able to save sufficiently in their earlier years, these changes provide a means to bolster retirement funds in a relatively short period of time.
As pension plans become less common and the responsibility for retirement savings shifts increasingly to individuals, higher catch-up limits ultimately provide pre-retirees with a valuable lever to improve their retirement readiness and financial resilience in their golden years.
#3: Mandatory Roth Contributions for High Earners
Starting in 2026, individuals earning more than $145,000 in the previous tax year must make their catch-up contributions to Roth accounts, using after-tax dollars. The provision also indexes the $1,000 IRA catch-up limit to inflation starting in 2024, allowing this amount to increase over time to maintain its purchasing power.
These changes have several implications for high earners, including:
- Immediate Tax Implications. High earners subject to this provision of the SECURE 2.0 Act will pay taxes upfront on any catch-up contributions, losing the immediate tax deduction advantage that comes with making traditional pre-tax contributions.
- Tax-Free Growth and Distributions. Despite the lack of an initial tax break, Roth earnings are tax-free, as are distributions (provided certain conditions are met). And since Roth IRAs don’t have RMDs, individuals can let their investments grow for longer, potentially increasing their tax-free income in later retirement years.
- Consideration for Tax Diversification. Mandatory Roth contributions promote tax diversification in retirement accounts, giving retirees the flexibility to manage their taxable income more effectively.
- Potential for Greater Retirement Savings. With catch-up contributions indexed to inflation, individuals can consistently save more year over year, potentially leading to greater retirement savings overall.
- Reduced Necessity for Backdoor Roth. Since high earners will be required to make catch-up contributions directly to Roth accounts, this change may eliminate the need for a backdoor Roth conversion for these contributions.
While the SECURE 2.0 Act doesn’t directly alter the backdoor Roth process for regular contributions, this provision could be a precursor to future legislation affecting backdoor Roth conversions. It may also introduce a new layer of complexity to retirement planning, particularly for high earners who must consider current and future tax rates when deciding between traditional and Roth contributions.
#4: Transferring Unused 529 Plan Funds to a Roth IRA
Starting in 2024, the SECURE 2.0 Act allows beneficiaries of 529 college savings accounts to roll over unused funds to a Roth IRA. While the new rule may be a boon for many savers, it comes with specific limitations:
- A beneficiary can transfer a lifetime maximum of $35,000 from a 529 plan to a Roth IRA.
- The Roth IRA must be in the beneficiary’s name.
- The 529 account must have been in existence for at least 15 years before any transfers can be made.
- Beneficiaries can’t transfer any contributions or earnings on contributions from the last five years to a Roth IRA.
- Transfers are subject to the annual Roth IRA contribution limits ($6,500 as of 2023), even if the 529 plan has more funds.
It also has distinct financial planning implications, including:
- Tax-Free Growth and Withdrawals. Unused 529 plan funds can continue to grow tax-free once they roll over to a Roth IRA. Moreover, distributions from a Roth are tax-free if certain conditions are met.
- Avoidance of Penalties and Taxes on Unused 529 Funds: Typically, non-qualified withdrawals from a 529 plan are subject to income tax and a 10% penalty on the earnings portion of the withdrawal. This provision helps minimize these taxes and penalties, easing many of the concerns parents previously had about overfunding a 529 plan.
- Impact on Retirement Planning: The ability to shift funds from a 529 plan to a Roth IRA provides an additional avenue to save for retirement, especially if the funds in the 529 plan aren’t needed for educational expenses.
For more details regarding the new 529-to-Roth IRA transfer rule, check out our recent blog article on this topic.
Navigate the SECURE 2.0 Act and Prepare for a Successful Retirement with Milestone Asset Management Group
The SECURE 2.0 Act represents a critical step forward in addressing the evolving needs of retirement savers. By understanding the nuances of these new provisions, you can make informed decisions that pave the way for a secure and fulfilling retirement.
Whether you’re already retired or planning for it, adapting to these changes is key to optimizing your financial future. At Milestone Asset Management Group, we’re committed to guiding you through this new retirement landscape and helping you achieve your financial goals. Contact us to schedule an introductory meeting and begin your journey today.