While most of us spent the last week of December unwinding from our holiday festivities, congress was busy pushing though a broad-based retirement tax bill. The Secure Act 2.0 enacted dozens of seemingly trivial changes to retirement account rules. For most people these changes won’t even register on the retirement planning Richter scale. However, upon closer examination, the Secure Act 2.0 offers a few golden nuggets in the form of new planning opportunities.
The three high-impact changes I’ll be covering in this article are by no means an exhaustive list. In fact, the bill introduced well over 50 changes to retirement account rules. The three that I’ll be highlighting are what I consider to have the greatest impact in terms of the scope and magnitude when it comes to retirement planning.
1. The Required Minimum Distribution Age Is Increasing (Again)
If you’re not familiar with Required Minimum Distributions (RMDs) here’s what you need to know. For individuals who have IRA accounts (including 401ks, 403bs, and 457 plans) the IRS forces you to withdraw a minimum amount from those accounts each year starting at a certain age. The minimum amount you are forced to withdraw is based on your age, and the combined value of all of your IRA accounts. The way the IRS has set up RMD tax rules dictates that as you get older you will be forced to take a larger portion of your IRA assets each and every year. For example, someone who was 75 in 2022 with a million dollars in an IRA had an RMD amount of $40,650. Whereas, someone with the same amount who was age 85 had an RMD of $62,500.
Having large RMDs is a good problem to have because it means you have substantial retirement assets in an IRA account. However, that doesn’t make them any less of a problem. More and more retirees are experiencing a tax crunch as they enter their late 70s because their RMDs are substantially more than what they want, or need, to sustain their desired retirement lifestyle. While this excess retirement income may seem like a good thing, it almost certainly doesn’t feel so good when RMDs force retirees into higher tax brackets, and cause oversized tax bills.
Bringing it back to the topic at hand, the Secure Act 2.0 increased the RMD age from 72 to age 73 for those born prior to 1960. For those born in 1960 and after the new RMD age will be 75. Golden nugget number one is that we now have one to three additional years to plan for, and minimize RMDs through Roth conversions. A Roth conversion is a financial strategy that allows you to take money from your IRA, pay the taxes now, and get that money into a Roth account where it will never be taxed again, nor subject to RMDs. A more comprehensive explanation of Roth conversions can be found here. When it comes to retirement tax planning, even one additional year of Roth conversions at a favorable tax rate can shave tens of thousands of dollars off a lifetime tax bill. With the passing of Secure Act 2.0, retirees will have a little extra breathing room before RMDs start, which means they retain more control of their retirement tax situation for longer.
2. 529 College Savings Balances Can Now Be Converted To A Roth Account
For those generous parents and grandparents who have 529 college savings plans for their loved ones, you deserve a big hug. And to some extent that’s exactly what the Secure Act 2.0 is offering starting in 2024. Historically, 529 balances that went unused could either be withdrawn triggering taxes and penalties, or the beneficiary on the account could be switched, and used to support someone else’s education costs. Either way, 529 account holders had very few options for efficiently gaining access to 529 money for themselves. To some, left over 529 balances were looked at as ‘dead money’. The Secure Act 2.0 changes that by allowing 529 balances to be incrementally transferred into Roth IRA accounts.
It’s worth noting that in order to enact such a conversion strategy, there are some stipulations that must be met. Firstly, the 529 account that intends to be drawn from to fund the Roth must have been open for at least 15 years. Conceivably, most 529 accounts should meet that threshold assuming the account was opened when the beneficiary was a child. This is yet just another reason to open a 529 account as early as possible. Second, funds that you intend to convert to a Roth must have been in the account for at least five years. Third, conversion amounts are subject to the annual Roth contribution thresholds, which in 2023 is $6,500. Fourth, the lifetime maximum that can be rolled into an individual’s Roth from a 529 is $35,000. Finally, the unused balance can only be contributed to the named beneficiary’s Roth account.
Let’s focus on that final stipulation for just a moment. The law was drafted to state that the 529 conversion must be rolled into a Roth account owned by the beneficiary. For almost all 529 accounts the beneficiary is someone other than the account owner. However, changing the beneficiary on a 529 is as easy as a few clicks online. With this new rule being hot off the press, this particular stipulation has left the financial planning community a bit confused. Theoretically, the account owner could make themselves the beneficiary on the account, and add the unused balance to their own Roth account. Taking it a step further, they could even change the beneficiary to their spouse, and add to their spouse’s Roth account in the same year. If this strategy were to continue for the next several years the account owner could potentially add up to $70,000 to their and their spouse’s Roth accounts. While it remains unclear exactly how the IRS will rule on this beneficiary swapping methodology, it still leaves the door open to put what was historically dead money to good use.
3. Employer 401k Matches Can Now Be Roth
Are we seeing a theme here? If you can’t tell, I’m a huge proponent for Roth accounts, and the Secure Act 2.0 appears to share my enthusiasm. The new legislation’s third and final golden nugget will (in my opinion) have the greatest impact on the broader retirement savings and tax landscape. Starting in 2024, employers will be able to offer their 401k / 403b matches in Roth dollars. Prior to Secure Act 2.0 employers contributed only to employees’ traditional 401ks (tax-deferred). It simply wasn’t an option for companies to add their matching dollars to a post-tax Roth 401k account. While this change won’t impact current retirees, it will create the opportunity for current workers to add substantially more to their Roth savings beyond the annual limits. Quite honestly, I’m not sure how quickly Roth matches will be available within company plans. At the earliest it will be 2024, but I’ll be very interested to see what the rate of adoption is among companies and their 401k programs.
For those who are currently working, determining how much to contribute to a traditional 401k versus a Roth 401k should be a year-to-year assessment. That said, with Roth matches soon to be on the table the stakes have been heightened. When it comes to yearly tax planning, it’s about striking a balance. In years of high income and/or unfavorable tax rates, it typically makes sense to favor traditional 401k contributions. Conversely, in years of lower income and/or favorable tax rates it can make sense to contribute more to a Roth 401k. This new Roth matching rule will essentially have a compounding effect (positive or negative) on your year-to-year tax strategy.
There you have your three gold nuggets from the recently passed Secure Act 2.0 – Eureka! With a bill of this size I would expect to see further clarifications by congress and the IRS before we truly know all the impacts on the retirement planning landscape. But for the time being we have a minimum of three actionable retirement planning items that we can (and should) begin to consider when it comes to our retirement preparation and strategy. As more hidden gems from the bill continue to be uncovered I’ll be sure to keep you informed.
