Financial Planning Updates From Recent Legislation for 2023 and Beyond
In December 2022, Congress passed a retirement bill called the SECURE 2.0 Act of 2022. As a brief reminder, the original SECURE Act was passed into law in December 2019 and between the two, there were a number of major changes for retirement plans, financial planning and accounting for individuals and companies.
Now that we have had almost a full year since the passage of the SECURE 2.0 Act, we thought it would be a good time to look at how the changes have affected the financial planning needs of clients.
Let’s start with a couple of rules that were clearly not ready for prime time, where we have seen the can kicked down the road.
Rules Not Ready for Prime Time
- The elimination of “stretch” IRAs, and inherited IRA and Roth IRA required minimum distributions (RMDs)
The original SECURE Act eliminates “stretch” IRAs for the majority of non-spouse beneficiaries for any account owner who passed away after December 31, 2019. It is still possible to stretch IRA distributions if the beneficiary falls into one of the following categories, known as eligible designated beneficiaries:
- Surviving spouses
- Minor children (until the age of majority)
- Beneficiaries who are no more than 10 years younger than the deceased account owner
- Individuals with disabilities and chronically ill individuals
But the focus of this piece will be on the effect on non-eligible designated beneficiaries (such as children who have reached the age of majority). These beneficiaries are required to take all distributions from inherited IRAs or Roth IRAs by the end of the 10th year following the year of death of the IRA owner. For example, if an owner of an IRA passed away on December 15, 2021, and the beneficiaries of the IRA were children who had reached the age of majority (18 in most states), the resultant inherited IRA would need to be fully distributed by December 31, 2031, and the distributions would be taxable at the beneficiaries’ tax rates (Roth IRA distributions are not taxable).
Professionals were upset that the ability to stretch the IRA distributions over the beneficiary’s lifetime was removed, requiring concentrated distributions over 10 years that could have tax bracket impacts on beneficiaries. What people did not realize initially is that the rule was even more complex.
Many experts initially thought that the 10 years could be used and planned for however they saw fit as long as the accounts were empty after 10 years. This planning flexibility could be useful. For example, if a beneficiary was working during the first few years of the 10-year period and was in a high-income tax bracket, they could avoid taking distributions, waiting until they retired to realize the income and taxes at a much lower tax bracket.
Unfortunately, this was not the correct interpretation. It turns out that the Internal Revenue Service (IRS) also wanted beneficiaries to take yearly RMDs based on the beneficiary’s age, which the IRS clarified on February 24, 2022.
The blowback was immediate. The IRS opened a comment period on the rule, and it seems the comments were overwhelmingly negative. The 10-year rule as initially envisioned was simple. Suddenly, this additional requirement, which required a lot of tracking and calculations, became onerous.
Realizing that many investors, financial professionals and accountants were not ready to comply with the rule, the IRS waived the interpretation for 2021 and 2022 with 2023 as the year when it would go into effect. On July 14, 2023, the IRS released another suspension of the rule until 2024. Note that the IRS has not released the final guidelines around this rule, so there is some hope that the requirement for RMDs may be eased. Our guidance would be that individuals should prepare as if 2024 RMDs from inherited IRAs will be required.
- Catch-up contributions for individuals 50 and older with high income ($145,000 or more) would be required to be Roth 401(k) contributions, not pre-tax starting in 2024
The problem this rule encountered is that many plans do not currently have a Roth 401(k) option as part of the plan, and the way the law is written, it requires the plan administrators to suspend all catch-up contributions for high-income earners if there is no Roth 401(k) option available. This is an administrative nightmare, and on August 25, 2023, the IRS announced that the change is suspended until 2026.
In both the inherited IRA RMD and the catch-up rule, it is clear that the law as written did not anticipate all the practicalities of trying to comply with the rule.
Two Changes That Seem To Be Going According to Plan
- The ability to distribute up to $35,000 lifetime to a Roth IRA from long-standing (15+ year) 529s
An issue for 529s has been what to do if money is left over after a child finishes schooling. There were two less than ideal answers. The first was to let the 529 grow and eventually change the beneficiary to a sibling or grandchildren. The other option was to withdraw the assets as a non-qualified withdrawal and pay ordinary income tax plus a 10% penalty on any growth — not a palatable choice but sometimes the only real option.
The new ability to distribute $35,000 provides added comfort to clients that the money they put into a 529 won’t be trapped if it is not fully used. Note that it is constrained by the yearly maximum contribution to the Roth IRA ($6,500 for 2023), so to use the full lifetime exemption would take about 5–6 years.
Given the relatively low limit, this rule change still does not resolve the “what if” scenarios when a child does not attend college or gets a major scholarship, but it solves for when there is some money left over. It seems to have led to further interest in using 529s to fund higher education given the tax-free growth of 529s.
- RMD age extended to 73 now and 75 for people turning 74 after 2032
Considering the greater longevity overall for our population over the last few decades, having the ability to delay RMDs acknowledges that people are continuing to work until later and provides additional flexibility around financial planning. Moving from 70.5 to 72 in the original SECURE Act and then moving to 73 in the SECURE 2.0 Act was helpful to individuals because it provided more time for strategic Roth conversions and other methods of increasing after-tax wealth long term. These changes have also clearly increased the importance of planning for retirement early (at retirement or even earlier) to make appropriate choices around Roth versus pre-tax 401(k) contributions and strategic Roth conversions.
If you want to dive deeper into these planning topics, read this multi-part series on Kiplinger by Forum Partner David McClellan.
Changes That Have Not Kicked in Yet That Have Our Attention
With the SECURE 2.0 Act, there is a rule that allows employers to match student loan payments just like they currently provide matches for 401(k) contributions. This law is set to go into effect in 2024, right after student loan repayments restart for the majority of borrowers.
What appears simple in concept is administratively difficult with several rules to be followed, including what constitutes a student loan, how much can be matched and how it will be documented. It is a noble idea, especially given the number of recent graduates that cannot make 401(k) contributions due to the burden of student loan repayments, but this is a challenging rule for employers to properly implement.
We have highlighted the impact of some of the rules and rule changes to emerge from the SECURE Act and the SECURE 2.0 Act. Based on the rule adjustments that happened this year, we may see additional changes in 2024. If you have any questions, we encourage you to reach out to your financial advisor.
