SECURE 2.0 offers new wealth-boosting opportunities

A delayed start: Provisions in SECURE 2.0 delay the RMD start to age 73, rising to age 75 by 2033. This change may be a big boost for seniors who don’t need access to retirement funds. They can now keep that money sheltered in tax-advantaged 401(k), traditional IRA, and other qualified retirement plan accounts longer. (Effective immediately, with an additional change in 2033.)

Reduced penalties: The penalty is steep for those who fail to take their RMD but the new law reduces that hit from a 50% excise tax on distribution shortfalls to a more palatable 25%. Even more, that penalty drops to 10% for those who take the necessary RMD and submit a tax return reflecting the paid excise tax within a specified correction window. (Effective immediately.)

Waived for Roth 401(k) accounts: Bringing them in line with Roth IRA distribution rules, Roth 401(k) accounts will no longer be subject to RMD rules during the account holder’s lifetime. (Effective 2024.)

Expanded use for qualifying longevity annuity contracts (QLACs): SECURE 2.0 repeals the 25% limit on retirement plan balances for the tax-free transfer of assets on the purchase of a QLAC. (A QLAC is a deferred income annuity, which is a pension-like annuity; QLACs are not subject to RMDs until age 85.) It also bumps the maximum dollar amount to $200,000 (adjusted for inflation each year), increasing the level of funds that may be shielded from RMDs for a longer period of time. (Effective immediately.)

Broader qualified charitable donation (QCD) rules: People aged 70½ or older may use a QCD to donate up to $100,000 to a qualified charity, directly from an IRA; a QCD can be counted toward annual RMD requirements, if certain rules are met. SECURE 2.0 adds a provision to index the annual $100,000 cap to inflation. Also, to note: The new law includes a one-time election for a QCD to a split-interest trust, a move that allows people to pursue philanthropic goals while maintaining a lifetime interest in the income generated by the donated funds. (Effective immediately.)

A supersized catch-up contribution: Defined contribution participants between the ages of 60 and 63 will be able to sock away up to $10,000 ($5,000 for SIMPLE plans) in catch-up contributions or 50% more than the standard catch-up amount, whichever is greater. (The catch-up limit for people age 50 and older in 2023 is $7,500 and $3,500 for SIMPLE plans.) (Effective 2025.)

To know: Starting in 2026, employees earning more than $145,000 in the prior calendar year must make catch-up contributions in an after-tax Roth account.

More Roth savings opportunities and requirements: SECURE 2.0 requires all catch-up contributions be made in an after-tax Roth account for employees earning more than $145,000 (indexed for inflation). Starting in 2023, small business owners may now create Roth options for their SIMPLE and SEP IRAs*; larger employers can match contributions in 401(k) and 403(b) accounts with Roth dollars. (Effective 2024.)

Also notable: The legislation doesn’t include any provisions that restrict or eliminate the existing nondeductible traditional to Roth IRA conversion (backdoor Roth IRA) strategy. 

Starting in 2024, the new rules allow up to $35,000 of unused 529 plan assets to be moved to a Roth IRA, so long as certain conditions are met. The 529 plan must have been in existence for 15 years, funds must be in the 529 for five years before they (and associated earnings) can be moved, and they must be transferred to an IRA for the same beneficiary as the 529.  The 529 to Roth IRA conversion limit is equal to the annual Roth IRA contribution limit ($6,500 in 2023), with a lifetime cap of $35,000 per beneficiary. (Note: The $6,500 annual Roth IRA contribution limit still applies. A $6,500 529 to Roth IRA conversion can be made in place of an annual Roth IRA contribution but not in addition to it.)

“With a series of well-planned-out annual transfers, a 529 to Roth IRA conversion may offer an effective opportunity for wealth transfer between generations,” said Dickson. “The $35,000 lifetime limit, if reached earlier in the beneficiary’s life, could compound into a substantial nest egg by the time retirement age is reached or even provide a strong foundation for meeting other savings goals.” 

While these changes are largely good news for those with a high net worth, there is a caveat. The combination of these provisions—a longer savings horizon and increased contribution limits among them—may leave some super savers under threat of a ticking tax bomb.

Here’s how it works: Some savers are so good at socking away tax-deferred cash that they wind up with RMDs that, combined with other income, pay more than their previous annual salaries. The problem? A larger income could push a retiree into a higher tax bracket, which can crimp cash flow—but that’s not all. It can also trigger Medicare surcharges, increase taxes on Social Security payments, and create a tax burden on heirs.

In short, the SECURE Act of 2022 (SECURE 2.0) offers expanded options for estate, legacy, and tax planning, as well as one potential boon for those with an eye on tax-advantaged intergenerational wealth transfer. Even so, it also creates a number of planning opportunities and potential outcomes to be aware of—including challenging tax situations. A financial or tax advisor can help individual investors understand how the SECURE 2.0 changes may apply to individual situations.

Notes:

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