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The setting every community up for retirement enhancement (SECURE) 2.0 Act (SA 2.0) was a much-needed piece of legislation that addresses several issues around retirement that affect working and retired Americans. The legislation offers improvements, but as is often the case when Washington tries to “fix” things, there are some unintended consequences. Although most of the changes won’t take effect until 2024 or later, there are things that advisors should keep in mind, particularly for clients who fall into one of these three broad categories: retirees, savers, and small-business owners.
For most retirees, the biggest news about SA 2.0 is that it raises the age at which required minimum distributions (RMDs) begin from 72 to 73 in 2023. That sounds like a good thing, but looked at from another angle, it is also a stealth tax increase. Until the original SECURE Act in 2019, retirees had to begin taking RMDs at age 70.5. In three short years, Congress has extended the required beginning age by 2.5 years, and SA 2.0 will push it even further. In 2033, the beginning age jumps to 75.
That’s almost a full five years of additional growth that will not only be subject to taxation, but also can place the individual in a higher income bracket, which impacts the tax on Social Security and potentially increases annual Medicare costs.
Planning can address the potential tax implications. I recommend a Roth conversion. This may be an especially good time since last year when we saw markets decline by 20% or more in some cases. Clients can take advantage of the decline by paying taxes on lower portfolio values and redirect that future growth into a tax-free Roth IRA. For those who are charitably inclined, qualified charitable distributions (QCDs), especially in markets like 2021, where you likely saw significant portfolio appreciation, are great ways to reduce future IRA taxation and provide wonderful charitable gifts.
Good news for savers
Savers also stand to gain tremendous benefits from SA 2.0. With low retirement-savings rates, virtually nonexistent corporate pensions, and Social Security strained more each year, we have had a retirement planning crisis for too long. For many Americans, by the time retirement savings became a priority or they could start putting money away, it was too late. The government realized this and so, SA 2.0 provides additional catch-up provisions for those between the ages of 60 and 63, beginning in 2024. Specifically, they will be allowed a catch-up contribution of $10,000 to an employer-sponsored retirement plan, such as a 401k, and this figure will adjust with inflation.
Catch-up contributions come with a bit of a catch for higher earners that amounts to another stealth tax increase. Beginning in 2024, those earning $145,000 or more will see their catch-up contribution forced into a Roth 401k. For those already placing 100% of their contribution in the Roth bucket, this will have zero impact. However, for those who are focusing on the pre-tax or traditional account, this will become a tax increase as these dollars will be forced into the Roth 401k, thereby resulting in taxable income you otherwise wouldn’t be reporting.
An additional improvement for the saver, which was long overdue, is that SA 2.0 will allow employers to match employees’ contributions into their Roth retirement plan. Previously, matching could only be directed into a traditional or tax-deferred account, even if the employee was placing 100% of their contribution into the Roth. Again, this new provision is optional for employers, not mandated.
Another saving opportunity can be found within student loans. Student debt is hampering the ability of individuals, especially in those critical early stages of their careers, where through compounding, retirement savings receives the best longevity bang for their retirement buck. Beginning next year, SA 2.0 allows employers to match their employee’s student loan payment into their retirement plan. So, as an example, an employee that makes a $2,500 payment to their student loan, a company could match that $2,500, but place it inside the employee’s 401k account. This could be a huge benefit to employees who wouldn’t be able to save otherwise. This is also a differentiator for employers looking to attract new talent.
All of the previously mentioned aspects of SA 2.0 can help those looking for ways to save for retirement, but the biggest planning opportunity is the ability for unused 529 contributions to be placed into a Roth IRA. This new provision allows for a transfer of up to $35,000 to a Roth IRA from a 529, without penalty and tax-free. There are a few stipulations. It is capped at the annual Roth contribution limit, so you cannot front-load it with all $35,000, and the 529 must have been open for 15 years. With most of these beneficiaries likely in their 20s, $35,000 worth of Roth contributions combined with a likely long-time horizon is massive. Over a 40-year period, that figure grows to over $1 million fairly easily with a reasonable rate of return.
Changes for small businesses
Finally, small business owners will see impacts on the retirement-plan side. In addition to the changes to catch-up and Roth matching, the government is trying to incentivize more small businesses to offer retirement programs.
Owners of businesses with 50 or fewer employees are now eligible for a tax credit of 100% of the administrative costs associated with a new start-up retirement plan. On top of that, for these newly created plans, there is a tax credit for contributions made by the employer, capped at $1,000 per employee who earns less than $100,000 annually.
New plans established after December 31, 2024, must include the automatic enrollment of eligible participants to 401(k) plans and 403(b) plans, initially at a minimum of 3% of their salary (capped at 10%). This rate is required to automatically increase by 1% annually until the contribution rate reaches 10% (but no more than 15%).
In my experience, for those companies that have low turnover, these programs have been highly successful. Participation has increased and the plan participants’ success rates for retirement have all benefited. On the other hand, for those companies that have a high turnover, automatic enrollment has created headaches. When you have employees regularly coming and going, dealing with terminated employee balances, transfers, and tracking folks down who have moved, it can be cumbersome. My advice to small business owners that intend to set up plans after December 31, 2024, is to carefully consider eligibility for the new plan and have a capable administrator overseeing the process.
Ultimately, the SECURE Act 2.0 will do much to address the coming retirement crisis in this country. But advisors would be wise to look at it carefully and devise plans to avoid pitfalls that are waiting for clients.
Matthew Spradlin, CFP® is director, wealth manager with Godfrey & Spradlin Private Wealth Advisory of Steward Partners.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
