Key changes coming to retirement accounts

For the second time in approximately three years, Congress passed broad legislation with sweeping impacts on employer-sponsored retirement plans and IRAs. The SECURE 2.0 Act of 2022 (the “Act”) contains 92 provisions designed to promote savings, boost incentives for businesses, and offer greater flexibility to those saving for retirement. Many of the changes do not take effect until 2024 or 2025. However, select provisions will impact employer-sponsored plans and IRAs in 2023. We will review the provisions that we consider to be most important in the sections that follow.

Key Provisions Beginning in 2023

Increased Age for Beginning Required Minimum Distributions

Tax-deferred retirement accounts generally require individuals to begin taking distributions during their lifetime. These mandatory distributions are known as required minimum distributions. Required minimum distributions must commence on the individual’s required beginning date. The purpose of the required beginning date is to limit the amount of time funds can grow on a tax-deferred basis within the retirement account.

Legislation passed in 2019 increased the age at which individuals must begin taking distributions from employer-sponsored retirement plans and traditional IRAs from 70½ to 72 (if you were born after June 30, 1949.) As of January 1, 2023, the Act increased the age to 73. This applies to anyone who turns 72 after December 31, 2022. In 2033, the age increases further to age 75 for those who turn 75 after December 31, 2032.

Many people reading this will likely have the initial reaction to delay required minimum distributions for as long as possible to defer the income tax liability that will be due on such distributions. But there are other factors to consider. We will discuss potential considerations in a future blog post.

Reduced Penalty for Failure to Take Required Minimum Distributions

If an individual fails to satisfy the required minimum distribution amount in any given year, a penalty is imposed. Starting in 2023, the steep penalty for failing to take a required minimum distribution will decrease from 50% to 25% of the amount not taken. If the individual takes corrective action within two years (subject to limitations), the Act further reduces the penalty to 10%. It is important to note that the individual must file an amended income tax return in a timely manner to take advantage of the further reduced penalty.

While this is welcome news, any penalty is still a penalty, and should be avoided. Your client service team at Boston Trust Walden will collaborate with you each year to ensure required minimum distributions are properly taken.

Key Provisions Beginning in 2024

Tax-Free Rollovers from 529 Plans to Roth IRAs

529 plans are tax-advantaged savings vehicles designed to encourage families to save for future education expenses. Funds within a 529 plan grow tax deferred. Distributions from the 529 plan are not subject to income tax if utilized for qualified education expenses. Despite the rising costs of education, there are occasions when funds may remain in a 529 plan after the beneficiary has completed their education. This could be due to a variety of reasons, such as the beneficiary receiving scholarships or grants, unintentional excess funding of the 529 plan, or robust investment performance.

If an individual utilizes 529 plan funds for something other than qualified education expenses, the earnings portion of the distribution will be subject to both income tax and a 10% withdrawal penalty. A common solution to deal with remaining 529 plan funds is to change the beneficiary of the 529 plan to another child or eligible relative. However, there are times when this is not a viable solution. The Act provides another option for individuals who find themselves in this predicament.

Effective January 1, 2024, beneficiaries of 529 plans will be able to make direct rollovers from the plan to a Roth IRA. The rollover will not be subject to income tax or the 10% penalty. Typically, the ability to make contributions to a tax-favored Roth IRA is subject to income limits. In 2023, the income limits are $153,000 for single filers and $228,000 for joint filers. The Act waives the income limits for 529 plan to Roth IRA rollovers.

It is important to note there are other restrictions. First, the amount rolled over cannot be more than the annual Roth contribution limit set by the IRS. For 2023, the Roth IRA contribution limit is $6,500 or $7,500 for individuals ages 50 and older. Second, the amount rolled over cannot exceed $35,000 total in the beneficiary’s lifetime. Third, the 529 plan must have been open for at least 15 years. Lastly, 529 plan contributions or earnings from the past five years are not eligible for rollover.

Roth 401(k) Required Minimum Distributions Eliminated

Prior to the Act, Roth 401(k) plans were subject to required minimum distributions. In comparison, Roth IRAs did not, and do not, require owners to take required minimum distributions during their lifetime, thereby extending the amount of time that funds may remain in the Roth IRA and grow tax-free. Beginning in 2024, the Act eliminates required minimum distributions for Roth 401(k) plans. This enhancement may make Roth 401(k) plan contributions more attractive when considered as a tax diversification strategy or estate planning tool.

Key Provisions Beginning in 2025

Higher Catch-Up Contributions Allowed at Ages 60, 61, 62, and 63

Defined contribution retirement plans, such as 401(k) plans, 403(b) plans, or 457(b) plans, are permitted to allow participants who are age 50 or older to make additional elective deferrals, known as “catch-up” contributions. In 2023, the annual dollar limit on catch-up contributions is $7,500.

Beginning in 2025, participants ages 60 through 63 can contribute the greater of $10,000 or 50% more than the standard catch-up amount to their defined contribution plan. This amount will be indexed for inflation beginning in 2026.

Catch-Up Contributions Must Be Made on an After-Tax Roth Basis for High Wage Earners

Beginning in 2024, the Act mandates that catch-up contributions must be directed to the plan’s Roth account for individuals with wages in excess of $145,000 for the prior calendar year. Once this provision becomes effective, individuals within this category will not have the option of choosing between pre-tax deferrals or Roth contributions.

Conclusion

The Act provides many changes to how individuals can accumulate funds for retirement. It is important to review your personal retirement saving strategy in light of the Act and determine whether changes should be made.

At Boston Trust Walden, we believe that a holistic approach to wealth planning is a valuable complement to our disciplined approach to portfolio construction and our long-term track record of providing attractive after-tax, after-fee, risk-adjusted returns. We are committed to our clients’ continued success.