Planning for Your Retirement – New Wrinkles from the SECURE 2.0 Act

Article Highlights:

• SECURE 2.0 Act
• Catch-up Contributions
• Incentives to Contribute to a Plan
• Long-term Part-time Workers
• Automatic Enrollment
• Required Minimum Distributions
• RMD Penalties
• Emergency Savings Accounts
• Penalty-Free Withdrawals
• Other Distribution Changes 

In 2019 Congress passed legislation named the Setting Every Community Up for Retirement Enhancement Act – shortened to the SECURE Act – that included a number of retirement plan changes and enhancements. In late December, 2022, the SECURE 2.0 Act was passed and signed by President Biden. Many of the provisions of SECURE 2.0 were designed to encourage more Americans to save more for their retirement years and make it easier to do so. Some of these changes could impact your retirement plan strategy. Here are some of the highlights of SECURE 2.0:

Contributions to IRAs and Other Plans

Some of the law changes that are meant to encourage more workers to save for retirement include:

Catch-up contributions – Employees age 50 and older are allowed to make additional pre-tax contributions to their 401(k) plans over the regular annual limit. Referred to as “catch-up” contributions, the idea is to get older workers to build up their retirement accounts in their last few years of working. The catch-up amount originally started out many years ago at $1,000, but has grown with annual inflation adjustments to $7,500 for 2023. Starting in 2025, for plan participants age 60 to 63, the catch-up amount increases to at least $10,000 per year and will be inflation-adjusted after 2025.

The amount of the catch-up contribution IRA owners age 50 and over can make has long been $1,000 per year. Starting in 2024, the $1,000 will be indexed for inflation in $100 increments.

Under SECURE 2.0 employers can revise their retirement plans so that employees can choose to have employer-matching and catch-up contributions go into a Roth-style plan with after-tax contributions. Historically, the matching and catch-up contributions have only been allowed as pre-tax contributions. However, starting in 2024, plan participants making more than $145,000 per year from the employer sponsoring the plan can only have their catch-up contributions and the employer-matching amounts go into the employer’s Roth plan. With Roth contributions there is no tax deduction or tax-free wages benefit, but withdrawals from the Roth plan, including investment gains, are tax-free once the account owner reaches age 59½ and has had the plan for at least 5 years.

Financial incentives to contribute to a plan – As noted above, employers can provide matching contributions as a long-term incentive for employees to contribute to a 401(k) plan. However, immediate financial incentives (like gift cards in small amounts) have been prohibited even though individuals may be especially motivated by them to join their employers’ retirement plans. SECURE 2.0 enables employers to now offer de minimis financial incentives, not paid for with plan assets, such as low-dollar gift cards, to boost employee participation in workplace retirement plans.

Long-term part-time workers –The original SECURE Act required employers to allow long-term, part-time workers to participate in the employers’ 401(k) plans. Except in the case of collectively bargained plans, employers maintaining a 401(k) plan have had a dual eligibility requirement under which an employee must complete:

• 1 year of service (working at least 1,000 hours) or
  
  
• 3 consecutive years of service (where the employee completes at least 500 hours of service).

Starting in 2025, SECURE 2.0 reduces the 3-year rule to 2 years, disregards pre-2021 service for vesting purposes, and extends the long-term part-time coverage rules to 403(b) plans that are subject to the Employee Retirement Income Security Act of 1974 (ERISA). These plans are generally provided by governments or tax-exempt organizations and are sometimes known as “tax-sheltered annuities.”  

Automatic enrollment required – Most employees under-save for their retirement. Some don’t participate at all in their employer’s plan. To encourage greater participation, effective for plan years beginning after 2024, SECURE 2.0 requires 401(k) and 403(b) plans to automatically enroll participants in the respective plans upon becoming eligible, although employees may opt out of coverage. The initial auto-enrollment amount is at least 3% but not more than 10% of an employee’s compensation. Each year thereafter that amount is increased by 1% until it reaches at least 10%, but not more than 15%.

All 401(k) and 403(b) plans in existence before December 29,2022 are not required to have automatic enrollment, but some of these employers may want to do so anyway, or may have already established auto-enrollment arrangements. Also exempt from mandatory enrollment are small businesses with 10 or fewer employees; SIMPLE Plans; employers that have been in business for less than three years; and church and government plans.  

Distributions from IRAs and Retirement Plans

The SECURE 2.0 Act made significant changes to when distributions must or may be made from retirement plans, including the following:

Required Minimum Distributions (RMD) – While some individuals would prefer to keep their tax-advantaged contributions to retirement plans and traditional IRAs growing until their death so that more money goes to their heirs, Congress doesn’t see it that way and requires distributions to be made. As far back as the 1960s distributions had to be made once the account owner reached age 70½, but the SECURE Act extended the age to 72, and SECURE 2.0 changes it again, to 73 as of 2023. But the language of the SECURE 2.0 bill is a bit awkward and can be interpreted that because someone who turned 72 in 2022 was required to take a 2022 distribution, the fact that they turn 73 in 2023 doesn’t let them claw back the 2022 distribution already made or skip a 2023 distribution. So, unless the wording of the tax code is changed in a technical corrections bill, just those who turn 72 in 2023 will be excused from being required to take a 2023 distribution. Starting in 2033 the distribution beginning age increases to 75.

Regardless of the required beginning date, if a taxpayer so chooses, he or she can delay the first year’s RMD until the second year, thus making the distribution includible in the second year’s tax return. This is sometimes desirable if the taxpayer has substantial wages or other income in the year the mandatory distribution age is reached and expects less income the next year. In this situation, by delaying the distribution to the second year the tax bracket could be substantially lower. If the taxpayer chooses that option, then:

• The first year RMD must be taken by April 1 of the following year, and
  
  
• The taxpayer must also take the second year RMD distribution by December 31 of year two, thus doubling up the distributions in year two.

RMD Penalties – Existing law sets the formula for computing the minimum amount that must be withdrawn once the required beginning age is reached, and to enforce the requirement, there has been an egregious excise tax (commonly referred to as a penalty) of 50% of the amount that should have been withdrawn and wasn’t.

SECURE 2.0 reduces the excise tax for failure to take required minimum distributions from 50% to 25%, starting for 2023. If a failure to take an RMD from an IRA is corrected in a timely manner, the 25% penalty rate is reduced to 10%.Timely means submitting a corrected return either in the second year after the RMD was missed or before the IRS assesses a penalty, whichever comes first.

Prior to SECURE 2.0, IRS offered administrative relief from the penalty for those who failed to take their RMD whereby the taxpayer could file a request for relief using IRS Form 5329 along with an explanation why the correct amount of distribution wasn’t made. Generally, the IRS would waive the penalty if the taxpayer had immediately taken steps to rectify the shortfall once it was discovered and had a reasonable excuse for why the RMD hadn’t been made. Reasonable excuses included health problems, a death in the family, confusion about the rules, or receiving erroneous advice from an investment advisor or tax professional. There is no language in SECURE 2.0 that removes this method for eliminating the penalty, but the IRS may not be as inclined to waive the penalty as in the past now that the penalty is lowered to 10%.

Emergency Savings Accounts - Though individuals can save on their own, far too many fail to do so. According to a report by the Federal Reserve, almost half of Americans would struggle to cover an unexpected $400 expense. Many are forced to dip into their retirement savings. A recent study found that, in the past year, almost 60% of retirement account participants who lack emergency savings tapped into their long-term retirement savings, compared to only 9% of those who had at least a month of emergency savings on hand.

Congress decided that separating emergency savings from a person’s retirement savings account will provide participants a better understanding that one account is for short-term emergency needs and the other is for long-term retirement savings, thus empowering employees to handle unexpected financial shocks without jeopardizing their long-term financial security in retirement through emergency hardship withdrawals.

To that end, SECURE 2.0 provides employers the option to offer retirement plan-linked emergency savings accounts to their non-highly compensated employees. Employers will need to amend their plans before they can offer these accounts. Some of the details:

• Employers may automatically opt employees into these accounts at no more than 3% of their salary, and the portion of an account attributable to the employee’s contribution is capped at $2,500 (or lower as set by the employer).
  
  
• Once the cap is reached, the additional contributions can be directed to the employee’s Roth defined contribution plan or stopped until the balance attributable to contributions falls below the cap.
  
  
•  Contributions are made on a Roth-like basis and are treated as elective deferrals for purposes of retirement matching contributions with an annual matching cap set at the maximum account balance – i.e., $2,500, or lower as set by the plan sponsor.
  
  
• The first four withdrawals from the account each plan year may not be subject to any fees or charges. At separation from service, employees may take their emergency savings accounts as cash or roll it into their Roth defined contribution plan or IRA.

Penalty-Free Withdrawals – Domestic Abuse - A domestic abuse survivor may need to access his or her money in their IRA or retirement account for various reasons, such as escaping an unsafe situation. SECURE 2.0 allows retirement plans to permit participants that self-certify that they experienced domestic abuse to withdraw a small amount of money that will not be subject to the 10% early withdrawal penalty that applies to plan withdrawals prior to age 59½. These withdrawals cannot exceed the lesser of $10,000, or 50% of the present value of the nonforfeitable accrued benefit of the employee under the plan. To be eligible, the distribution must be made during the 1-year period beginning on any date on which the individual is a victim of domestic abuse by a spouse or domestic partner.

Domestic abuse means physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently including by means of abuse of the victim’s child or another family member living in the household.

While the early withdrawal penalty won’t apply to domestic abuse distributions, regular tax does apply. However, the domestic abuse survivor may redeposit the amount that was withdrawn into their IRA or the employer’s plan at any time up to 3 years after the date on which the distribution was received, and then file an amended return to recover the tax that was previously paid on the distribution.

Other distribution rules changes – The penalty when an individual takes an early distribution (before age 59½) from their traditional IRA or employer’s plan is 10% of the amount withdrawn. There are many exceptions to the penalty and SECURE 2.0 added some new ones in addition to those already on the books. Briefly these new exceptions include:

• Individuals in federally declared disaster areas can now withdraw up to $22,000 from an IRA or retirement plan with no penalty. The tax on the distribution can be paid over 3 years.
  
  
• As of 2023, an employee who has been certified by a physician as being terminally ill and who presents evidence of that diagnosis to the plan administrator can make a penalty-free withdrawal from their retirement plan.
  
  
• As of December 30, 2025, penalty-free distributions up to $2,500 can be made to cover long-term care expenses.

 The SECURE 2.0 Act changes discussed in this article are only a few of the more than 90 provisions in the Act that affect retirement plan participants and employers offering the plans over the next few years. If you have questions about how your retirement contributions and distributions – and your overall strategy for a comfortable retirement – will be impacted, please contact this office.