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SECURE 2.0 Act: Important retirement plan changes

Feb 09, 2023

As part of the omnibus budget bill passed at the end of December 2022, Congress included the SECURE 2.0 Act of 2022, and on December 29, 2022, the bill was signed into law.

Like the previous SECURE Act passed at the end of December 2019, this bill is focused on making numerous changes to retirement plans, including required minimum distribution (RMD) dates, tax credits and changes to what plans can offer.

These changes may impact many taxpayers or be narrowly focused. To further complicate the changes, the effective date when provisions take place may depend on the tax year of the taxpayer, retirement plan year or the date when the bill was signed in to law.

Here are the SECURE 2.0 Act items that are most likely to impact people and raise questions:

Distribution from retirement funds for federally declared disasters

Effective: Disasters occurring after January 26, 2021.

As the effective date above indicates, this is a retroactive provision. Under this provision, permanent rules are established for affected individuals to withdraw from their employer retirement plans or IRAs.

An affected individual can withdraw up to $22,000. The distribution is not subject to the 10% penalty, and the income is taxed evenly over three years instead of all at once in the year of the withdrawal. Any distributions can be repaid, and special rules apply to those that have taken money out for a home purchase prior to the disaster.

Statute of limitations established for excess contributions and failure to take RMD

Effective: December 29, 2022.

Under current law, unless Form 5329 was filed by itself or along with a Form 1040, the statute of limitation never started for missed RMDs or excess contributions to a retirement account.

The SECURE Act 2.0 RMD changes include limitations on this going forward. So long as a 1040 is timely filed, the statute of limitations begins to run on the date the 1040 is filed.

For missed RMDs, the statute of limitations will be three years, while for excess contributions, the statute of limitation will be six years.

Penalty exemption on early distributions due to terminal illness

Effective: Distributions made after December 29, 2022.

An individual who has been certified by a physician as having a terminal illness can withdraw funds for their retirement account early and avoid the 10% penalty. In this case, terminal illness refers to a diagnosis that the taxpayer has 84 months (7 years) or fewer to live. Amounts withdrawn can be repaid within three years of distribution and taxes recouped.

Reduced penalty on failure to take RMDs

Effective: Taxable years beginning after December 29, 2022.

The act will reduce the penalty for failure to take an RMD from 50% to 25%. If the error is caught and the RMD taken in a timely manner, the penalty is further reduced to 10%.

Be aware that this change may not be as favorable as it first appears. Historically, the IRS was very open to abating this penalty in whole, so long as the taxpayer reached out to them first. The common reasoning was that the penalty was viewed as excessive.

Now that the penalty can be as low as 10%, it is not likely the IRS will be as willing to abate it.

Elimination of additional tax on corrective distributions of excess contributions

Effective: After December 29, 2022.

When excess contributions to an IRA have been withdrawn, any earnings associated with the excess contribution are also subject to the 10% early withdrawal penalty. SECURE 2.0 removes this penalty from the withdrawal of those earnings.

This applies to any determination of, or affecting liability for, taxes, interest or penalties made on or after December 29, 2022.

Enhancements to qualified charitable contributions from an IRA

Effective: Taxable years beginning after December 29, 2022.

The act will now begin indexing the $100,000 maximum direct charitable contributions from an IRA annually. Additionally, a one-time, $50,000 distribution can be made from an IRA to a charitable gift annuity, charitable remainder unitrusts and charitable remainder annuity trusts.

The change presents an opportunity for the right taxpayer to make this contribution. However, the costs to establish and maintain these trusts may not be worth the time and effort.

Repayment of qualified birth or adoption distributions fix

Effective: Taxable years beginning after December 29, 2022, and retroactive to the SECURE Act.

The SECURE Act introduced a provision that allowed an individual to take an early withdrawal from their retirement plan for expenses related to a qualified birth or adoption. After that distribution, the individual could repay what they took out and be eligible for a refund of taxes previously paid.

The SECURE Act 2.0 clarifies that the statute of limitations to claim a refund remains at three years from the tax year when the distribution was made.

Tax treatment of IRA involved in a prohibited transaction

Effective: Taxable years beginning after December 29, 2022.

Under current law, if an IRA account was deemed to have been involved in a prohibited transaction, such as self-dealing, then all of the IRA accounts for that taxpayer were deemed to have been distributed, even if there were separate accounts. SECURE Act 2.0 clarifies that if there are multiple IRA accounts, only the account that has engaged in a prohibited transaction will be deemed to have been distributed.

Taxpayers have been increasingly interested in maximizing the value in their IRAs by using the IRA to invest in businesses and real estate. Because of the all or nothing treatment, many have steered away from using their IRA as a vehicle for this transaction — particularly due to self-dealing issues.

However, going forward, the financial risk of these dealings will be lower so long as they separate the risk transactions into their own IRA. People should still use caution, but at least they won’t be betting their entire aggregate IRA balances.

Increase in age for required beginning date for mandatory distributions

Effective: Taxable years beginning after December 31, 2022.

Under the current law, the required minimum distributions begin at 72 years old. This age is being increased again in two stages:

  • Age 73: Beginning January 1, 2023, if not age 73 before then.
  • Age 75: Beginning January 1, 2033, if not age 75 before then.

Under the current drafting of the bill, the wording is more complex than the summary above. As a result, someone born in 1959 will meet both tests, so that their RMD will be required at both age 73 and age 75.

Hopefully this error is resolved in advance so that those born in 1959 know whether they are under the age 73 or age 75 rule.

Indexing IRA catch-up limit

Effective: Taxable years beginning after December 31, 2023.

IRA catch-up contributions, historically set at a flat $1,000, will now be indexed for inflation in $100 increments.

Treatment of student loan payments as elective deferrals for matching contributions

Effective: Plan years beginning after December 31, 2023.

SECURE 2.0 will allow employers to make matching contributions to an employee’s retirement account based on the employee’s qualified student loan payments being made. Qualified student loan payments are broadly defined as any indebtedness incurred by the employee, solely to pay qualified higher education expenses of the employee.

The plans that will be able to do this will include 401(k) plans, 403(b) plans, SIMPLE IRAs and 457(b) plans. For purposes of the nondiscrimination test in these plans, employees who receive matching contributions under this provision are allowed to be tested separately.

Emergency savings accounts

Effective: Plan years beginning after December 31, 2023.

Employers can now offer non-highly-compensated employees a pension-linked emergency savings account. The maximum balance these accounts may have is $2,500 (indexed). And during the year, the employee can withdraw up to $1,000 from the account with no penalty or income tax consequences.

Contributions into the account are made with post tax dollars (ROTH), and the funds are meant to cover personal or family emergencies.

Withdrawals for certain emergency expenses

Effective: Distributions made after December 31, 2023.

A new early withdrawal exception is made for unforeseeable or immediate financial needs for an individual or family. Under the exception, one distribution of up to $1,000 can be made from a retirement account.

This distribution avoids the 10% early withdrawal penalty but is still subject to normal income tax rules. Further, no additional distributions can be made and avoid the 10% penalty until either three years have passed or the original disbursement has been paid back — whichever occurs earlier. Any repayment in a future period will result in prior taxes paid to be refunded.

Penalty-free withdrawal for domestic abuse

Effective: Distributions made after December 31, 2023.

The act will allow participants to self-certify that they experienced domestic abuse and can withdraw the lesser of $10,000 (indexed) or 50% of their retirement account. This distribution will be taxable but not subject to the 10% penalty.

Additionally, the money can be paid back into the account within three years to be able to claim a refund of taxes paid.

Tax and penalty free conversion of 529 plans into ROTH IRAs

Effective: Distributions made after December 31, 2023.

SECURE 2.0 establishes a new provision that will allow the beneficiary of a 529 plan to roll the plan in to a ROTH IRA in their name. There are several catches to this plan, including:

  • A $35,000 life-time limit on this conversion.
  • The 529 plan must have been in existence for at least 15 years.
  • The amount that can be rolled in a given year is limited to the annual ROTH contribution amounts, ignoring income limitations.

Money converted this way will avoid any penalty from improper 529 distributions and income taxes on the money. However, there is a five-year lookback period. And any money and the associated earnings cannot be converted until it has been in the account for five years.

This limits the tax planning strategy of loading up a 529 plan and then converting it in to a ROTH a day later, since the money would need to sit for five years before it could be converted.

Surviving spouse election to be treated as an employee

Effective: Calendar years beginning after December 31, 2023.

If an employee dies before RMDs had begun, their surviving spouse can make an election to be treated as the employee and receive RMDs based on their life expectancy.

Higher catch-up limits for retirement plans

Effective: Taxable years beginning after December 31, 2024.

Under current law, those age 50 or older can contribute an additional amount into their retirement plans. For most plans the limit is $7,500, but for SIMPLE plans it is $3,500.

SECURE 2.0 makes the following changes:

  • The introduction of an additional catch-up limit for those ages 61-63.
  • The new limit will be the greater of $10,000 ($5,000 for SIMPLE) or 50% more than the regular catchup, indexed for inflation.

Modification of age requirement for qualified ABLE programs

Effective: Taxable years beginning after December 31, 2025.

Under current law, when someone becomes disabled prior to age 26, an ABLE plan may be set up for their benefit. These plans allow funds to invest and be withdrawn tax free for the beneficiary’s benefit. The act will increase this age to 46.

Long-term care contracts purchased with retirement plans

Effective: Distributions made after December 28, 2025.

Retirement plans will be able to distribute up to $2,500 (indexed) per year, to pay premiums for certain long-term care insurance contracts. Such distributions will be exempt from the 10% penalty on early withdrawals.

Saver’s match

Effective: Taxable years beginning after December 31, 2026.

This older tax credit mostly benefits low-income individuals and families. SECURE 2.0 has updated it so that when an individual makes a contribution to an IRA or retirement plan, they will receive a federal matching contribution instead of a tax credit.

The matching contribution will be 50% of the taxpayer’s contribution, up to $2,000 per individual. The contribution will be made to the individual’s account.

For married individuals, the phase-out for this credit starts at $41,000 and will be complete at $71,000. Single and married filing separate are half those amounts, while head of household phase out ranges from $30,750 to $53,250.

Deferral of tax for certain sales of employer stock to ESOP

Effective: Sales made after December 31, 2027.

Under 1042, a C-corporation owner that sells their stock to an ESOP can defer gain if they reinvest the proceeds into qualified replacement property, such as stocks and securities in a US corporation.

SECURE 2.0 partially expands this treatment to S-corporation owners. Deferrals can be made on not more than 10% of the amount realized on such sales, for the purpose of determining the amount of gain not recognized.

How Wipfli can help

Wipfli is here to serve the tax planning needs of both individuals and businesses. Our tax team provides knowledge and experience to help you navigate complex legislation and be confident in your retirement plan. Our human capital management consultants can also provide support to your business as you strive to maintain competitive employee benefits.

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Author(s)

Michael J. Santo, CPA
Senior Tax Manager
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