The Secure Act 2.0 & Estate Planning Opportunities

We will admit that it feels odd to speak about “The SECURE Act 2.0” when it feels like we are still getting our arms around some of the planning and administrative implications of the original SECURE Act (see the proposed regulations released in April 2022 and “4 IRA Rules you should know from the SECURE Act of 2020”).

Long-held strategies for estate planners and financial advisors were up-ended as a result of several features of the SECURE Act relating to inherited IRAs resulting in a bit of a paradigm shift for using retirement assets as vehicles to pass wealth to younger generations.

Changes to Required Minimum Distributions (“RMDs”)

Beginning this year, the required beginning date for minimum distributions has increased to 73 (up from 72 under 2019’s SECURE Act). SECURE 2.0 has also scheduled increases in future years – in 2033 increasing to age 75. By increasing the age at which individuals are subject to RMDs, the legislation is attempting to recognize the changes inherent from the increasing life expectancy, as well as acknowledging the shift in how and when we retire. This means that, to the extent that you may retire early, or partially retire, but are able to live off of income from other resources, you can continue to defer income taxes on the investments in your retirement plans.

For some time, RMDs have not been required of Roth IRAs for the owner (only for those who inherit the Roth account). But this was not always true of Roth 401(k) plans – leading many to rollover their Roth 401(k) account into a Roth IRA. However, this is not a perfect solution as the 5-year rule for withdrawals does not transfer with the rollover, which is problematic if you had not created a Roth IRA prior to the rollover. Luckily for some, SECURE 2.0 removes the requirement for RMDs from Roth 401(k) plans beginning in 2024 – unfortunately, if you have a Roth 401(k) and are already subject to RMDs prior to 2024, this will not affect your requirements now or in the future.

If you are subject to RMDs and have missed taking your required distribution, penalties will be cut in half under SECURE 2.0 beginning this year – from 50% to 25%, or even 10% provided that the error is corrected in a timely manner. While 25% of the missed amount is still a hefty penalty, it is a significant improvement. In reality, these penalties can be forgiven at the discretion of the IRS – generally requiring that you correct the missed RMD as soon as possible and have an understandable reason as to why the RMD was missed. Further, while the IRS is likely to agree to forgive or abate the penalties in many cases, you cannot rely on this as there is no guarantee that forgiveness will be granted.

Updates to “Catch-up” Contributions

“Catch-up” contributions offer a significant opportunity for individuals who are at least 50 years old, permitting additional contributions to a variety of plans so that you can bolster your retirement savings as you get closer to retirement age. In general, if you are at least 50 years old, you can save an additional $1,000 per year in an IRA (whether for Traditional or Roth accounts) or an additional $6,500 per year in your employer’s 401(k) plan (for 2022 contributions, increasing to $7,500 for 2023).

While the base numbers for maximum IRA contributions have been tied to inflation, the catch-up contribution amount have not been. So, while the maximum total IRA contributions that a person can make increased from $6,000 in 2022 to $6,500 in 2023, the catch up amount has been unchanged. SECURE 2.0 fixes this error so that in future years that $1,000 catch up will be adjusted for inflation in future years (rounding to the nearest $100).

In addition to the standard catch up amounts for employer sponsored plans, like 401(k) plans, beginning in 2025, SECURE 2.0 provides that individuals who are between age 60 and 63 (but not those 50-59 or above 63) can increase their catch-up contributions. Beginning January 2025, these employees can elect to save the greater of an additional $10,000 or 150% of the standard catch-up amount – with that $10,000 also being indexed for inflation for years after 2025.

Transfer of Excess College Savings Plans to Roth IRAs 

One significant opportunity we want to draw attention to is the newly established ability for beneficiaries of College Savings Plans (a/k/a “529 Plans”) to rollover unused plan funds into Roth IRAs beginning in 2024. In addition using 529 plans for qualified education expenses, SECURE 2.0 will allow those 529 plan beneficiaries to shift assets to Roth IRAs so long as 1) the 529 Plan is at least 15 years old and 2) the amount rolled over is within the limits for Roth IRA contributions – i.e., the lesser of either 1) the beneficiary’s earned income or 2) $6,500 dollars (for 2023), and provided that the beneficiary’s Modified Adjusted Gross Income falls below the applicable threshold limits for Roth IRA contributions. Any beneficiary seeking to take advantage of this new opportunity will also only be allowed to do so up to a total of $35,000 over the course of their lifetime.

While the rollover itself can be completed without penalties or income tax consequences, the 529 plan beneficiary must still be eligible to make Roth IRA contributions. This means that, beginning next year, if an older child has a 529 plan which has been open for at least 15 years has assets which are no longer needed for their education – whether the child has finished school or the plan itself is considered to be “over funded” – the funds from the 529 plan can be used to start or add to a Roth IRA for the child rather than he or she taking taxable distributions an incurring penalties by using funds for purposes other than their education. Not only does this provide an immediate opportunity for many families, especially those with older children who have not needed the entire account for any reason, but this also may provide an opportunity for new families who are planning for a young child’s future success and financial savings.

For example, a couple could start a 529 plan for a child shortly after his or her birth, and rollover assets once the child is a teenager and provided that he or she has earned income. Families making annual exclusion gifts to children that include Roth IRA contributions, will need to be mindful of annual contribution limits to ensure. Additionally, parents who rollover funds on behalf of a child should keep track of the total transfers so that the child does not accidentally exceed the lifetime maximum in the future if he or she still has 529 plan assets remaining after finishing their education.

Updates to Qualified Charitable Distributions

One topic we have spoken with many clients about has been meeting their charitable planning goals with retirement assets, provided that they do not otherwise need the cash flow from their RMD by taking advantage of Qualified Charitable Distributions (“QCDs”). For many years this has been limited to a maximum of $100,000/year per individual without any adjustment. Under SECURE 2.0, this maximum amount will be indexed for inflation beginning 2024. Additionally, SECURE 2.0 expands the IRA charitable distribution provisions to permit a one-time IRA charitable distribution of up to $50,000 to charities through charitable gift annuities or charitable remainder trusts effective beginning this year.

The SECURE Act 2.0 contains many provisions not covered here – affecting individuals and small business owners, entrepreneurs and those who have been with the same companies for decades – many of which could impact your individual estate plan. For more information on the effect that the new legislation may have on your overall estate plan, schedule a consultation with your estate planning attorney to discuss your goals and the opportunities available to you and your family.