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3 Notable Changes in Secure Act 2.0 for Advisors

Roth IRAs, charitable distributions, and 529 conversions deserve advisors’ attention.

The Secure Act 2.0 contains new rules that affect your clients. Part of a larger spending bill recently signed into law by President Joseph Biden, the law revises the retirement provisions of the original Secure Act and includes many new detailed rules regarding required minimum distributions, or RMDs; Roth conversions and distribution modifications; relief for emergency and other “needs based” early withdrawals; and more. For a detailed look at these changes, go here and here.

What I want to focus on here is what advisors can do to take advantage of the new rules to help their clients. Here are three areas to consider tackling now.

1) Roth IRAs

The Secure Act 2.0 contains numerous changes to Roth and other retirement accounts. Some of these will be beneficial to clients—now and in the future. Note that the new rules do not limit or change current “backdoor” Roth strategies.

New Limits

The new rules allow IRA catch-up contributions to automatically adjust for inflation, but not until 2024. The adjustments will be in increments of $100, so the 2024 limit will likely be $1,200 rather than the current $1,000.

Beginning in 2025, the catch-up contributions of employer retirement plans such as 401(k)s and 403(b)s will increase depending on the participant’s age. For participants of ages 60 to 63, the catch-up contribution limit will be increased to the greater of $10,000 or 150% of the regular catch-up contribution amount (indexed for inflation).

Simple Plan participants of ages 60 to 63 will have the catch-up contribution limit increased to the greater of $5,000 or 150% of the regular Simple catch-up contribution amount.

What this means for clients: Your clients who are approaching retirement age will be able to defer more into their IRAs and qualified plans, beginning in 2024 and 2025, respectively.

No More RMDs

Under previous law, qualified plan Roth accounts (such as 401(k)s and 403(b)s) were subject to RMDs—even though Roth IRAs were not. Beginning in 2024, qualified Roth accounts will not be subject to RMDs.

What this means for clients: Qualified Roth contributions will be more attractive.

Employer Matching Contributions

Effective upon enactment, employer matching and nonelective contributions can be made to employees’ designated qualified Roth accounts. Although allowed now, company plans might need some time to adopt the changes.

What this means for clients: There will be greater opportunities to accumulate savings in Roth accounts. Even for high-bracket taxpayers, the permanent elimination of tax on growth should be a powerful incentive.

Roth Catch-Up Contributions for High-Wage Earners

Under the Secure Act 2.0, catch-up contributions for employees with wages over $145,000 must be designated to the Roth portion of the account. It is interesting to note that this provision does not apply to employer plans not offering a Roth option or to self-employed individuals.

What this means for clients: As above, although there will be no deduction for catch-up contributions, the high-wage earners will benefit from the permanent elimination of tax on growth—without RMDs.

Roth Conversions

Roth conversions are especially attractive between retirement and the beginning of RMDs, when taxable income is typically low. The Secure Act 2.0 delays the start of RMDs, providing opportunities for more Roth conversions at lower tax rates over a longer period of time.

Under the new rules, depending on the taxpayer’s age, RMDs will not be required until age 75, at the latest. For taxpayers who attain age 72 after 2022 and age 73 before 2033, the RMD age will be 73. For taxpayers who attain age 74 after 2032, the RMD age will be 75.

For example, a person who retired at the end of 2022 and will be 66 in 2023 will attain age 73 in 2030. Because this is before 2033, RMDs will be required in 2030 (or 2031, if the decision is made to “double up” that year). Thus, for years 2023-29 (or 2030), Roth conversions can be planned at minimal tax cost over a period of seven (or eight) years.

What this means for clients: Now is the time to do Roth conversion planning. By delaying retirement distributions, your clients can have additional years to convert IRA funds to Roth at lower tax rates.

These changes all seem to encourage, even require, a greater emphasis on Roth rather than pretax retirement contributions. Although this means more money to the IRS as contributions (or conversions) are made, the opportunity to permanently exclude future growth (and previously taxed principal) from taxation, coupled with the elimination of RMDs, should be a big win for taxpayers in the long run.

2) Qualified Charitable Distributions

Changes to qualified charitable distributions, or QCDs, are not huge, but they should be noted.

Maximum QCD Amount

The new rules allow the maximum annual QCD amount, currently $100,000, to be indexed for inflation beginning in 2024.

What this means for clients: Taxpayers of age 70½ and older will be able to make higher pretax charitable contributions (no deduction and no income) beginning in 2024.

QCD to Split-Interest Entity

Beginning in 2023, taxpayers can use a one-time opportunity to use a QCD of up to $50,000 to fund a charitable remainder trust (including a charitable remainder annuity trust and charitable remainder unitrust) or a charitable gift annuity.

The requirements are:

1) The beneficiary must be the taxpayer and/or spouse.

2) The minimum annual payout must be at least 5%.

3) Annual distributions will be treated as ordinary income.

4) The trust or annuity must be funded by a QCD.

The latter requirement means that the taxpayer must be at least 70½ and the $50,000 would count against the $100,000 annual QCD maximum (to be indexed for inflation beginning in 2024).

From a practical standpoint, the cost of setting up a charitable remainder trust would be prohibitive for a $50,000 principal amount. Thus, the client would want to use a charitable gift annuity.

For example, assume your client is age 71 and contributes $50,000 to a charitable gift annuity established by the Mayo Clinic. Your client will receive 6%, or $3,000 a year, for life. The $50,000 withdrawn from the client’s IRA will not be taxable (nor will the contribution to the charitable gift annuity be deductible).

Considering that RMDs range from 3.6% (age 72) to 5.4% (age 82) to 6.9% (age 87), the CGA is roughly equivalent to these amounts. The differences between the charitable gift annuity and simply taking RMDs are:

  • The initial principal cannot exceed $50,000.
  • The annual amount is fixed and not dependent on returns.
  • The principal amount goes to charity upon death, not to heirs.

So, why would a client want to do this? The answer is their charitable intent.

What this means for clients: This is not a monumental financial opportunity. However, it is an option that should be presented to clients.

3) 529 Plan Conversions

The Secure Act 2.0 allows a limited ability to convert 529 plan funds into a Roth IRA beginning in 2024. To qualify, the following requirements must be met:

  • The Roth IRA receiving the funds must be in the name of the 529 plan beneficiary.
  • The 529 plan must have been in existence for 15 years or longer.
  • Contributions made within the last five years (and the related earnings) are ineligible.
  • The annual limit for the amount that can be converted from a 529 plan to a Roth IRA is limited to the IRA contribution limit for the year, reduced by any traditional IRA or Roth IRA contributions made for the year. (In other words, no doubling up with funds.)
  • The maximum amount that can be moved from a 529 plan to a Roth IRA during an individual’s lifetime is $35,000.

This opportunity can be very limited in most cases. For example, assume your client’s child, who is now an adult, is the beneficiary of a 529 account with funds in excess of what was needed for education and the account has been in existence for more than 15 years. Assume the beneficiary makes a Roth IRA contribution of $2,000 in 2024. If the IRA contribution limit in 2024 is $6,500, a maximum of $4,500 can be converted from the 529 account to the Roth. This can be continued in future years up to a maximum conversion amount of $35,000.

It is possible to contribute a substantial amount to a 529 account when a child is young, with the intent of using the excess to fund a Roth IRA. However, if funding a Roth IRA is the ultimate goal, the Roth should be funded separately. This eliminates the need to “jump through hoops.” If all of the 529 funds are not required, then these new provisions can be used.

What this means for clients: Consider converting excess 529 holdings over time to the extent that beneficiaries no longer have a need for educational funding.

The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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