February 16, 2023 Dave Wigginton

Congress managed to pass a meaningful piece of legislation at the end of 2022 that has many favorable provisions for taxpayers. The SECURE Act 2.0 came three years after 1.0 was passed. Many have reviewed the part of the bill that relates to retirement accounts and identified some of the tax planning implications and opportunities. This post is intended to identify some of the more favorable provisions for the broadest audience. But first, a slight detour.

Planning vs. Preparing

Tax planning is not the same as tax preparation. Tax preparation is the actual preparing and filing of tax returns as required by the IRS each year. Tax planning is the exercise of identifying the path to paying the least amount of taxes within the confines of the tax code. Ultimately, tax efficiency is the objective of tax planning. How do I pay the least amount of taxes while still complying with the tax code?

The impact of tax planning on an individual’s or family’s overall financial picture is often overlooked and underappreciated. The benefits of tax planning aren’t always apparent in one year’s time but do accrue and compound over multiyear timeframes. According to a white paper, proper tax planning and management can add value of about 1% per year. If you compound that over 20 years, that would result in 22% of added value, a not insignificant addition to anybody’s investment portfolio or overall liquid cash balance.

Understanding the tax code and effectively applying it to an individual’s or family’s tax situation requires effort and expertise that not every financial advisor is able to provide. Furthermore, not all tax preparers provide tax planning services, or at least the comprehensive planning some may require. The benefits of tax planning are significant enough that it merits more of your attention and understanding.

Now back to SECURE 2.0

One of the larger benefits, in my view, of the Act was something that wasn’t in the bill. The Backdoor Roth IRAs haves been on the chopping block for several years. Fortunately, there was no mention of eliminating Backdoor Roth IRAs in the new legislation. This allows higher earning taxpayers a path to the tax benefits of Roth IRAs. But remember, Backdoor Roth IRAs aren’t for everyone. If you have a large Traditional IRA account balance, any Roth conversion will be subject to the pro-rata rule, which requires the taxable amount of the conversion to be based on the ratio of pre-tax funds to total funds in IRAs held by the taxpayer. In other words, if you had traditional IRA consisting of 75% pre-tax money and 25% after-tax money, you would be taxed on 75% of any Roth conversion you made regardless of what percentage of the funds transferred was pre-tax and what was after-tax.

Catch up contributions: For those over 50, catch up contributions are a great way to supercharge your savings within an IRA or 401(k). Starting in 2024, catch up contributions will be subject to cost-of-living adjustments. Additionally, beginning in 2025 employer retirement plan (401k, 403b, etc.) participants who are ages 60, 61, 62, and 63 have higher plan catch-up contribution limits equal to the greater of $10,000 or 150% of the regular catch-up contribution amount for 2024.

Similarly, SIMPLE IRA plan participants of the same ages as above will be able to make larger catch-up contributions equal to the greater of $5,000 or 150% of the SIMPLE catch-up contribution amount for 2025.

This is a great feature for those that may be behind on their retirement savings or for those that want to maximize their savings. Don’t underestimate the power of being able to defer more income now and add to your nest egg.

Required Minimum Distributions: The age for RMDs was raised to age 73 for individuals born between 1951 and 1959 and age 75 for those born in 1960 or later. Good news for those that may not need to take distributions, especially if they push them into higher tax brackets. This provision buys many retirees more time to determine how best to manage the drawdown of their retirement accounts. Remember, tax-planning can assist you in developing the optimal distribution and/or conversion strategy for your personal situation.

Qualified Charitable Distributions (QCD): While the RMD age was pushed back, individuals are still eligible to make qualified charitable distributions at age 70 ½. A qualified charitable distribution is an otherwise taxable distribution from an IRA that is paid directly from the IRA to a qualified charity tax-free. For those that have aspirations to give generously, QCD’s are an extremely tax efficient way to make contributions from proceeds in their IRAs.

Surviving Spouse Beneficiaries: Another option has been created for surviving spouse beneficiaries of their deceased spouses’ IRAs. Beginning in 2024, surviving spouse beneficiaries will be allowed to be treated as the deceased spouse for RMD purposes. So, if the surviving spouse is older than the deceased spouse, RMDs could be further delayed by electing to be treated as the deceased spouse from an age perspective. This provision provides potential added tax planning flexibility for inherited IRA owners.

New Roth Opportunities: Beginning in 2023, individuals will be able to open and contribute to Roth SIMPLE and Roth SEP IRAs. Up until now, SIMPLE and SEP IRA accountholders were only able to contribute on a “pre-tax” basis. This added flexibility increases the attractiveness of SIMPLE and SEP IRAs.

Employer Match: Employers will be permitted to deposit matching and/or nonelective contributions to employees’ designated Roth accounts. The downside is those contributions will be included in employees’ income in the year they’re made, increasing the employees’ taxable income. However, the employee will be able to compound growth within those accounts and take distributions tax free at the appointed time.

529 Plan to Roth Conversions: Unused funds within 529 plan accounts that meet certain criteria will be able to be converted to Roth IRAs in the name of the beneficiary of the 529 account. On the surface, this appears to be quite favorable, but it has its limitations. The 529 plan must have been maintained for 15 years or longer to qualify for the conversion. Any contributions made to the 529 plan within the last five years are ineligible to be moved to a Roth IRA. The annual limit for how much can be moved from a 529 plan to a Roth IRA is the IRA contribution limit for the year, less any “regular” traditional or Roth IRA contributions that are made during the same tax year. In other words, the total amount contributed to an IRA in a given year can’t exceed IRS mandated contribution limits on a combined basis between Traditional and Roth IRAs and 529 conversions. The maximum amount that can be moved from a 529 plan to a Roth IRA during an individual’s lifetime is $35,000. This provision adds needed flexibility to 529 plans but it still doesn’t necessarily solve the problem of what if my child doesn’t ever have any qualified education expenses and there aren’t any other beneficiaries. This situation won’t be a problem if the balance in the 529 account is $35,000 or less.

Matching for Student Loan Payments: This provision enables student loan payments to be treated as retirement plan contributions eligible for an employer match up to the elective deferral limit for the plan type. This feature is available for 401(k) plans, 403(b) plans, 457(b) plans, and SIMPLE IRAs. Existing retirement plans will need to be updated by employers.

Emergency Expense Withdrawals: Beginning in 2024, retirement plan participants and retirement plan accountholders will be eligible to take penalty-free distributions for personal or family emergency expenses, limited to a maximum of $1,000 and to one distribution every three years unless the recent distribution is re-contributed.

Early Withdrawal Penalty Exemption Age: Qualified public safety employees can avoid the early withdraw penalty at the earlier of 25 years of service or age 50. While a modest adjustment, it offers a little more flexibility to police officers, firefighters, and other public safety employees.

Tax Efficient

There are many other provisions in the SECURE 2.0 Act that may be applicable to your situation. As I mentioned at the outset, I wanted to highlight what I thought would be applicable to the broadest audience. Remember, effective tax planning can add value of about 1% annually. Making sure you’re taking advantage of everything that is available to you will increase your wealth over time and give you the peace of mind that you’re doing everything you can to be tax efficient.