In late December of 2022, while most of us were busy with other things, Congress was working on passing a giant omnibus budget bill. The 2023 omnibus bill was signed into law by the President on December 29, 2022. Buried within it was the Setting Every Community Up for Retirement Enhancement 2.0 Act of 2022 (SECURE 2.0). It provides new incentives for employers to offer retirement plans to their employees and for employees to participate and improve their retirement security. SECURE 2.0 helps employees and their beneficiaries, owner-employees, small businesses, and retirees, and eases costs, administrative burdens, and penalties for inadvertent mistakes.
Employers wishing to adopt these new benefits for their employees should contact their retirement plan administrators as soon as possible so their plans can be amended to incorporate these changes.
To pay for the tax benefits of SECURE 2.0 the Act included a new provision to limit the charitable deductions taxpayers can claim from “syndicated conservation easements”.
This article focuses on some of the key provisions of the bill:
- Benefits for Employees and Retirees Effective in 2023
- Provisions Benefitting Employers Effective in 2023
- Employee Provisions Effective after 2023
- More Penalty-Free Withdrawals Permitted
- Age increased for required distributions – Under the Act, the age used to determine required starting dates for distributions of IRA owners and other retirement plan participants will increase in two stages, from the current age of 72 to age 73 for those who turn age 72 after 2022 (i.e. born 1951-1959), and to age 75 for those who attain age 74 in 2032 (i.e. born 1960 or later).
- Reduced penalty tax on failure to take Required Minimum Distributions (RMDs) – The Act reduces the penalty for failure to take required minimum distributions from qualified retirement plans, including IRAs, or deferred compensation plans from the current 50% to 25% of the amount by which the distribution falls short of the required amount. It reduces the penalty to 10% if the failure to take the RMD is corrected in a timely manner.
- Roth (after-tax) contributions for Simplified Employee Pension (SEP) and SIMPLE IRAs – The Act allows SEP and SIMPLE IRAs to be designated as Roth accounts. Any contributions will be treated as taxable income of the account owner. This contribution will limit the allowable contributions that can be made to the owner’s other Roth accounts.
- Retroactive first-year deferrals for sole proprietors – Taxpayers have the ability to set up and contribute to SEP IRA accounts after the end of the year up until their tax return due date (including extensions) in order for the contribution to apply to the prior year. Now, this flexibility will also apply to solo-401(k) plans that are set up by sole proprietors. However, taxpayers will have only until the tax return due date, not including extensions, to fund the employee portion of the contributions made to the plan. This provision only applies to the plan’s initial year.
- Employer Roth (after tax) contribution option – Before the Act, employers were not permitted to make contributions on a Roth basis. For contributions made after December 29, 2022, however, a qualified plan such as a 401(k) may permit a participant to designate some or all employer contributions as designated Roth contributions. This applies only to the extent that a participant is fully vested in these contributions as they would be taxable income to the employee.
- Return of excess contributions – The Act specifies that earnings attributable to excess IRA contributions that are returned by the taxpayer’s tax return due date (including extensions) are exempt from the 10% early withdrawal tax.
- Bigger tax credit for start-up retirement plans – The SECURE Act improves the small employer pension plan start-up cost credit in three ways for tax years starting after 2022.
- First, it makes the credit equal to the full amount of creditable plan start-up costs for employers with 50 or fewer employees (up to an annual cap of $5,000). Previously, only 50% of costs were allowed (which still applies to employers with 51 to 100 employees).
- The Act also retroactively fixed a technical glitch that prevented employers who joined multi-employer plans in existence for more than three years from claiming the start-up cost credit. Employers that joined a pre-existing multi-employer plan in 2020 should contact us about filing amended returns claiming the credit.
- Perhaps the biggest change is that certain employer contributions for a plan’s first five years now may qualify for an additional credit. The credit is based upon a percentage of employer contributions, up to a per-employee cap of $1,000: The applicable percentage is 100% during the plan’s first and second tax year (so contributions up to $1,000 per employee could be fully funded with the tax credit), 75% in the third year, 50% in the fourth, and 25% in the fifth. For employers with between 51 and 100 employees, the contribution portion of the credit is reduced by 2% times the number of employees above 50.
In addition, the employer contribution credit is not allowed for contributions for employees who make more than $100,000 (adjusted for inflation after 2023). The credit for employer contributions also is not available for contributions to a defined benefit pension plan.
- Catch up contributions of highly compensated – For tax years beginning after 2023, catch-up contributions for Code Sec. 401(k), 403(b), or 457(b) plans are subject to mandatory Roth (after-tax) treatment, for those made by participants whose wages for the preceding calendar year exceed $145,000, as annually indexed for inflation. This rule does not apply to simplified employee pensions, or to SIMPLE IRAs.
- Bigger catch-up contributions permitted – Starting in 2025, the Act increases the current elective deferral catch-up contribution limit for employees (age 60-63) from $7,500 for 2023 ($3,500 for SIMPLE plans) to the greater of $10,000 ($5,000 for SIMPLE plans), or 150% of the regular catch-up amount in 2024 (2025 amount for SIMPLE plans). The dollar amounts are inflation-indexed after 2025.
- Elimination of Roth 401(k) Required Minimum Distributions (RMD) – Beginning in 2024, Roth 401(k)s will no longer be subject to lifetime RMDs. Roth IRAs were never subject to lifetime RMDs, and now employer plans will have that same benefit.
- Qualified Charitable Distributions (QCD) – A QCD allows individuals who are 70 1/2 years old or older to donate up to $100,000 in total to one or more charities directly from a taxable IRA instead of taking their RMD. Beginning in 2024, this annual amount of $100,000 will be increased for inflation.
- Tax-free rollovers from Educational Savings (529 Plan) accounts to Roth IRAs – After 2023, the Act permits beneficiaries of 529 college savings accounts to make up to $35,000 of direct trustee-to-trustee rollovers from a 529 account to their Roth IRA without tax or penalty. The 529 account must have been open for more than 15 years and contributions made in the last 5 years before the rollover do not qualify. Rollovers are not limited based on the taxpayer’s adjusted gross income and are subject to the Roth IRA annual contribution limits. So the full $35,000 cannot be used in one year.
- Favorable surviving spouse election – For plan years after 2023, the surviving sole spousal designated beneficiary of an employee who dies before RMDs have begun under an employer qualified retirement plan may elect to be treated as if the surviving spouse were the employee for purposes of the required minimum distribution rules. If the election is made distributions need not begin until the employee would have had to start them. Hence it can be beneficial in situations where the deceased spouse is younger than the surviving spouse.
- Employer match for student loan payments – To assist employees who may not be able to save for retirement because they are overwhelmed with student debt, and are missing out on available matching contributions for retirement plans, SECURE allows them to receive matching contributions by reason of their student loan repayments. For plan years after 2023, it allows employers to make matching contributions under a 401(k) plan, 403(b) plan, or SIMPLE IRA for “qualified student loan payments.”
- Improved coverage for part-timers – The Act modifies the rules that apply to long-term part-time employees under a 401(k) or 403(b) plan to reduce the service requirement for these employees from three years to two consecutive years if the employee has worked for the employer at least 500 hours per year and have met the minimum age requirement of 21 by the end of the two-year period. This change is effective for plan years beginning after 2024.
- More taxpayers will qualify for ABLE programs – States may establish tax-exempt ABLE programs to assist persons with disabilities. Under current law, an individual must become disabled or blind before age 26 to be eligible to establish an ABLE account. The Act raises the age threshold from 26 to 46. The change is effective for tax years beginning after 2025.
The Act adds new 10% penalty exemptions for amounts that a taxpayer withdraws before reaching age 59 1/2 for certain specific reasons:
- Federally declared natural disasters – penalty free distributions of up to $22,000 may be made from employer retirement plans or IRAs for affected individuals. Regular tax on the distributions is taken into account as gross income over three years. Distributions can be repaid to a retirement account. Additionally, amounts distributed prior to the disaster to purchase a home can be re-contributed, and an employer may provide for a larger amount to be borrowed from a plan by affected individuals and for additional time for repayment of plan loans owed by affected individuals. This provision is retroactive for disasters occurring after January 25, 2021.
- Any distributions made for terminal illness starting 2023 – For the purposes of the SECURE Act, the definition of terminal illness is an illness or physical condition which can be reasonably expected to result in a death in 84 months (7 years) or less based on a physician certification. Taxpayers must have received this certification on or before the date they receive a distribution from their retirement account in order for this exemption to apply.
- Financial emergencies–Starting in 2024, one distribution per year of up to $1,000 used for emergency expenses to meet unforeseeable or immediate financial needs relating to personal or family emergencies. The taxpayer has the option to repay the distribution within three years. No other emergency distributions are permissible during the three-year period unless repayment occurs.
- Pension linked savings account – The Act also contains an emergency savings provision that allows employers to offer non-highly compensated employees emergency savings accounts linked to individual account plans that automatically opt employees into these accounts at no more than 3% of their salary, capped at a maximum of $2,500.
- Domestic abuse – Plans may permit participants that self-certify having experienced domestic abuse to withdraw the lesser of $10,000, indexed for inflation, or 50% of their account. The participant has the opportunity to repay the withdrawn money from the retirement plan over three years and get a refund of income taxes on money that is repaid. This provision is also applicable starting in 2024.
- Long-term care – Beginning December 29, 2025, retirement plans may make penalty-free distributions of up to $2,500 per year for payment of premiums for high quality coverage under certain long-term care insurance contracts.
These are just a few of the over 90 provisions contained in this Act. There are many more complicated provisions with varying effective dates that have not been discussed. In addition, the state laws may or may not conform to all the provisions of the Act.
We, at Abbott, Stringham & Lynch, are here to help you navigate the complexities and help you with planning opportunities and implementation related to the Act. Please contact us for more information and assistance.