As a special Christmas present to all of us, the Secure Act 2.0 is expected to become law right before the holiday.
The SECURE Act 2.0 caught a ride on the $1.7 trillion omnibus spending bill that was unveiled on December 19. While the bill presents numerous changes to existing retirement savings and withdrawal rules, as my present to you, I’ve jumped right in to analyzing what the sweeping changes mean for your Roth IRAs in particular.
Roth IRAs are good tools for various reasons. As I’ve written in the past, they are underutilized retirement savings and investment vehicles that offer a number of tax and liquidity benefits. They are also a valuable tool for people who don’t have access to an employer-sponsored retirement plan, which is roughly half of private sector employees ages 18 to 64, according to AARP.
I’ll dive into the provisions in the Secure Act 2.0 that will impact Roth accounts and whether they are positive, negative, mixed, or neutral.
Section 107: Increase in RMD Age to 73 and 75
Current law has RMD age set at 72. The Secure Act 2.0 would move the required minimum distribution age to 73 for anyone reaching this age in 2023. If you reached age 72 in 2022 you are subject to the age 72 RMD. And then on January 1, 2033, the applicable required beginning date age will be 75.
My rating on this provision, which goes into effect in 2023 and 2033, is neutral. Most people will not be impacted by it because most people are already taking out more than their RMD at 72. Nearly 80% of people took out more than their RMD at age 70.5 and it’s likely that fewer than 20% that take RMD only at 72. This number would drop even more by age 73 and even further by age 75. This provision mostly impacts people with wealth who don’t need their RMD and can leave the money to grow.
So you might be asking why did I include this with a Roth article? Because of Roth conversion planning opportunities. Pushing back the RMD age gives people more flexibility over when to spend their money, more planning opportunities for Roth conversions, and an increased ability to design smart spending strategies from their taxable retirement accounts. The best time to do Roth conversions is often after you’ve retired when taxable income drops and before RMDs are due. While you can do a Roth conversion after RMDs are due, you need to do conversion above and beyond what you owe that year for RMDs, often increasing your taxes. Instead, look for low tax rate years where you can do some conversion from a traditional IRA or retirement account to a Roth IRA or account and keep taxes low.
Remember, if you want to convert money from a traditional IRA to a Roth, the amount you convert is typically included in taxable income if it was tax deferred money in the IRA. Additionally, to have that Roth conversion money show up on your tax return for the current year, it must be done by 12/31.
Section 126: 529 to Roth Accounts
SECURE Act 2.0 adds a new way to do a tax- and penalty-free rollover from a 529 account to a Roth IRA under certain conditions. Currently, money in a 529 that’s distributed for non-education expenses can be subject to penalties and taxes.
But under the new provision, beneficiaries would be able to do a rollover of up to $35,000 aggregate in life from a 529 to a Roth IRA in their name. The rollovers would be subject to the Roth IRA annual contribution limits and the 529 would need to have been open for at least 15 years. Earnings and contributions would be treated like any other Roth account or rollover. However, the income limitation to be able to contribute to a Roth IRA is removed for the 529 to Roth IRA rollover, but the annual contribution limit remains.
My rating of this provision, which would go into effect in 2024, is positive. The main benefit here might be to remove the uncertainty that happens if you were to overfund a 529 or if your kids don’t need it. Now, you likely can reposition that money back to yourself as a beneficiary to your Roth IRA or to your children’s Roth IRA. For the vast population of Americans, overfunding college expenses by $35,000 in 529s is not a big risk, but it can happen. But this does give parents a lot of certainty that if they do overfund, their kid gets a scholarship, or doesn’t go to school that the money can eventually be repositioned for this kid’s retirement in a tax advantaged way inside of a Roth IRA.
Section 325: Removal of Pre-Death RMDs Roth Accounts
There will be no more RMDs for Roth accounts – such as Roth 401(k) or Roth 403(b) accounts – pre-death after 2023. Currently, Roth IRAs are not subject to pre-death RMDs but Roth accounts like 401(k)s and 403(b)s are subject to RMDs. This caused people to do rollovers from their 401(k)s or 403(b)s to a Roth IRA to avoid the RMD. Ultimately, it was creating extra work and movement of accounts without really creating a universal policy or benefit. Roth IRAs and Roth accounts remain subject to the same rules pre-SECURE 2.0 once the owner has passed away.
My rating on this provision, which would go into effect in 2024, is positive. This provision simplifies this question and reduces the need for rollovers to Roth IRAs. Since Roth accounts were subject to RMDs post-required beginning date (RBD), you were generally advised to rollover to a Roth IRA that would not be subject to the rules. But that would sometimes force people out of a retirement plan or account that was otherwise better for them. While rare, it was an added complexity. This new provision will simplify the process, allowing assets to stay in Roth 401(k) or 403(b) accounts and not be subject to lifetime RMDs.
Section 601: SIMPLE and SEP Roth IRAs
Currently SIMPLE IRAs and SEP IRAs do not allow for Roth contributions. The bill would change this, allowing for SIMPLE Plans to accept Roth employee contributions. Additionally, the bill would allow SEP IRAs to offer employees the ability to treat SEP contributions as Roth. The SIMPLE and SEP plans would have to decide to offer this feature as it is not automatic.
My rating of this provision, which would go into effect in 2023, is positive. This allows employees to get Roth tax treatment inside of SEP and SIMPLE IRAs. This makes sense because there are often starter plans for small companies and for employees not making a lot of income yet. As such, their tax liability might be low at that time and people would benefit more from a Roth account than a tax-deferred account. It also provides better flexibility.
Section 603: Catch-up Contributions are Roth Contributions
Currently catch-up contributions can be a Roth or pre-tax depending on what the plan allows. The new provision would require that all catch-up contributions would be subject to Roth tax treatment. There is an exception for employees with $145,000 or less in their Roth the previous year, indexed for inflation, who would still be able to opt into a pre-tax account.
My rating of this provision, which goes into effect in 2024, is negative. This is a tax revenue raising provision. Increasing the catch-up contribution amounts earlier and requiring high income catch-up contributing participants to do Roth will push revenue forward into a higher tax year.
People who can use catch-up contributions are over age 50 and often in the highest earning and tax years of their lives. This shifts money into a high tax year as opposed to allowing it to be deferred into the future in a lower tax rate year.
This is viewed as a tax revenue generator to offset some of the other tax cuts or tax benefit extensions in the bill. Lastly, this creates a good deal of complexity for plan providers as many companies are not set up for Roth accounts and there was no grandfathering out older plans. There will likely be some needed changes or regulations in the next year to help out existing plans.
Section 604: Employer Matching can be Roth or Pre-Tax
The bill will allow employers to let participants in 401(k), 403(b), and governmental 457(b) plans to get matching contributions on a Roth basis. It doesn’t require plans to offer this but creates it as an option.
My rating of this provision, which goes into effect in 2023, is positive. It allows for matching contributions to go into a Roth account. This can make sense for many lower-income employees that don’t benefit that much from tax deferral, especially early in their career. Roth tax treatment gives them a better overall tax outcome. Because this is at the direction of the employee, it gives additional savings and tax management flexibility.
Final Thoughts: Roth and the SECURE 2.0 Act
When you look at this bill, there was a clear lean toward Roth accounts, which pushes tax revenue forward for the government. It was used in certain areas of the SECURE 2.0 Act to make the whole bill more revenue neutral. For instance, the mandatory Roth treatment of catch-up contributions is a revenue producer. It allowed some of the other additional tax benefits and extensions to make it into the SECURE 2.0 bill.
Overall, the bill created a great deal of additional tax flexibility to choose between Roth or tax-deferred accounts. Moving forward, those saving for retirement will have more control over how their money is taxed than they did prior to the SECURE 2.0 bill.