Tax benefits for wealthy earners in SECURE 2.0


SECURE 2.0, the sweeping retirement package now poised to become federal law, contains several boosts for higher-income people.

For starters, there’s an unusual provision that converts unused college savings plans into tax-free Roth accounts. Meanwhile, the penalties for failing to take required minimum distributions from individual retirement accounts and 401(k) plans will drop by half. Companies will be allowed to make matching contributions to workers’ employer-sponsored Roth accounts. Starting in 2024, Roth 401(k)s won’t face RMDs. With other plans, the age to start taking minimum distributions rises to 73 in 2023 and 75 in 2033 — more years for retirement accounts to grow in value.

On other fronts beneficial to higher earners, annual distributions won’t be required from an employer-sponsored Roth starting in 2024. Meanwhile, beginning next year, people age 70½ or older can make a one-time gift up to $50,000 from a taxable IRA to a popular type of trust. While the gift isn’t deductible, it counts toward an individual’s RMDs and thus can keep a donor from being pushed into a higher tax bracket when taking distributions.

All of the SECURE 2.0 provisions, tucked into the $1.7 trillion spending bill Congress passed last week, give financial advisors new tools for client planning. That’s because they create new ways and longer time horizons to grow money over time. To be sure, the package, which President Joe Biden has pledged to sign, isn’t just for higher earners. For example, it creates a “lost-and-found” database of retirement plans that go abandoned when workers quit. Companies will be able to add an emergency savings account structured as a tax-free Roth for lower-wage employees starting in 2024; contributions are capped at a maximum $2,500 a year. Younger workers saddled with student debt will get a boost, but only if their employer is on board: Starting in 2024, companies can make a “matching contribution” to the amount the worker is paying on their loans. It’s not clear what the percentages might be.

And a complicated provision known as the Saver’s Credit will see lower- and middle-income workers making up to $71,000 receive a matching contribution from the federal government when they save inside a 401(k) or IRA. The credit allows people to get back up to half of their retirement savings contributions as a dollar-for-dollar refund on their tax bills. Currently, if any part of the credit is left over, there’s no benefit. But starting in 2027, the government will swap that refund for a matching contribution to a retirement plan.

Still, while the package is aimed at shoring up the long-term nest eggs of a broad swathe of Americans, it’s sprinkled with benefits that expand the ways in which higher earners — and future higher earners — can grow their savings.

From 529 plan to Roth
On the top shelf of the box: A way to roll unused dollars in a 529 college savings plan into a Roth IRA whose beneficiary is that college student. The rollover, which can happen only after 15 years, is subject to annual Roth contribution limits ($6,500, plus an extra $1,000 for those age 50 or older) as well as to a total lifetime limit of $35,000.

The benefit is a boon to parents who socked away dollars in 529 plans but found themselves facing hefty tax bills if they wanted to withdraw the funds because they were no longer needed for higher education costs. The plans, which are sponsored by states, are funded with dollars on which taxes have already been paid and are tax-free when used to pay for eligible educational costs, including, in some states, pre-school, elementary and high school expenses. Fidelity Investments noted that a rollover is treated as a contribution toward the annual Roth IRA contribution limit.

Jamie Hopkins, a managing partner of wealth solutions at Carson Group, called the change “one of the most interesting provisions” in SECURE 2.0. He added that the shift will allow parents and grandparents who are funding 529s for their children or grandchildren to shift extra dollars to retirement savings if the beneficiary goes to a less expensive school, receives a scholarship or forgoes college altogether.

Catching up with the Joneses
A major boost comes in the bill’s permission for some older employees to sock away substantially more for retirement.

Next year, those aged 50 or older can make catch-up contributions of $6,500 to their 401(k)s, on top of the total $22,500 limit. But starting in 2025, the picture gets brighter for people aged 60 to 63: They can kick in either an extra $10,000 or 50% more than their current catch-up amount, whichever is greater.

For people with IRAs, the catch-up scenario improves only slightly. Under current law, those aged at least 50 can toss in an extra $1,000 a year, for a total of $6,500. The bill indexes that amount for inflation starting in 2024.

But for higher earners, all the leeway comes with a twist. Come 2024, all catch-up contributions for workers earning $145,000 or more during the previous year must go into a Roth account. That means they must be made with after-tax dollars. The income threshold will be adjusted annually for inflation.

Ed Slott, a retirement expert in Rockville Centre, New York, called the catch-up boost “the biggest deal for higher-income people” in the bill. “It’s the ability to stuff in more money and catch up contributions, with different growth options.”

The change to workplace plans could help springboard a new cohort of savers into greater retirement security, thanks to other provisions in the bill.

Companies that start new employer-sponsored plans will be required to automatically enroll employees, at a 3% contribution rate that would nudge up 1% annually until it reaches 10% of gross pay. But workers can choose to opt out. Businesses with 10 or fewer employees and those in operation for less than three years are exempt from so-called “starter 401(k)” plans.

Part-time workers would be eligible to participate in their employer plans starting in 2025, a year earlier than previously. The bill also makes the transfer, or “portability,” of low-balance retirement plans a done deal when a worker changes jobs. Starting in 2024, employers will automatically transfer account balances of up to $7,000 (the current, voluntary transfer limit is $5,000) into an IRA, unless the workers opts out.

“The change could be especially useful for lower-balance savers who typically cash out their retirement plans when they leave jobs, rather than continue saving in another eligible retirement plan.” Fidelity said.

Greg Wilson, the head of institutional client business at Goldman Sachs Ayco Personal Financial Management, said that the 401(k) provisions “are key changes that can help working Americans overcome expected and unexpected obstacles to saving.”

The bill expands the ways in which people who are age 70½ and older can use trusts in tandem with charitable giving to potentially lower their federal tax bills.

Starting next year, such people can make a one-time gift up to $50,000, adjusted annually for inflation, to a charitable remainder unitrust, a charitable remainder annuity trust or a charitable gift annuity. The new rule on so-called qualified charitable distributions expands the types of “charities” that can receive the gift.

Before, distributions had to go to charities with a 501(c)(3) status, such as the American Red Cross. Disbursements to private foundations or donor-advised funds still aren’t allowed. The key benefit of a distribution, which must be made from a taxable IRA by year’s end, is that it counts toward a taxpayer’s annual RMD. While no deduction materializes, the disbursement keeps an RMD from kicking a donor into a higher tax bracket. Whether to a traditional charity or, now, to a trust or gift annuity, the distribution counts toward the $100,000 that can be gifted annually while counting as a required distribution from taxable accounts.

Charitable remainder trusts and gift annuities provide income to a beneficiary during the grantor’s life; when he dies, what’s left in the trust goes to a charitable cause.

Your ATS Bradenton Team is looking forward to speaking with you soon!