In July of 2019, the Setting Every Community Up for Retirement Enhancement Act, also known as the SECURE Act, changed the rules pertaining to 401(k), Roth, IRA, and other retirement savings plans. In December of 2022, the updated SECURE Act 2.0 was signed into law, supplementing the 2019 Act. Before delving into the recent changes brought about by the SECURE Act, it’s important to understand the different types and fundamental elements of retirement plans.
What is a 401(k)?
A 401(k) is a tax deferred retirement savings account, typically offered by employers for the benefit of their employees. Each pay cycle, employees contribute a percentage of their gross pay, and employers may match that contribution up to a certain limit. 401(k) funds can be invested in stocks, bonds, mutual funds, and certain securities. The proceeds of these investments are not taxed until they are withdrawn at retirement.
What is an IRA?
Individual Retirement Accounts (IRAs) are another form of tax-deferred retirement savings accounts established and funded by individuals. They can be created and held by banks, brokerages, and investment firms. Contributions made to traditional IRA’s are tax deductible. As such, earnings, interest, and dividends earned will accumulate on a tax-free basis. However, like traditional 401(k) plans, funds are taxed at the time of withdrawal. Roth IRAs are funded with after-tax money. Although contributions to Roth IRAs are not tax deductible, account proceeds are not taxed at the time of withdrawal.
What is an RMD?
At retirement age, many IRA plans require that participants withdraw a certain amount of money each year to avoid a tax penalty. These are known as Required Minimum Distributions (RMDs). The amount of each distribution is determined by dividing the account’s prior year-end fair market value by the owner’s life expectancy. The life expectancy factor is published by the IRS in the Uniform Lifetime and Single Life Table.
In 2022, SECURE Act 2.0 implemented the following changes:
- The Starting Age for RMDs:
As of January 1, 2023, SECURE 2.0 requires IRA participants to take RMDs by April 1, beginning the year they reach age 73. From that point onward, RMDs must be received by December 31 on a yearly basis. By January 1, 2033, the threshold age for RMDs will increase to 75. This reflects the fact that American life expectancies are increasing. It also allows individuals to keep retirement savings in tax-advantaged accounts for a longer time-period before being required to take distributions. Additionally, the penalty for failing to take RMDs on a timely basis has been significantly reduced from 50% of the undisputed amount to 25%.
- New RMD Rules for Surviving Spouses:
A surviving spouse, who is sole beneficiary of a deceased plan participant or IRA owner, may now elect to have RMDs determined using the Uniform Lifetime Table rather than the Single Life Table. This gives widowing spouses the benefit of a longer distribution period and a smaller RMD obligation.
- “10-Year Rule” for Inherited IRAs:
SECURE Act of 2019 required most non-spousal beneficiaries inheriting IRA assets after January 1, 2020, to withdraw the full balance of the account within 10 years of the original owner’s death. However, the 2019 Act did not state whether the “10-Year Rule” required annual distributions. SECURE Act 2.0 clarified that such beneficiaries must take out annual RMDs, with a full payout by year 10.
However, surviving spouses, beneficiaries with disability or chronic illness, minor children, and beneficiaries no more than 10 years younger than the original IRA owner, are exempt from the 10-Year Rule. These beneficiaries may take annual RMDs based upon the life expectancy tables, as referenced above. They have until December 31 the year following the original IRA owner’s death to begin taking distributions.
- Increased Catch-Up Contributions:
Catch-up contributions allow those aged 50 and up to contribute additional funds, beyond the maximum contribution amount for workplace retirement plans.
- As of 2023, the maximum amount that can annually supplement a workplace plan increased from $6,500 to $7,500.
- In 2025, those aged 60 to 63 can annually contribute $10,000 above the standard limit.
- In 2026, all catch-up contributions in such plans must be made on an after-tax basis, unless the plan owner earns less than $145,000 annually.
- New Exceptions to Penalty for Early Withdrawals:
Currently, there is a 10% penalty for distributions taken from a retirement account before the recipient reaches age 59-1/2.
- Per SECURE Act 2.0, this penalty is waived for those who receive a physician certification as to having a terminal illness or condition that can reasonably result in death in 84 months or less. Those distributions must be repaid within three years to avoid a fee penalty.
- In 2026, annual withdrawals of up to $2,500 can be made to pay premiums on certain long-term care contracts.
Despite the beneficial provisions introduced by SECURE Act 2.0, navigating the intricacies of retirement planning can still be overwhelming. Our team at Mandelbaum Barrett PC has extensive experience and is committed to relieve any retirement plan insecurities you may have. Planning today can SECURE the future for you and your loved ones.