As a component of a larger spending bill, Congress has passed SECURE 2.0, which is a set of new rules designed to make retirement savings plans more attractive to employers and individual taxpayers. Here are a few details that we think will be of interest to you:

Automatic enrollment in retirement plans

Beginning after December 31, 2024, retirement plans can be designed to permit employers to automatically enroll employees in the plan at predetermined employee contribution rates between 3% and 10%. Employees may opt out. Why does this matter? Retirement plans serve a dual purpose of retirement savings for employees and tax deductions for employers. However, many plans suffer from low participation, which can affect the cost and tax-efficiency of maintaining the plan. This provision seeks to address low participation.

Increase in Age Required to Begin Taking Distributions

The trade-off of having a retirement account partially or fully funded with pre-tax dollars is that the IRS requires that account owners begin taking taxable distributions from the account once owners reach a certain age. The current age is 72, and the minimum distribution is the account value multiplied by a life expectancy factor determined by your age. The new age for starting these distributions is 73 beginning next year and age 75 beginning in 2033.

Higher Catch-Up Contributions at Ages 60, 61, 62, and 63

The IRS sets maximum amounts that you can contribute to your 401(k) account each year. In 2022, that amount is $20,500 (rising to $22,500 in 2023). Once you reach age 50, you may opt to make an additional contribution of $6,500 to your account ($7,500 in 2023). Beginning in 2025, this catch-up limit increases to the greater of $10,000 or 150% of the 2024 catch-up amount for participants ages 60, 61, 62, and 63. Please note that the catch-up contribution rules also apply to SIMPLE IRAs but with lower limits.

Penalty-Free Withdrawals for Certain Emergency Expenses

Absent certain exceptions, early withdrawals from retirement plans are not only taxable, but also subject to a 10% penalty. Here are a few distribution scenarios qualifying for a penalty exception:

1. Made on or after the employee’s death.
2. Attributable to the employee’s becoming disabled.
3. Part of a series of substantially equal payments for the life of the employee or the joint lives of the employee and the employee’s designated beneficiary.
4. Used to pay medical expenses to the extent a deduction for the expenses is allowable for the tax year of the distribution.
5. From an IRA if used to pay deductible medical insurance of certain unemployed individuals.
6. From an IRA to an individual qualifying as a first-time home buyer, subject to a lifetime cap.
7. From an IRA to pay higher education expenses.
8. Made on account of an IRS levy on the plan.

An additional exception made by SECURE 2.0 is $1,000 per year emergency distribution. However, if you do not repay your emergency distribution back to your retirement account, you are only allowed one emergency distribution over a three-year period. This new exception applies to emergency distributions made after December 31, 2023.

Starter 401(k) Plans

Effective in tax years after December 31, 2023, SECURE 2.0 has established a new kind of retirement plan called a “starter 401(k) deferral-only arrangement”. Under this plan, each participating employee can defer a qualified percentage of their wages into the plan. The qualified percentage is set by the employer and cannot be less than 3% or more than 15%. The contribution cap is $6,000 per year with a $1,000 “catch-up” amount for employees 50 and older. There are no employer matching or nonelective contributions to the plan.

Presumably, this type of plan is being established as a lower-cost alternative to 401(k) plans and SIMPLE IRAs for employers to offer its employees.

Part-Time Workers

Prior to the passage of the first SECURE Act, part-time workers would often have a difficult time meeting the service time benchmark required for participation in their employer retirement plans. SECURE 1.0 lowered the working hours requirement to 500 per year for three consecutive years. SECURE 2.0 has now lowered the service requirement from three years to two years. This provision is effective for plan years beginning after December 31, 2024.

Reduced Excise Tax

As mentioned previously, the trade-off of funding a retirement plan with pre-tax dollars is that you are required to take minimum taxable distributions from the account once you reach a certain age. Failure to take the minimum distribution results in a hefty penalty of 50% of the distribution shortfall. SECURE 2.0 reduces this penalty to 25% and to an even lower 10% if the shortfall is corrected in a timely manner. This provision is effective on the legislation enactment date of December 29, 2022.

Optional Treatment of Employer Matching or Nonelective Contributions as Roth Contributions

Before SECURE 2.0, 401(k) plans that had a Roth option allowed employees to contribute to their retirement account on an after-tax basis. However, the employer matching and nonelective contributions were required to be made on a pre-tax basis. Effectively, the employee would then have two buckets of retirement assets – after-tax (Roth) and pre-tax (Traditional) – and the tax treatment would be different for each.

Effective December 29, 2022, SECURE 2.0 allows employers to make matching and nonelective contributions on an after-tax (Roth) basis. These contributions would be taxable to the recipient but would carry the Roth benefits of tax-free appreciation and distributions.

Small Employer Retirement Plan Startup Costs

Retirement plan start-up costs tend to be pricy, especially for a small business. SECURE 2.0 provides a credit up to $5,000 incurred during the first three years of the plan’s existence for employers of less than 50 employees. Businesses with between 50 and 100 employees can receive a credit of up to 50% of plan start-up costs, also capped at $5,000.

The act also provides a credit up to $1,000 per employee for employer contributions for the first five years of the plan. A smaller contribution credit applies to businesses that employ between 51 and 100 employees. Note that employees making more than $100,000 are ineligible for employer contribution credit. These rules apply after December 31, 2022.

Tax-free Rollovers from 529 Accounts to Roth IRAs Permitted

If you have any unused 529 plan assets, you will soon have an ability to roll those assets into a Roth IRA. There are limitations though: First, the 529 plan must have been in existence for 15 years or more. Second, the rollover cannot exceed what you contributed into the 529 plan more than five years before the rollover. Third, the lifetime rollover amount is capped at $35,000. Lastly, the annual rollover amount is limited to the annual Roth contribution limit, but the income caps do not apply. This new rollover option is effective after December 31, 2023.

Treatment of Student Loan Payments as Elective Deferrals for Purposes of Matching Contributions

Workers are often unable to save for retirement while repaying student loan debt. This provision allows employees to receive matching contributions in their retirement accounts (401(k), 403(b), and SIMPLE IRA) based on student loan repayments beginning after December 31, 2023.

Small Immediate Financial Incentives for Contributing to a Plan

Cash and cash equivalent payments to employees is generally taxable to the recipient. However, SECURE 2.0 allows low-dollar gift cards and other small financial incentives to be paid to employees as inducements to contribute to the retirement plan. This provision is effective on the enactment date of December 29, 2022.

The SECURE 2.0 Act of 2022 is enormous, and we have only covered a few provisions here. If you have any questions about this legislation, please feel free to contact our office.