7 tax-planning provisions in SECURE 2.0

7 tax-planning provisions in SECURE 2.0 now that filing season is over

The big retirement package that went into effect this year affects workers and savers of all income levels.

A sweeping retirement package signed into law last December overhauled the way Americans of all income levels will plan and save for their golden years. With the April 18 federal return filing deadline now in the rearview mirror, investors and financial advisors are confronting a host of provisions that will impact how they game out their tax bills for next and future years.

Whether they're in the top 1% of wealthiest taxpayers, a young gig worker just starting out, or somewhere in between, millions of savers face both fresh incentives and new restrictions on their long-term nest eggs. Some provisions are already in force for this year, while others will roll out over a decade through 2033.

What's known as SECURE 2.0 piggybacked on a 2019 law, called SECURE, which stands for Setting Every Community Up for Retirement Enhancement. Both packages are grounded in behavioral economics principles that show "nudging" savers into accumulating greater wealth can be more effective and lead to better financial outcomes than forcing them to hew to legal or corporate requirements.

When the new law went into force, Greg Wilson, a partner and the head of institutional client business for Goldman Sachs Ayco Personal Financial Management, said in an email that it would "help Americans better prepare for a comfortable retirement" amid "a vortex of unique and significant financial challenges throughout their working years that can derail their retirement savings."

The changes present big opportunities for investors and financial advisors to deploy tax planning strategies as policy makers grope with what gets broadly called a retirement crisis, in which most Americans aren't prepared to bankroll their last decades. As advisors draw up or reexamine wealth-building plans for clients of all ages, here's what you need to know about the seven most significant of the roughly 90 provisions in SECURE 2.0.

Roths

The tax-free cousins to traditional individual retirement plans are now even more attractive.

This year, employers can tweak their plans to allow employees to choose that employer-matching and non-elective contributions be made as after-tax Roth contributions, not as pre-tax contributions. Contributions to Roth are made with dollars on which taxes have already been paid and are invested in stocks, bonds and funds. There's no deduction for contributions, but withdrawals of the compounded gains are tax-free once the saver is at least age 59½ and has had the plan for at least five years.

Some 90% of 401(k) plans now offer Roth options, with 3 in 10 employees with access to the plans making contributions, according to the Plan Sponsor Council of America. For 403(b) plans offered to teachers, employee participation is just under 60%.

Required minimum withdrawals

Millions of Americans have a little more time to let their savings grow in value before they have to start pulling money out of most retirement accounts, even if they're still working. RMDs are taxed at ordinary rates, so knowing when you will need to take them is crucial.

This year, savers with traditional retirement accounts, including individual retirement accounts, simplified employee pension (SEP) accounts, simple IRAs (for small businesses), 401(k)s and similar plans for teachers and for public-sector and nonprofit workers, must start taking required minimum distributions at age 73.

The 2019 law had raised the age to 72 from 70½. The new higher age gives the plans a little more time to grow in value. In 2033, the age rises to 75.

Owners of Roth IRAs don't have to take RMDs. Those with Roth 401(k)s have to take a distribution in 2023, but that's the last year. Come 2024, those savers can let that money grow tax free for as long as they're alive.

Clear enough, but some things are complicated, given the late Dec. 29 passage of the law last year and its impact just three days later.

As the Internal Revenue Service explains, if you turn 73 this year, you were age 72 sometime in 2022, and thus already taking RMDs as required under the 2019 law. But even though the age is now 73, there's no clawback — you had to take your first distribution by April 1, 2023, based on your year-end 2021 account balance, and must take a second one by Dec. 21, 2023, based on your year-end 2022 balance. The only option for a saver aged 72 who took an RMD last year is to roll the funds back into a retirement account within 60 days of making the withdrawal or to apply for a waiver from the IRS.

If a saver turns 72 this year, they can delay their initial distribution until 2024 or 2025. If she turns 73 in 2024, she must take her first distribution by April 1, 2025, and her 2025 required distribution by Dec. 31, 2025. The 2024 distribution can be taken in 2024 so that the saver doesn't take double distributions, with double the tax bill, in the next year. No IRA owner will face their first RMD this year, according to Rodgers & Associates.

RMD penalties

Starting this year, the steep penalty for failing to take an RMD falls by half, to 25% of the amount not taken from 50%. The penalty is slashed to 10% if the account owner withdraws the RMD amount previously not taken and submits a corrected tax return in a "timely manner." That means either in the second year after the RMD was missed or before the IRS assesses a penalty, whichever comes first.

Read more: Inheriting a retirement plan has gotten complicated. How advisors can keep up

Early withdrawal penalties

Savers who pull money out of their IRAs before age 59½ are socked with a 10% penalty on the amount withdrawn, calculated at their ordinary rate. While exceptions exist, SECURE 2.0 added new ones, easing the pain.

People in federally declared disaster areas can withdraw up to $22,000 from an IRA or workplace retirement plan with no penalty. The tax owed can be paid over three years.

Savers can also make penalty-free withdrawals if they are terminally ill. Come 2024, they can pull out $1,000 to cover a financial emergency, $10,000 if they are a victim of domestic abuse and $2,500 if they have an emergency savings account that's tied to their retirement plan. In 2025, they can take out penalty-free up to $2,500 to cover long-term care expenses.

Catch-up contributions

This year, savers age 50 and older can contribute an extra $7,500 per year annually into their 401(k) accounts. The amount increases to $10,000 per year starting in 2025 for participants aged 60 to 63.

2023 is the last year that savers making more than $145,000 a year can make contributions to a plan on a pre-tax basis. Starting next year, all those contributions must be with after-tax dollars.

Come 2025, savers age 60 through 63 can make catch-up contributions up to $10,000 annually to a workplace plan such as a 401(k), an amount that will be indexed yearly to inflation. The catch-up amount for people age 50 and older in 2023 is $7,500.

This year, IRAs have a $1,000 catch-up contribution limit for people age 50 and over. Starting in 2024, that limit will be indexed to inflation, meaning it could increase every year, based on federally determined cost-of-living increases.

Starting in 2023, savers who are at least age 70½ can make a one-time $50,000 qualified charitable distribution, or QCD, to a charitable gift annuity, charitable remainder unitrust or charitable remainder annuity trust. The annual $100,000 cap on the distributions will be indexed yearly for inflation come 2024.

Employee contribution limits for SIMPLE IRAs will rise in 2024 by 10% for employers with 25 or fewer workers. Employers with 26 to 100 workers will also have higher SIMPLE contribution limits if the employer meets certain criteria. Employers can also make up to $5,000 more in contributions to the plans.

Americans hold nearly 10 jobs during their working careers, but many 401(k)s are either raided or abandoned when a worker takes a new job. The new law allows, but does not require, companies to automatically transfer a former employee's plan to their new employer.

Starting 2025, employers must open up their retirement plans to part-time workers who perform at least 500 hours of service during two consecutive 12-month periods.

Read more: Cashing out 401(k) accounts: the new retirement crisis

529 plans

The December 2022 law lets owners of 529 college savings plans redirect up to $35,000 of any unused dollars to a Roth IRA come 2024. The shift will morph leftover money originally intended for a child's college (or kindergarten through 12th grade) costs into retirement dollars, all without socking the saver, or the beneficiary, with a tax bill. The 529 owner will need to have had the account for at least 15 years and is subject to the annual Roth contribution limits.

Read more: College savings plan money left over? Hello, tax-free Roth