How are individual retirement accounts affected by SECURE 2.0?
Many of the general changes, such as the Saver’s Credit and the
gradual increase in the age at which required minimum distributions
(RMDs) must commence (to 73 in 2023, and up to 75 thereafter) apply
to individual retirement accounts (IRAs) as well as to other types
of retirement plans. Other new options apply to SEP-IRAs and SIMPLE
IRAs, which are popular IRA-based arrangements for smaller
employers seeking limited employer responsibilities. These new
options include the ability to match participant loan repayments
under SIMPLE IRAs and the ability to establish a SEP for domestic
employees. Additional changes that enhance the benefits of
participation and permit increased contributions are specific to
IRAs, SEP-IRAs and SIMPLE IRAs. Here are the key takeaways—
Increased Contribution Limits.,
IRA catch-up contributions, which are currently frozen at $1000,
will be indexed beginning in 2024.
SIMPLE IRAs are similar to traditional 401(k)s except that
contributions are made to IRAs. SIMPLE IRAs have always had lower
annual employee deferral limits than traditional 401(k) plans and
are only available if the employer does not have more than 100
employees. In 2023, employees may defer $15,500 under a SIMPLE IRA
with an additional catch-up contribution of $3500 if they are 50 or
older. Employers must make either a 3% matching contribution or a
2% nonelective contribution. The elective deferral limits for
SIMPLE IRAs will increase beginning in 2024 to 110% of the
otherwise applicable 2024 limits for employers with 25 or fewer
employees. Employers with 26 to 100 employees will be able to make
the increased limits available if they make enhanced employer
contributions of either a 4% match or a 3% nonelective
contribution. . Additional uniform contributions of up to $5000 (or
10% of pay, if less) are also now permitted.
SEPs provide only for employer contributions, but some SEP-IRAs
permit additional employee contributions. In that case, the SEP
participants would presumably continue to be subject to IRA
SEP and SIMPLE IRA Roth Options. Contributions
to SEPs and SIMPLE IRAs are now permitted to be made on a Roth
basis, whereas previously they could be made only on a pre-tax
basis. This is consistent with a general trend in SECURE 2.0 of
expanding Roth contribution opportunities. For example, 401(k)
plans may now permit participants to elect that their 401(k) plan
matching and nonelective contributions be made as Roth
contributions. Roth contributions, of course, will be subject to
SEPs for Domestic Employees.
SEPs, like other types of employer-sponsored plans, have been
established only by employers engaged in a trade or business. This
and penalties for making nondeductible contributions to a plan
prevented individuals from establishing plans covering their
domestic employees such as nannies. SECURE 2.0 now specifically
permits employers to establish a SEP covering domestic
SIMPLE IRA Full Year Requirement.
A basic SIMPLE-IRA requirement is that they must be in effect
for the entire year. SIMPLE-IRAs cannot even be terminated
mid-year. However, beginning in 2024, SECURE 2.0 permits an
employer to switch from a SIMPLE IRA to a safe harbor 401(k) plan
in the middle of a year, provided that plan limits are prorated.
Since safe harbor plans, like SIMPLE-IRAs, have minimum employer
contributions, employees will not be adversely affected by the
switch as they could be by a mid-year change to a plan with
discretionary contributions . Employees will also have higher
annual deferral limits in the 401(k) plan.
Reductions in IRA Penalties
If insufficient RMDs are taken, the Code has imposed a penalty
of 50% of the deficiency, though this harsh penalty could be waived
or reduced. SECURE 2.0 reduces the penalty from 50% to 25%, with a
further reduction to 10% in the case of inadvertent violations that
are timely corrected. The Code also imposes a harsh penalty if the
IRA engages in a prohibited transaction, such as the use of IRA
money to buy a vacation home regularly used by the IRA owner. In
that case, the entire IRA balance, and not just the amount
involved, becomes immediately taxable. However, SECURE 2.0
clarifies the law by providing that if the IRA owner maintains
multiple IRAs, only the IRA that engaged in the prohibited
transaction is disqualified.
Helpful changes have also made to the statute of limitations
that applies when the IRS pursues insufficient RMDs and excess
contributions. Previously, filing of Form 5329 reporting the
transaction started the statute of limitations running. This
created a potentially open-ended audit period for unsophisticated
IRA owners who were not aware they had to file the form. Under
SECURE 2.0, the statute of limitations will now begin to run from
the date the regular individual tax return for the year in which
the violation occurred was filed. It will run for 3 years from that
return for insufficient RMDs and for 6 years from that return in
the case of excess contributions. In addition, the 10% early
distribution penalty will not apply when excess contributions and
their associated earnings are paid out in a corrective
distribution. This provision can even apply retroactively. Other
penalty reductions are effective now.
SECURE 2.0 contains several new exemptions from the 10% penalty
for early distributions that apply to IRAs and have different
effective dates. These exemptions include personal emergency
distributions up to $1000, distributions of up to $22,000 due to a
federally-declared disaster (the basic tax on these may also be
spread over 3 years), and IRA distributions used to pay premiums on
qualifying long term care insurance.
Increased Qualified Charitable Distributions.
IRA owners are permitted to use up to $100,000 of their RMDs
annually to make a tax-free contribution to approved charities.
SECURE 2.0 now indexes the $100,000 limit for inflation and
authorizes a new one-time tax free distribution of up to $50,000,
which is also indexed. if the contribution is made to buy
charitable gift annuities or to charitable remainder unitrusts or
charitable remainder annuity trusts, which are not qualifying
recipients under the general rules.
Rollovers from 529 Plans Permitted.
529 plans allow parents and grandparents (and others) to put
money aside for tuition and educational expenses of beneficiaries
on a tax favored basis. There is no tax when the funds are used for
qualifying educational expenses. Funds not used for educational
expenses are subject to regular tax as well as a 10% penalty.
SECURE 2.0 helps encourage 529 savings beginning in 2024 by
permitting leftover funds of up to a lifetime limit of $35,000 to
be rolled over on a tax free and no-penalty basis to a Roth IRA.
The 529 plan must have been in existence for at least 15 years and
Roth IRA contribution limits will apply.
Looking Ahead. These changes can be expected to
make it easier and more advantageous to sponsor or participate in
IRA-based plans. They will also mitigate the harsh penalties for
RMD and excess contribution violations. As the increasing number of
state-facilitated retirement programs, which cover employees who do
not have access to an employer-sponsored plan, deposit
contributions in IRAs, increases in IRA catch-up contribution
limits should also carry over to those programs.
Although a number of SECURE Act changes have deferred effective
dates, a number of these provisions are effective in 2023. However,
employers looking to take advantage of new options would be
well-advised to wait until some IRS guidance is issued. In any
event, the ability of employees and employers to take advantage of
the newly effective provisions will be dependent on when
recordkeeping systems are updated by vendors to accommodate
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.