secure act 2.0The SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019) was signed into by Donald Trump on December 20, 2019. As with most revenue acts that propose to provide benefits, the SECURE Act took away many tools to delay tax on the distributions from tax deferred retirement accounts. Prior to the SECURE Act, retirement accounts could more easily be transferred to future generations on a tax deferred basis with careful planning. After the enactment of the SECURE Act, almost all of those planning opportunities were lost.

A second version of the SECURE Act, nicknamed the SECURE Act 2.0, was signed into law on December 29, 2022. These provisions were intended to improve and clarify the SECURE Act. These changes are discussed below.

Increased Age for RMD’s

SECURE Act 2.0 increased the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement plans and IRAs (i.e., the Required Beginning Date or RBD). SECURE Act 2.0 increases the RBD from age 72 to 73 in 2023 and again to 75 in 2033. More specifically, an individual’s RBD by which they must begin taking RMDs is April 1 of the year after the year in which they reach the stated or designated age. If an individual turned 72 before 2023, they must continue taking RMDs.

For example, a 72-year-old with a retirement plan act holding $1,000,000 would otherwise be required to take a distribution in the amount of $36,500 this year. This amount would be required to be recognized and reported as ordinary income this year. Since this distribution is taxable income, the distribution could affect and possibly increase the cost for Medicare insurance premiums.  Delaying the withdrawal avoids the tax liability on $36,500 this year and would permit the funds to continue to be invested and to grow on a tax deferral basis.

Inherited Retirement Accounts

As for heirs who are non-spousal beneficiaries such as children, the tax deferral retirement accounts must be emptied with the distributions reported as income within ten (10) years after attaining the age of 18. Careful consideration and planning are needed as the accounts grow on a tax deferred basis while within the retirement account providing faster increase in wealth but may then be distributed to the beneficiaries when they are in their highest-earning years and paying the highest margin tax rates.

Catch-Up Distributions

Individuals age 50 or over can make annual catch-up (i.e., additional) contributions to retirement plans and IRAs. Beginning in 2025, catch-up contribution limits to retirement plans increase for those age 60 through 63 to the greater of: $10,000 or 150% of the regular catch-up amount for those 50 and older. Retirement plans catch-up contributions for those over 50 have also increased to $7,500 in 2023, up from $6,500 in 2022. Catch-up contributions for IRAs from individuals age 50 and older will begin being indexed for inflation starting in 2024. The $10,000 catch-up contribution limited for people between 60 and 63 will also be indexed for inflation beginning in 2026.

Decreased Penalties for RMD Failure

An often-overlooked opportunity provided by SECURE Act 2.0 is the increased premium cap or ceiling on an IRA investment in a Qualified Longevity Annuity Contract (“QLAC”). The premium cap or ceiling is raised from the lesser 25% of the account balance or $125,000 to $200,000 without any percentage limitation. Beginning in 2023, the penalty for failing to take a full RMD (the excess accumulation penalty) will decrease to 25% of the RMD shortfall. This is a penalty reduction from the prior rate of 50%. The penalty will be further reduced to 10% for IRA owners if the owner withdraws the RMD amount previously not taken and submits a corrected tax return in a timely manner. SECURE 2.0 decreases the penalty for failing to take the minimum RMDs. Taxpayers can continue to request and IRS waiver of the penalty entirely under IRC § 4974(d).

A New Planning Opportunity: Introducing the QLAC

A QLAC is an annuity purchased from an insurance company with assets of an IRA. Before SECURE Act 2.0, the maximum premium for a QLAC could not exceed the lesser of 25% of the account balance or $125,000. This low ceiling on the premium or investment severely limited the benefit of the QLAC. SECURE Act 2.0 removed the percent limitation and raised the maximum premium to $200,000. This increase makes QLAC’s a more attractive strategy in 2023.

To qualify as a QLAC, besides the premium limitation, the QLAC must meet these requirements:

  1. Distributions under the contract must begin no later than a specified annuity starting date, that is, by the first day of the NEXT month following the 85th anniversary of the employee's birth.
  2. After distributions under the contract begin, those distributions must otherwise satisfy the requirements of this section.
  3. The contract does not provide any communication benefit, cash surrender right, or other similar feature.
  4. No benefits are provided under the contract after the death of the employee.
  5. When issued, the contract must state that it is a QLAC.
  6. The contract may not be variable, indexed, or similar. However, a cost-of-living change is allowed.
  7. The issuing insurance company must file annual reports on the QLAC to the IRS and copy participants.

Using a QLAC Provides Many Benefits:

  • When buying the QLAC, the account holder can elect to defer the QLAC payments for years but no later than the month after the account holder turns 85 years.
  • QLACs do not count when calculating an individual’s RMD, lowering the RMD.
  • A QLAC is a Medicaid compliant annuity. Since a retirement account owns the QLAC, it is exempt from the general requirement that it is “actually sound” under DRA, with the state listed as the beneficiary. And since a QLAC cannot be surrendered or reduced to cash, and payments under a QLAC do not begin until age 85. The QLAC is not recognized as an available resource for Medicaid eligibility until the patient turns 85. This is true even in states that require the complete spend down of IRA to receive benefits; and
  • A QLAC can include various features like a return of premium or a lifetime annuity for a surviving spouse or a disabled child before any repayment to the state. Even if the account owner dies before payments under the QLAC begin, a surviving spouse or disabled child effectively limits a state’s right to recovery.

Qualified Charitable Distributions

Qualified Charitable Distributions (QCDs) allow eligible older America’s a way to give to charity directly from their IRAs. QCDs count toward the IRA owner’s RMD for the year, up to $100,000 per individual and is excluded from income. SECURE Act 2.0 expanded the QCD rules beginning in 2023 to allow individuals age 70 ½ and older to elect as part of their QCD limit a one-time gift up to $50,000 (adjusted annually for inflation), to a CRT or a Charitable Gift Annuity. To qualify as a QCD, such distributions must come directly from the IRA to the qualified charity. A QCD may not be made to a Donor Advised Fund.

Penalty for Early Withdraw

There is currently a 10% penalty for distributions taken from a retirement account prior to reaching age 59 ½ unless an exception applies. SECURE Act 2.0 expands the exceptions by eliminating the penalty for hardship distributions made by terminally ill employees and those living in declared disaster areas, up to $22,000. This provision is effective immediately. For these purposes, a terminally ill individual means an individual who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification. Starting in 2024, hardship withdrawals are available for individuals who have been subject to domestic abuse equal to the lesser of $10,000 or 50% of the vested balance of the retirement account. The withdrawal should occur within one year after the individual because a victim of abuse. And all or a portion must be repaid within three years. Starting in 2026, withdrawals of up to $2,500 per year can be made to pay premiums on certain types of long-term care contracts.

More Planning Opportunity with 529 Plans

As with all tax changes, a mixed bag of planning opportunities may arise. In today’s world, planning for retirement is more important than ever before. None of us know what the future may bring. In the past few years, we have seen a political insurrection, fires, (in California and other western states), long term drought issues, atmospheric rivers bringing floods (both in California and other western states), a pandemic, a potential recession and the list continues. People are living longer, and concerns arise about out living available retirement assets. A 529 plan to be rolled over to Roth IRA for the beneficiary, subject to annual Roth contribution limits and total lifetime limit of $35,000. To qualify for this provision, the 529 plan must have been open for at least 15 years. Contributions or earnings form the past 5 years cannot be rolled over. The roll over is treated as a contribution towards the annual Roth IRA contribution limit. Understanding the planning opportunities that arise and may be lost with new legislation is critical. We hope that you find this information helpful.

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