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 contribution limits.
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 current tax.
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 employees.
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 them.