On December 29, 2022, President Biden signed the Consolidated Appropriations Act of 2023.  The act includes over 350 pages of new retirement plan rules that comprise the much-anticipated SECURE Act 2.0.

SECURE 2.0 implements a long list of significant changes to the tax code as it relates to retirement plans.  While some components of the act only apply to larger employer plans, several key changes will impact savers with a self-directed IRA or Solo 401(k) plan.

We plan to spend the next several months parsing through the details and sharing our thoughts.

In this two-part introduction, we will outline some of the new rules that specifically impact individuals with a self-directed retirement plan.

Roth Changes

Congress loves the Roth IRA.  They would rather have taxes on $10,000 today to offset current budget goals than leave the government the ability to receive taxes on the $75,000 that same $10,000 might grow to in 30 years.

SECURE 2.0 creates several new Roth incentives to create more short-term revenue to offset current government expenditures.

Whether that is a good long-term strategy or not is questionable.  As retirement savers, however, if the government gives us a Roth option, we may want to take advantage.

Roth SIMPLE and SEP IRA Options

Starting in 2023, or as soon as all the plan document and custodial infrastructure is in place, SIMPLE IRA and SEP IRA plans can accept Roth contributions.

For many small businesses that may have avoided setting up a retirement plan in the past, this may be a big incentive to choose a SIMPLE IRA.

Savers with an existing SEP or SIMPLE may start considering a Roth conversion strategy.

Roth Employer Contributions in Solo 401(k) Plans

The employer profit sharing contributions to a Solo 401(k) plan have previously been limited to tax-deferred status only.

Starting with the effective date of the law (December 29, 2022), employer non-elective contributions can be made on a Roth basis.

Considering that Solo 401(k) participants could previously choose to conduct an In-Plan Roth Rollover on tax-deferred employer profit sharing contributions, the net-effect of this change is nominal. The real advantage is simplicity – you can just make the contribution on a Roth basis instead of having to contribute tax-deferred and then convert to Roth.

Unused 529 to Roth IRA

This change is likely to produce much more media coverage than it deserves.

Section 129 of SECURE 2.0 provides the option to move unused 529 plan funds to a Roth IRA.

For people who built up a 529 plan and their child elected not to go to college or earned enough scholarships to not need the money, this is a nice pathway to jump start that child’s Roth IRA.

If a 529 plan has been in place for 15 years, it can be rolled over to a Roth IRA, but there are several caveats.

• The lifetime maximum is $35,000.
• Contributions and earnings within the prior 5-year period cannot be rolled over.
• The rollover may not exceed the normal Roth IRA contribution limit, and is reduced by any Roth IRA contributions made by the plan holder.
• The plan participant must have income to justify the rollover amount, just as they would for a normal Roth IRA contribution.

The real takeaway here is that you should definitely contribute to a 529 plan for your child starting in year one.  If the money is not needed for education purposes, it can be used to seed a Roth IRA.

Catch-Up Contributions

Congress seems to have recognized that most people in their 50’s are looking at their retirement plan balances and scratching their heads.   Several new means of caching away more savings at the latter end of the career cycle have been added with SECURE 2.0.

Inflation Adjusted IRA Catch-Up Contributions

Starting in 2024, IRA catch-up contributions for those age 50 and older will be indexed to inflation in increments rounded to $100.

The catch-up contribution limit has been $1,000 since 2006.

Catch-Up Booster in Early 60’s

Starting in 2025, employer plan participants will have an enhanced ability to make catch-up contributions to their plan.  This will benefit Solo 401(k) and SIMPLE IRA account holders.

For the ages 60 through 63, the catch-up limit is increased to the greater of $10,000 or 150% of the regular catch-up contribution amount for such plans as of 2024.

Roth Catch-Up Required for High Income Plan Participants

We will be looking forward to clarification from the IRS on this one, to be sure.

SECURE 2.0 section 603 stipulates that starting in 2024 a qualified plan participant who has wages from the sponsoring employer for the prior year in excess of $145,000 (to be indexed for inflation) must make catch-up contributions into a designated Roth account within their plan.

It would appear that with respect to a Solo 401(k), this rule will only apply to plan participants with a corporation who pay themselves a W-2 wage.  Sole proprietors or those with a LLC or partnership taxed as a pass through will still be able to choose to make catch-up contributions on a tax-deferred basis if they choose, regardless of income.

Note that only employer plans like a 401(k) are impacted by this section.  An IRA based plan such as a SIMPLE is not subject to this rule.

Hardship Distributions & Loans

Normally, a 10% penalty applies for early distributions from a retirement plan before normal retirement age of 59 ½.  The tax benefits conferred by a retirement plan are designed to help savers accumulate more of a nest egg to retire on.  The “rule 72” penalty for early distribution is an incentive to keep that money set aside for future use.

Congress has allowed for certain exceptions in the past, such as an extreme financial hardship or a first-time home purchase.

Secure 2.0 includes several new provisions that exempt an early distribution from the 10% penalty in cases where tapping retirement savings may be considered acceptable.

Qualified Disaster Distributions and Loans Made Permanent

In the past, Congress has specifically authorized penalty free distributions from retirement plans for extreme natural disaster events like hurricanes, floods, and wildfires.

Rather than rely on ad-hoc acts of Congress, Section 331 of the SECURE 2.0 permanently enacts Qualified Disaster Recovery Distributions” (QDRDs).  The new rule applies retroactively to disasters occurring on or after January 26, 2021.

An individual qualifies for a QDRD if their primary residence is within a Federally declared disaster area and the distribution is taken within 180 days of the applicable date of the disaster.

The limit on such QDRDs is $22,000, which is less than the more common amount of $100,000 applied in the old per-disaster method.

These distributions also share features of prior disaster declarations and the CARES Act.  The tax amount of the distribution can be paid entirely in the first year or spread over 3 years.  The distributed amount can also be re-contributed to a qualifying plan within a 3-year window.

Section 331 also allows for larger loans of up to $100,000 with extended repayment periods from 401(k) and similar employer plans in the case of a disaster declaration.

Personal Emergency

With Section 115, Congress opened up a very broad “Emergency Withdrawal” provision starting in 2024.

A taxpayer who experiences “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses” can take a distribution without the 10% penalty.

We’re not sure “I really need to see Taylor Swift in concert” applies, but there is definitely a lot of leeway here.

Because the exemption is so broad, it is limited to $1,000 and may only be used once per year.

Further Emergency Withdrawals may not be taken until the prior distribution has been repaid, new contributions to the plan in excess of the distribution amount have been made, or until three years from the prior Emergency Withdrawal.

This new provision is likely intended to encourage those on the lower end of the income ladder to actually participate in retirement savings, knowing they have a way out.

Terminal Illness

Someone certified by a physician to have a terminal illness or physical condition that will reasonably result in death within 7 years can take distributions without a 10% penalty.  Such distributions may be repaid within a 3-year period.

This exception is effective immediately.

Domestic Abuse

New rules included in Section 314 of the Act provide for an early distribution penalty exemption in the case of domestic abuse.

A distribution of up to $10,000 may be taken within one year after an incident of abuse.  Such distributions may be repaid to the plan within a 3-year period.

For purposes of this new rule, “domestic abuse” is characterized as “physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently, including by means of abuse of the victim’s child or another family member living in the household”

The effective date of this section is tax years beginning with 2024.

Read More in Part Two

See our next article in this series to learn more about the changes that SECURE 2.0 brings to the retirement savings landscape.