SECURE Act 2.0 – What Is In It And How Does It Impact You?

The SECURE Act 2.0 was signed into law at the end of 2022 with some pieces of it going into effect almost immediately in 2023. This new bill changes many aspects of retirement savings accounts from IRAs, 401ks, QLACs, and 529s.

In short, if you are saving money for retirement or college, this new bill is going to affect you somehow.

All the changes in the act are fairly positive and make improvements to the law for you. You can rollover college saving plans (529s) into Roth IRAs, required minimum distributions are deferred, qualified longevity annuity contracts (QLACs) have higher limits, and employer 401ks just became more beneficial for employees. There is even changes that benefit people still paying down student loans.

What are the major changes in the SECURE Act 2.0 and how do they impact you?

1) 529 College Saving Plan Improvements in SECURE ACT 2.0

College saving plans (529) are funded with after-tax money and grow tax-free. If the money is used to pay for education expenses there are no taxes or penalties on withdrawals. Additionally, if your state had an income tax, you may be able to deduct 529 contributions on your state filing. But one of the major concerns parents had was if the money wasn’t needed for college.

The SECURE Act 2.0 has addressed the major concern.

Now you are able to rollover $35,000 of a 529 plan into a Roth individual retirement account (IRA) for your child, but are limited by regular Roth IRA contribution limits. The 529 plan needs to have been open for 15 years to be eligible for the rollover.

Previously, Roth IRA contributions could only be made if the child earned income and only up to the annual earnings.

This new rule allows you to contribute to a 529 plan and then after 15 years, you can start rolling money into a Roth IRA.

[Professor B.T. Effer Note – we recommend asking friends and family to consider contributing to the college fund instead of buying toys for your kids. People don’t like giving cash, but are more likely to help pay for college. This way you have less clutter and can build more savings for your child.]

2) Required Minimum Distribution (RMD) Changes in SECURE Act 2.0

Required minimum distributions (RMDs) are money that needs to be withdrawn from pre-tax retirement plans after a certain age. This includes employer sponsored plans like 401ks, traditional IRAs, and SEP.

RMD amounts are set by the IRS to stop people from using retirement accounts to never pay taxes. And RMDs can force you to be tax-inefficient in retirement while having very steep penalties for not taking out enough.

2.1) SECURE Act 2.0 Lowered RMD Ages

The RMD starting age was 70.5 years old in 2019, and increased to 72 in 2020. With the SECURE Act 2.0, the age is increased again to 73 and is scheduled to increase to 75 in 2033.

Higher RMD starting age means more flexibility for you, making this a beneficial update.

2.2) Lower Penalties on RMDs in SECURE Act

Additionally, on top of the older RMD age, the penalty for not taking enough withdrawals was also decreased. The previous penalty was 50%, but has been reduced to 25%.

However, if you correct the mistake, the penalty is now further reduced to 10%. This aligns it with the 10% penalty on early withdrawals from retirement accounts.

2.3) Removal of RMD on Employer Roth 401ks

If your employer offers a Roth 401k option, this was previously included in the RMD ’employer-sponsored retirement plan’ bucket. This despite a Roth account not being qualified as you already paid tax on it.

The SECURE Act removed the RMD requirement on Roth employer retirement plans like the Roth 401k.

3) 401k Changes in SECURE Act

Employer-sponsored savings accounts (ie- 401k), are one of the primary ways people save for their retirement. The SECURE Act 2.0 made some major changes to the 401k.

3.1) Employer-Match to Roth 401k

Currently, your employer match to your 401k goes into the pre-tax account, not the Roth 401k account. Going forward, employers are able to set their match as a Roth 401k contribution.

This update is optional and may take a while to implement at your company.

But the power of Roth accounts is putting in after-tax money and never paying taxes again or worrying about your future tax rate. And this change makes Roth 401k growth easier as you can have higher contributions. If you are in a relatively low tax rate, you should seriously consider Roth 401k contributions if offered and employee match to Roth 401ks when they are available.

3.2) Auto-Enrollment & Auto-Increases to Contributions

Under the SECURE Act 2.0, employers receive a tax credit for automatically enrolling employees in the company 401k and setting up automatic contribution increases.

The automatic enrollment can be up to 3% and can be automatically increased up to 10%.

This change is backed by research that shows any extra step in a process has significant drop-off. If you make people opt into their 401k, the extra step of signing up will prevent some people who otherwise would want to contribute, from actually enrolling.

Similarly, if you automatically sign people up with the option to opt out, people are more likely to stay enrolled.

Anything that helps encourage more saving is likely beneficial for society.

3.3) Increased 401k Catch-Up Contributions

Currently people over 50 can make additional ‘catch-up’ contributions to their 401k. This is above the standard contribution amount. In 2022, your max 401k contribution was $20,500 and your max catch-up contribution was $6,500 for a total of $27,000 for anyone over 50.

In 2023, these limits increase to $22,500 with a $7,500 catch-up for $30,000 total contribution for anyone over 50.

The SECURE Act 2.0 adds a ‘special’ catch-up contribution starting in 2025 for employees 60 to 63 years old. The catch-up will be increased to the greater of $10,000 or 150% of the standard catch-up. Additionally starting in 2026, the $10,000 will be inflation indexed, so it will increase automatically.

However, employees making more than $145,000 in the previous year will need to deposit all catch-up contributions into a Roth account. The $145k limit will be indexed to inflation as well, starting in 2025.

3.4) Old 401k “Lost-And-Found” Database

The Secure Act 2.0 also set up a ‘lost-and-found’ database for old 401ks and other retirement plans. This database will be run by the Pension Benefit Guarantee Corporation (PBGC).

When many people change jobs, they forget to rollover an old 401k from previous roles. The result is old, forgotten retirement accounts lingering.

Additionally, when you are employed at a company, your employer will often pay some or all of the admin fees on your 401k. However, most companies don’t continue paying these fees for ex-employees. This means that you may be paying high fees on old 401k accounts.

This database will help people locate any old retirement accounts so they can roll them over into their new 401k or into a personal IRA.

3.5) Part-Time Worker Retirement Accounts

Long-term, part-time workers who have been with a company for 3 years and worked at least 500 hours a year each year, will now be able to contribute to retirement plans.

Previously, only full-time employees were typically eligible for contributions to retirement accounts.

This is a big benefit to those who are balancing work with other obligations that limit them to part time.

3.6) Employer Incentives for Enrollment

Employers are now able to provide “small financial incentives” for enticing employees to contribute to retirement plans. Currently, incentives are not allowed.

These incentives are small, like gift cards, but should help encourage employees to sign up.

3.7) Emergency Savings Account in 401k

Non-highly compensated employees will get a new emergency savings account option for their 401k. This account is in a designated Roth 401k and employees can contribute $2,500 a year to the emergency savings account.

If needed, you can take 4 free withdrawals in a year, with no penalty or fees.

This encourages employees on tight budgets to contribute to a 401k, as they know they can get free withdrawals to pay for any unexpected expenses.

3.8) Student Loan Payment Contribution Match

Lastly, the SECURE Act 2.0 allows employers to ‘match’ an employee’s student loan payment with a 401k contribution. For example, if you pay $100 towards your student loan, your company may deposit a $100 matching company contribution in your 401k.

This is helpful for newly graduated employees who have a lower salary and lots of student loan debt. Now they don’t have to worry about paying down debt vs starting to save.

This is a big benefit as it allows earlier contributions to a 401k than otherwise would be possible for these young workers.

4) IRA Changes In SECURE Act 2.0

The SECURE Act 2.0 also made changes to individual retirement accounts (IRAs). There are two common types of IRAs: Traditional IRAs and Roth IRAs.

Traditional IRAs allow you to put your contribution in pre-tax and it grows tax-deferred, but the money gets taxed when you withdraw it. These are good for lowering your current taxable income, but the actual ending value will depend on where your taxes are in retirement. If your tax rate in retirement is significantly higher, then traditional retirement accounts are less beneficial.

Roth IRAs are like other Roth accounts. You put in after-tax money and they grow tax-free and you currently don’t pay taxes on withdrawals. Additionally, since you are putting in money you already paid taxes on, you have more flexibility in taking your principal out. However, there are income limitations to contribute to a Roth.

We generally recommend diversifying your tax risk by allocating money to both traditional and Roth accounts when available.

4.1) IRA Catch-Up Limit Increased

Similar to how the 401k catch-up was increased, IRAs now get an extra catch up contribution starting at 50. Currently, in 2022 the contribution limit to an IRA is $6,000 with a $1,000 catch-up contribution limit for those 50 and older.

Starting in 2023, the IRA contribution will increase to $6,500 with a $1,000 catch-up.

But the SECURE Act 2.0 indexes the $1,000 to inflation, rounded down to the nearest $100. Therefore, going forward the catch-up contribution will likely grow.

5) QLAC Improvements in SECURE Act 2.0

A QLAC is a qualified longevity annuity contract. They are a deferred annuity that doesn’t start paying out till later in life. The benefits of a QLAC are:

1. Remove some retirement money from the required minimum distribution calculation which can help with efficient retirement tax planning
2. They are cheap relative to other annuities
   • Annuity payments are based on the current market interest rate and expected mortality. How annuities work is you pay a lump sum to an insurance company, and in return, they provide a future income stream. To figure out how much to charge, the insurance company discounts back the future cashflows adjusted for interest rates and the probability you are alive to collect the payment.
     • Read about Time Value of Money to understand how discounting works
   • Since QLACs don’t pay out any cashflow till you are older, the probability of you surviving another year is relatively low, meaning the likelihood the insurance company needs to make a lot of payments is low. This means they can give a bigger payment to you. Or said another way, the lump sum you need to pay for a large future cashflow stream is lower.
3. QLACs defer taxes since you don’t pay tax until you withdraw the money (ie-receive the payment)
4. QLACs are true longevity insurance
   • A very real risk is that you outlive your money. If you live longer than you expected, you may run out of retirement savings. QLACs kick in late in life and continue till you die. If you live longer than expected, these can be invaluable.
   • However, the trade-off is that if you die early, you will get significantly less than expected from a QLAC.
     • You need to think of a QLAC as similar to term insurance. With term insurance, you pay a premium to the insurance company and if you die during the term your beneficiaries get a death benefit. However, if you live longer than the term, you get no payment back for all the premiums you paid. (Although you can extend your term life insurance coverage).
     • QLACs follow a similar type of protection, where you only receive money back if you live longer than expected. You are paying to negate a risk, but if you don’t need th benefit, you lose the money you paid.

The current maximum premium you can use to purchase a QLAC is the lesser of 25% of your retirement balance and $125,000. The SECURE Act 2.0 removed the 25% cap and increases the limit to $200,000.

QLACs are likely underutilized, but they are a unique product, so if you considering one, you will want to work with a financial advisor.

The Final Word

There are some other items in the SECURE Act 2.0 that pertain to tax-credits being extended to military spouses and incentives for small employers to offer retirement savings.

However, for the majority of people, the items covered above are the ones that most likely pertain to your situation. The SECURE Act 2.0 is a beneficial for your personal finance.

In general, the SECURE Act 2.0 is a positive for retirement savings. Many of items in the law were heavily lobbied for by the retirement savings industry (insurance companies, finance companies, asset managers, etc). The result is a fairly positive bill and it even has elements focused on behaviors which are important for personal finance.

Many items in the SECURE Act 2.0 will go into effect in the next couple of years and will start having major positive impacts to peoples ability to save for retirement.

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