Secure Act 2.0: 6 Tax Law Changes for Military Families
Leading into the New Year, Congress passed a $1.7 Billion spending package which included a bill known as the SECURE Act 2.0 because it builds on the original SECURE Act that passed in December 2019. Through the SECURE Act 2.0, Congress seeks to encourage Americans to save more for retirement and allow employers to help their employees increase their savings.
On the surface, the SECURE Act 2.0 will be known for extending the age at which retirees must begin to tap their pre-tax retirement accounts from age 72 to age 75; but this comprehensive tax bill contains nearly 100 specific changes to the tax law, some effective retroactively to 2019, others not slated to be in force until 2030.
It will take the IRS months to detail how it intends to implement these changes, and financial professionals even longer to unwind all the nuanced strategies to take advantages of them; but for now, let’s look at a handful of changes that will impact military families.
#1 Military Spouses & Workplace Retirement Plans
The bill provides a tax credit to small businesses who employ military spouses provided they ensure military spouses have access to workplace retirement plans sooner and with a reduced vesting schedule.
Typically, a company may require an employee to work a minimum of one year before offering them the opportunity to participate in a workplace retirement plan like a 401(k). Additionally, when employers offer to match an employee’s contribution to the retirement plan, they typically establish a minimum vesting period from 1 to 3 years before the employee “fully vests” or owns the employer match contributions. In this way, the company incentivizes the employee to stay at the company longer to earn these additional retirement savings dollars.
In recognition of the inordinate challenge military spouses face in building retirement savings while job hopping their way through their spouse’s military career, the SECURE Act 2.0 offers valuable tax credits to small businesses who employ military spouses. To earn the credit, qualifying companies must make military spouses eligible to participate in the company retirement plan within 2 months of joining the company. They must also immediately vest the spouse’s earned company match; ensuring the employer’s matching funds are credited to the spouse’s account when they PCS with their serving spouse.
#2 College 529 Savings & Roth IRAs
Effective in 2024, parents who have excess college savings in their child’s 529 account will be allowed to rollover up to $35,000 of those funds to a Roth IRA. The intent is to encourage parents to contribute to 529 college savings accounts as their child grows up without the fear that they will be taxed and penalized if the funds are not needed for college expenses.
Prior to the SECURE Act 2.0 families faced tax penalties if they took 529 distributions outside the strict IRS definition of education expenses. Military families who can transfer GI Bill benefits to their dependents often find they have left over 529 savings when their child graduates from college, especially if their child attended a college that offered the Yellow Ribbon Program. Under the new rules, parents have an opportunity to use these excess savings to fund either their own or their child’s Roth IRA.
To meet the new requirements, the 529 account must have been open for at least 15 years, there is a lifetime limit of $35,000 for each 529 account, and the annual IRS limit for IRA contributions will still apply (for example, 2023’s IRA limit is $6500). Additionally, the recipient Roth IRA would have to be in the name of the 529 account beneficiary. This last detail is not as restrictive as it may seem because an owner of a 529 account can change the beneficiary to any number of family members at their discretion.
This means that a parent could change the 529 beneficiary to themselves, or their spouse then use the excess college savings funds to contribute to their own or their spouse’s Roth IRA. Alternatively, the excess 529 funds could be used to fund their child’s Roth IRA giving them a savings boost in the early years of their career.
#3 Expanded Savings Opportunities for Young Employees
SECURE Act 2.0 includes numerous provisions designed to encourage younger employees to start saving for retirement, along with incentives for employers to help them get started.
Student Loan Debt. Beginning in 2024, employers can “match” an employee’s student loan payments with a contribution to their workplace retirement plan.
Emergency Savings. Also in 2024, employers can add a Roth emergency savings account to their workplace retirement plan allowing some employees to contribute up to $2,500 each year.
Automatic Enrollment. Beginning in 2025, employers offering new workplace retirement plans will be required to automatically enroll eligible employees at an initial contribution rate of at least 3% of income. This automatic contribution rate must increase by at least 1% in each subsequent year with a target contribution rate of 10 percent.
#4 Required Minimum Distribution (RMD) Delayed and Penalties Reduced
IRS mandated required minimum distributions are intended to generate tax revenue by forcing retirees to begin paying taxes on their retirement savings. The SECURE Act of 2019 increased the age at which retirees must begin taking RMDs from age 70 1/2 to 72; SECURE Act 2.0 further raises the RMD age to 73 for individuals born between 1951-1959, and age 75 for individuals born after 1959.
This delay provides retirees with greater control over when they recognize this additional taxable income, allows them some control over their income based Medicare premiums and expands the window of opportunity for Roth Conversions by a few years.
Additionally, SECURE Act 2.0 reduces the penalty for failing to satisfy the annual RMD from 50 percent of the unrecognized RMD income to 25 percent. In acknowledgement that most RMD mistakes are unintentional, the new act further reduces the penalty to 10 percent if a taxpayer corrects the discrepancy within a “timely manner.”
#5 RMDs Eliminated for Roth Accounts in Employer Sponsored Retirement Plans
Previously, retirees were required to take RMDs from Roth based 401(k) and similar workplace retirement plans, including Thrift Savings Plans (TSP) accounts. Since Roth contributions are funded with after tax income, there was no income tax associated with these RMDs, but the mandatory distributions forced retirees to begin to drain their Roth account balances even when they don’t need the money. This change eliminates the need to rollover their Roth employer plan to a Roth IRA to avoid these Roth RMDs.
#6 Increased Catch Up Contributions
The IRS allows taxpayers aged 50 and older to make “catch up” contributions to their IRAs and workplace retirement accounts. These catch up contributions are intended to give older employees the opportunity to make larger contributions to their retirement accounts in the years leading up to their retirement.
In 2023, the catch up contribution limits are set to $1000 for IRAs and $7500 for an employer sponsored retirement plan. The annual limits for catch up contributions were not previously adjusted for inflation. Beginning in 2024, catch up contributions will be indexed to inflation insuring they keep pace with inflation and provide a meaningful extension to the baseline retirement contribution limits.
Additionally, employees between the ages of 60-63 gain the opportunity to make even greater catch up contributions allowing them to save an additional $10,000 in their retirement plan.
And just to complicate the situation even more, the new law requires employees who earn more than $145,000 per year to make their catch up contributions to Roth account, meaning highly compensated employees will need to pay tax on the additional contributions.
Financial Planning Implications
The tax law changes described here represent a small sample of the expansive list of SECURE Act 2.0 changes intended to get Americans to save more for retirement through expanded savings options for both employees and employers. The full impact of these changes will depend on the IRS’ interpretation of each section of the law which will evolve over the coming months and years.
As we learn more about the IRS’ implementation of these changes, we will post additional details.
