American workers aren’t investing enough for retirement.
Nearly half of U.S. workers rely on self-funded retirement accounts, such as IRAs and 401(k)s, as their primary sources of income in retirement, yet the median total household retirement savings balance is only $67,000, according to a study released by Transamerica Center for Retirement Studies in December 2022.
The Setting Every Community Up for Retirement Enhancement Act of 2019, also known as the Secure Act, made sweeping policy changes that affected retirement investors. And when President Biden signed the $1.7 trillion omnibus spending bill to fund the U.S. government, the Consolidated Appropriations Act of 2023, into law on Dec. 29, it included legislation to build on the original Secure Act, now called Secure Act 2.0.
Both pieces of legislation were designed to address significant retirement savings gaps among American workers, but Secure 2.0 also contains changes to the law that affect a wider swath of investors. Here are some of the key changes to retirement savings plans and investment rules put in place by Secure 2.0 that investors should know about:
— Secure 2.0 changes to retirement savings plans.
— How Secure 2.0 affects 529 plan investments.
— Rules for exchange-traded funds in annuities.
— Penalties on prohibited transactions.
Secure 2.0 Changes to Retirement Savings Plans
For investors who were eager for provisions to help them prepare more effectively for retirement, Secure Act 2.0 did not disappoint. There are roughly 90 provisions in Secure 2.0 that address retirement in some capacity; in fact, the legislative text mentions the word “retirement” 101 times and references the “savings” topic 39 times. Here are the standout rule changes:
Breaks on required minimum distributions. Secure Act 2.0 raises the age to take required minimum distributions from retirement accounts, or RMDs. The age to take RMDs will be 73 in 2023, then age 75 beginning in 2033. If you don’t take an RMD as required, the penalty has been lowered from 50% of the RMD amount to 25%. If the mistake is corrected for an IRA in a timely manner, the penalty is 10%. The act also allows for more flexibility with qualified charitable distributions that can count toward RMDs, expanding the type of charities that can receive QCDs.
More matching options for employers. Employer-sponsored retirement plans can now deliver both vested matching and non-matching dollars in the form of Roth contributions to eligible employees. Roth contributions in employer-sponsored plans and Roth IRAs are popular because qualified distributions from these accounts can be penalty- and tax-free in retirement.
Changes to Roth rules. Starting in 2024, any designated Roth balances in 401(k), 403(b) and 457(b) retirement plans are no longer subject to RMDs, which puts these types of accounts on par with Roth IRAs.
Automatic plan enrollment. New employer-sponsored retirement plans launched after Dec. 29, 2022, will be required to automatically enroll eligible employees at a contribution rate of at least 3% (but no more than 10%), starting in 2025.
Student loan payment perk. Effective in 2024, employers will be able to make matching contributions to retirement plans on behalf of employees who elect to make payments on student loans rather than contribute that money to the employer plan.
Catch-up contributions increase. Starting in 2025, individuals age 60 to 63 will be allowed to contribute up to $10,000 per year to an employer plan, indexed to inflation. The current limit for individuals 50 and older is $7,500.
Dig a little deeper into the legislative package, and you’ll find some references to investments (12 times), ETFs and mutual funds as well. Below are three key provisions that affect investors’ planning beyond the context of their workplace retirement plans.
How Secure 2.0 Affects 529 Plan Investments
With enactment in 2021 of the Economic Growth and Tax Relief Reconciliation Act, parents could save for their children’s college education in a tax-advantaged way through 529 plans. Withdrawals from 529 plans are generally exempt from federal and state income taxes if the funds are used for qualified educational expenses. Americans have largely embraced this strategy since 2001, and they currently own a total of 15.8 million 529 accounts holding nearly $458 billion in investments, according to the Education Data Initiative.
Over time, investors’ main challenge with 529s has been what do with any remaining balance not designated for educational expenses. Withdrawals for any other reason have been subject to a 10% penalty plus any applicable federal and state income taxes. Ouch.
Beginning in 2024, Secure Act 2.0 will help mitigate this challenge. Certain excess 529 assets will be eligible for rollover into a Roth IRA in the 529 beneficiary’s name. These rollovers will be tax- and penalty-free for the beneficiaries if certain conditions are met, including:
— The 529 plan account existed 15 years prior to the rollover.
— The 529 rollover does not exceed the annual Roth IRA contribution limit.
— Total rollover amounts do not exceed $35,000.
Rules for Exchange-Traded Funds in Annuities
Section 203 of Secure Act 2.0 will allow insurance carriers to include exchange-traded funds, or ETFs, as investment options in variable annuities. ETFs are pooled investments similar to mutual funds; however, unlike mutual funds, ETFs are eligible for active trading in the open market during the day. ETFs generally have low expense ratios, too.
Penalties on Prohibited Transactions
Individuals who prefer to own alternative investments, such as limited partnerships and direct real estate, within their IRAs have traditionally relied on the advice of their financial advisors
and tax professionals to comply with IRS-mandated rules regarding prohibited transactions.
Prohibited transactions in IRAs include things such as self-dealing (e.g., borrow from the IRA or sell property to it) and investments in collectibles such as art, antiques and alcoholic beverages. Traditionally, if someone ran afoul of the prohibited-transaction rules, then his or her IRA balance would be subject to a tax penalty.
Section 322 of the Secure Act 2.0 clarifies that, in the event of a prohibited transaction, only the IRA that was the source of the transaction will be subject to the tax penalty, not any additional IRAs an individual may own.
Essentially, Secure Act 2.0 enhances investors’ options for retirement planning and expands employers’ capabilities to help employees improve their financial status and retire on time.
What remains to be seen, though, is the extent to which investors will integrate the legislative provisions within their own financial plans, and how effectively employers, plan providers and financial planners will assist them in making the necessary adaptations.
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