SECURING RETIREMENT
A new federal law rewrites rules for retirement accounts
As a financial adviser, Vic Conrad is optimistic whenever Congress passes legislation intended to help retirement savers put away more for the future.
But he simply doesn’t believe that many retired people will have reason to cheer a new law raising the age from 72 to 73 when senior citizens — who haven’t already done it — are required to start withdrawing money from their retirement accounts.
People who turned 72 this year and thought they would have to finally start making required minimum withdrawals from their retirement accounts found out they will get another year extension thanks to Congress passing the Secure 2.0 Act and President Joe Biden signing it into law in December.
Mr. Conrad, owner of Pinnacle Financial Strategies in Pine, said many people that age are already pulling money from their retirement savings, and probably have been doing so for years.
“Well over half of my client base has been taking some out since the beginning of their retirement, and I imagine that’s very parallel to America in general,” he said. “For most people, this is really a moot point.”
He said the rule raising the required minimum distribution age — like other rules included in the Secure 2.0 Act of 2022 — will mostly benefit people who already have plenty of money.
Secure 2.0 is a broad piece of legislation that will reshape the rules for retirement savings programs. It builds on rule changes made in the Secure Act of 2019 and is the latest effort by the federal government to improve the retirement readiness of a nation of workers who haven’t been saving enough and have fewer pensions to fall back on.
Social Security benefits remain the No. 1 source of income for people 65 and older in the U.S., and 26% of American workers had no retirement savings in May 2021, according to the Board of Governors of the Federal Reserve System.
With some 90 provisions affecting retirement savings plans, many of the rule changes in Secure 2.0 don’t take effect until 2024 or 2025. But a handful are effective this year. One of them is the increased age for required minimum distributions.
Another is allowing leftover money — up to $35,000 — in 529 college savings plans to be transferred tax-free to a Roth IRA .
“But how many people end up with too much money in a college savings account?” Mr. Conrad said. “I work with some pretty wealthy people and that doesn’t happen often.”
Upside and downside
Congress doesn’t usually pass tax laws to help investors. So, what’s the catch?
“Deferring taxes can mean more taxes and more taxes makes Washington, D.C., happier,” said Kurt Carlson, a financial adviser at Baird Private Wealth Management.
The federal government sets an age when owners of retirement accounts such as 401ks and IRAs must start making withdrawals so that the government can finally start collecting taxes on money that has been allowed to grow tax-deferred for many years.
But delaying required minimum distributions could be more painful in the long run if the account balance is higher and the account owner is older. That’s because the withdrawal amounts will be bigger, which will have a ripple effect on the person’s tax bracket as well as the premiums they pay for Social Security benefits like Medicare, depending on what annual income they report to the IRS.
The required amount that seniors must withdraw is based on the account owner’s balance at the end of the year and the account owner’s age and life expectancy as determined by the Internal Revenue Service’s Uniform Lifetime Table.
By delaying withdrawals from retirement accounts, retirees could be forced to make bigger withdrawals, which are taxed at the account owner’s ordinary income tax rate, which may be higher due to the size of the withdrawals.
In just the past three years, the age for required minimum distributions has moved from 70½ to 73. Under the Secure 2.0 Act, the age will move to 75
in 2033.
For some who are in a position to take advantage of it, the higher age requirement for such distributions has advantages.
“In general, it’s a positive thing as nobody likes to be forced to do something and this loosens the requirements a bit,” said Jayme Meredith, a director and financial adviser at Baird Private Wealth Management, Downtown.
He said it also helps business owners who are still working and would otherwise be forced to make withdrawals. The government’s rules require those who hold 5% or more in ownership of a company to take required minimum distributions on their 401k assets.
The downside of the latest rule change is that it only delays, not eliminates, the required withdrawals. “Delaying IRA distribution to future years will most likely increase the size of the future distributions — assuming investments go up in value,”Mr. Meredith said.
Changes to impact everyone
Eventually, everyone with a retirement account will be impacted in some way by the rule changes tucked into the Secure2.0 act.
For example, starting this year, people age 50 and older will be able to increase their catch-up contributions — which are additional, elective payments made into retirement plans — from $6,500 to $7,500 per tax year. That amount increases to $10,000 per year starting in 2025 for people age 60 to 63.
Also, in 2024, all catch-up contributions made by people earning more than $145,000 a year must be made to a Roth IRA. Such contributions are taxed immediately, but the capital gains can be withdrawn taxfree.
Beginning in 2025, employers who start new retirement plans will be required to automatically enroll employees in the plan. The employee contribution in the automatic plans must be at least 3% of their eligible wages, but not more than 10%. Employees may opt out.
In 2024, employers will be able to help employees saddled with student debt start a retirement fund.
The law will allow employers to treat student loan payments made by employees as retirement contributions. That means employees who can’t actually save for retirement because they are repaying student debt can still qualify for workplace benefits in which the employer matches a worker’s contribution to their 401k plan to a limit.
The penalties for early withdrawals from a retirement account prior to age 59½ are easing up due to Secure 2.0.
Effective immediately, the 10% penalty for early withdrawals is waived for anyone certified by a doctor as having a terminal illness. In 2024, hardship withdrawals will be available for victimsof domestic abuse.
Effective in 2026, retirement account owners will be able to make early withdrawals of $2,500 per year with no penalty to pay the premiums on certain types of long-term care contracts.
Some flexibility, more options
Part of the rationale behind some of the changes is that the average life expectancy has gone up.
When the Employee Retirement Income Security Act, or ERISA, became law in the mid-1970s, life expectancy at birth was 72.6 years, according to the Centers for Disease Control and Prevention. By 2021, it had increased to 76.4 years.
Raising the required minimum distribution age gives retirees more flexibility, said Ashby Daniels, a financial adviser at Shore Bridge on Washington’s Landing.
“Pushing the ... age back to 73 offers retirees additional flexibility to managing taxes for a few extra years,” Mr. Daniels said.
Retirees also get more timeto convert traditional individual retirement accounts to Roth IRAs before they have to start taking money out. Roth IRAs have no required minimum distributions, and because the accounts are funded with posttax dollars, withdrawals in retirementare tax-free.
Mr. Daniels said the oneyear delay will “allow for additional Roth conversions, and the ability to keep Medicare premiums lower for longer depending on the income and wealth of the individual.”
Still, this planning strategy applies only to seniors with the luxury of holding off this long without tapping their retirement funds. Depending on how large the chunks of cash are when the senior finally starts taking those required minimum distributions, the increased income — depending on wealth — could bump him or her into a higher tax bracket.
Mr. Carlson, at Baird, said people who are preparing to start taking money out have three options: Convert the money they withdraw to a Roth IRA or insurance; spend it; or give it to charity.
Donna Kline, a financial adviser at HBKS Wealth Advisors in Pine, said most seniors won’t have the luxury of worrying about the required minimum distribution because most need the money for living expenses.
“The Treasury Department recently estimated about 20% of seniors required to take [required minimum distributions] withdraw only the minimum amount,” she said, which suggests 80% of people that age are living off their retirement funds.
“Pushing the age back will be a nonevent for most retirees. Most can’t afford to wait until 72 to start IRA withdrawals, let alone age 75.”