Jeff Levine Answers Secure 2.0 Tax Questions From Advisors

Over the past two weeks, Jeff Levine, Kitces.com’s lead financial planning nerd and Buckingham Wealth Partners’ chief planning officer, has been hard at work spreading the word about the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act.

Speaking on a Kitces.com webinar early in the new year, Levine said the Secure 2.0 legislation has firmly cemented the role of Roth-style accounts in the retirement planning effort. Levine said it is apparent that the current members of Congress “just love the Roth, and for good reason.”

Pro-Roth policies look good on the federal budget today, he explained, and people in the general public actually understand and appreciate Roth accounts. There are few other policy issues for which this dual-sided support is true, and Levine said that fact can give planning professionals a lot of confidence that the Roth is here to stay.

Levine shared some additional insights during a webinar hosted by the tax planning software provider Holistiplan, during which he fielded a long list of tax-focused questions from listeners. As summarized in the Q&A dialog below, a significant number of the more than 100 retirement-focused provisions in the Secure 2.0 package will have tax planning implications.

While some effects of the Secure 2.0 package won’t be felt until 2024 or later, parts of the law are already in effect, Levine warned, and so it is beholden on advisory professionals to get up to speed as quickly as possible.

AUDIENCE QUESTION: I understand that the Secure 2.0 law allows employers to direct their matching retirement plan contribution into Roth-style accounts. Will these contributions be subject to FICA taxes for the recipient?

JEFF LEVINE: The simple answer is no, these contributions won’t be subject to normal employment taxes, but the amount of the contributions will be included in the individual’s gross income for the year.

Effective immediately upon enactment, Secure 2.0 permits qualified plans to allow employees to designate that their employer’s matching or non-elective contributions be directed to a Roth account.

So, if you have a scenario where someone gets a $5,000 matching contribution and they elect that it goes into the Roth account, the end taxation result will be similar to what would happen if they had accepted the match into the traditional pretax account and then later in the same year converted it to their Roth IRA. The amount of the contribution will be added to their gross income, but it won’t be subject to FICA employment taxes.

Does the 529 plan to Roth IRA rollover lifetime limit of $35,000 apply per account or per beneficiary?

That’s a good question, as it is not entirely clear from the text of the legislation.

On my reading, it appears to be a rule that will apply per beneficiary. So, it seems likely that you could change the beneficiary and technically do several rollovers out of the 529 plan that would amount to greater than $35,000. Again, this is not entirely clear at this juncture, so we will have to wait and see what kind of guidance might be issued.

Listeners should take note that, whatever rollover amount is being considered, the 529 account has to have existed for 15 years in order to qualify. Given this 15-year requirement, you should probably go ahead and encourage your clients to just open a 529 plan today and put $50 or $100 in. That way they can just get that clock started, even if they have to name themselves as the initial beneficiary.

Can you expound on the rule that will apply in 2024 with respect to catch-up contributions going into Roth accounts for those with more than $145,000 in wages?

Basically, these catch-up contributions must go to Roth 401(k)s if wages from their company exceed $145,000 for the previous year, and this takes effect in 2024.

While the effective date is technically 2024, this ‘previous year’ feature does mean that those who earn more than this amount in 2023 will be subject to the new Roth requirement next year.

In 2023, participants age 50 and older can contribute an extra $7,500 per year annually into their 401(k) account. This amount will increase to $10,000 per year and will be indexed for inflation starting in 2025 for participants age 60 to 63.

What’s the latest information on required minimum distributions for non-spouse beneficiaries who inherit an individual retirement account? What new information should we understand about the 10-year drawdown window?

Unfortunately, this matter was not clarified as part of Secure 2.0 as some had hoped it would be. So, there is still some significant uncertainty regarding inherited IRAs as we await full IRS regulations, possibly later this year.

At this point the main guidance we can rely on is the IRS Notice 2022-53.

That notice emphasized that the IRS won’t impose RMDs for these inherited accounts in 2021 and 2022, but it did not say with certainty what would happen for 2023. It just said the final regulations, which we don’t have yet, will apply at the earliest in 2023.

Ultimately, we are still in a wait-and-see moment, but I can tell you for sure that for 2021 and 2022, no RMDs are required for these beneficiaries. However, just because these distributions aren’t required does not automatically mean it will be better, on a tax basis, for every taxpayer to avoid these distributions. It all depends on their specific circumstances and income needs.

Do you feel Roth distributions may be subject to taxation at some time in the future? Could the favorable treatment of Roth accounts be eliminated in the future if Congress needs more tax dollars?

That’s a good question, and I understand why you would ask it, but my gut sense is that they will not take action to tax Roth distributions in the future.

First of all, I think you would see major legal and legislative challenges to such an action. And even if such a change were made, when Congress changes retirement rules, they almost always grandfather people into the old set of rules. So, any Roth contributions made today will very likely get their favorable tax treatment grandfathered in if any changes were to be made in future years.

But again, I don’t think that is likely to happen anyway. Think about it. If they ever made a change like this and it was structured as a prospective change only, that would be really counterproductive. People would just stop making Roth conversions.

There would be no significant benefit for contributing to a Roth account if Congress did something like that, and so the contributions would stop, and that would defeat the whole purpose of the change in the first place. So, I don’t see it happening.

Regarding the 529 plan to Roth conversions, are there restrictions on who can be named as the beneficiary?

It does not appear so. As I noted, we have to wait for some additional guidance. But at this point it appears that you will be able to organize these rollovers with a substantial degree of flexibility.

Can you explain any changes to the treatment of spousal beneficiaries of inherited IRAs for RMD purposes?

There is just one big change, in my view, and it will not apply until 2024.

Before we reach 2024, you can still take the deceased person’s money and treat it as your own account, as the survivor, and afterward their money looks and feels like your money for RMDs and tax purposes.

After 2024, the situation reverses, in essence. What you will be able to do is make your money look like theirs. For RMD purposes, you can effectively jump into their shoes, whereas before, you were able to make their money jump into your shoes.

With respect to 529 plan to Roth conversions, does the Roth IRA owner need to have earned income to be eligible?

While this is another area where guidance will be helpful, it appears that the answer is yes.

Does the 529 to Roth conversion apply both to prepaid 529 accounts and investment-focused 529 accounts?

Yes it does. As the law is written, any type of plan or account organized under the 529 section of the tax code should be eligible for these new rollovers.

Did the Secure 2.0 law impact or change mortality and life expectancy tables, given the focus on RMDs?

No it did not, at least not directly. Eventually, the regulators will make updates, as they regularly do, but that was not done as part of Secure 2.0.

How does the IRS expect the average worker, who doesn’t work with a financial advisor, to calculate their inherited IRA RMDs? Will custodians be expected to calculate this for clients?

On the first part of your question, I frankly have no idea how they expect people to do this. I can tell you that a lot of advisors, and even a lot of tax professionals, don’t really know how to do this accurately. So yes, individuals lacking professional support are in a tough spot when it comes to making these calculations.

Will the custodians be required to do it? I highly doubt that, if only because the custodians would spend a lot of money lobbying against such a requirement, because of the liability that they feel it would bring.

I can understand this point of view. Even if they had all the basic information like client age and date of birth, they also would need a lot of other information, such as the date when the decedent died, in order to run the calculation accurately. It would be really complicated.

How is the five-year rule applied when Roth 401(k) assets are rolled into a Roth IRA account?

The Roth IRA five-year rule says you cannot withdraw earnings tax free until it has been at least five years since you first contributed to a Roth IRA account.

For practical purposes, the key insight is that once Roth 401(k) money goes into a Roth IRA, the Roth IRA five-year rule trumps. That’s what matters. So, whether you had the money in the Roth 401(k) for 5 days or 50 years, if it goes into a Roth IRA, and that Roth has been in existence for more than five years, you are good. That plan money always is subject to the Roth’s established five-year clock.

Can you clarify the changes to new plan startup credit for small-business owners?

Yes. To begin with, you will still have the normal startup credit that you can take advantage of.

In addition, there is now a new startup credit that will let you write off up to $1,000 of employer contributions per eligible employee — i.e., non-highly comped individuals. Over time, you then run that $1,000 amount through an annual percentage reduction grid, if you will.

That is, in year one, 100% of the contribution can be taken as the credit. Then in year two, this goes down to 75%. In year three it drops to 50%, and so forth.

So, lets say you have a client with seven employees who fit this description, and your client puts $10,000 in employer contributions into each of their accounts for the year. He is capped at that $1,000 credit per person, making for $7,000 in total as a credit in year one. Each year, this will be reduced by 25%, until the credit phases out entirely.

Will an employer still get a tax reduction for making Roth contributions on behalf of employees?

Yes they will.

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