SECURE 2.0 improves Roth retirement options, including allowing employer matching contributions directly to a Roth retirement plan and delaying Required Minimum Distributions (RMDs) for many.
On December 29, 2022, as part of the omnibus spending bill, President Biden signed into law the SECURE 2.0 Act of 2022 (SECURE 2.0). The law contains significant changes to employer-provided retirement plans and individual retirement plans and has particularly significant changes for Roth accounts. I colorfully described the original SECURE Act of 2019 as a stinky pig wrapped in tape (mainly due to the death of the IRA tranche), but SECURE 2.0 actually lives up to its name. Provides significant savings enhancements for retirement planning and allows for increased Roth contributions and conversion opportunities, including:
- Matching and non-elective contributions can now be Roth
- Roth SINGLE and SEP IRA
- Allowable Student Loan Matching Contributions
- No more RMD Roth 401(k)
I have long been a proponent of Roth IRAs and SECURE 2.0 will enable many more Roth savings options, which I will highlight below. As I’ve written before, the Roth IRA (or Roth retirement plan at work) is superior, in most cases, to the deductible IRA (or traditional retirement plan at work). And depending on the investment period and your current and future tax brackets, even making the most conservative assumptions, the Roth IRA will often provide more buying power than a traditional deductible IRA. See Figure 3.5 below.
Roth IRA Savings vs. Traditional IRA Savings
Assumptions for Figure 3.5: Roth IRA Savings vs. Traditional IRA Savings
- Contributions to a Roth IRA are made in the amount of $7,000 per year, beginning in 2022, for an investor age 55, for 11 years until age 65.
- Contributions to a regular deductible IRA are made in the amount of $7,000 per year by a different investor age 55, for 11 years until age 65. Contributing to this investor’s IRA creates an income tax deduction for him of 24 percent, or $1,680. I will give the best case scenario and say that this investor did not spend his tax savings. Instead, he invested his tax savings in his after-tax investment account and did not spend them.
- Investment rates of return on the Traditional IRA, Roth IRA and after-tax investment accounts are 6 percent per year.
- For after-tax money, the rate of return includes 70 percent capital appreciation, a 15 percent portfolio turnover rate (so much of the appreciation isn’t taxed immediately), dividends from 15 percent and ordinary interest income of 15 percent.
- Ordinary income tax rates are 24 percent for all years.
- Tax rates on realized capital gains are 15 percent.
- Starting at age 72, RMDs from the Traditional IRA are rolled over to the after-tax savings account.
- Balances reflected in the figures reflect purchasing power, which is net of a 24 percent income tax allowance on the remaining balance of the Traditional IRA. However, if the entire amount is withdrawn in one year, the tax bracket may be even higher and make the Roth IRA look more favorable.
Employees and employers, take note
The first big change for people who are still working is that employers will now be able to give employees the option to receive non-elective matching contributions to a Roth account for their 401(k)/403(b)/457(b) plans. ). . Under the old law, all employer contributions had to be deposited into a traditional (pre-tax) account, not a Roth account: Employees could choose a Roth account for their contribution, but the employer could not.
This is an optional provision for employers.. Employers must change their plan documents to provide this option. Employees will not have this option immediately unless their employer has changed their plan offerings since the beginning of the year. Employers are not required to provide the options.
One of the purposes of this article is to not only educate employees, but also to encourage all employers, both in the for-profit and non-profit world, to change their plans immediately. In most cases, every month that employers delay changing their plan, they hurt their employees. Plan documents without this vital plan amendment will limit valuable options for employees to save for retirement most effectively. Plus, this added feature is at no cost to the employer.
All taxes on Roth contributions will be the responsibility of the employee and the match will be granted immediately. Almost all younger workers should take advantage of this provision, and most mid-career and even some late-career employees should as well.
I had the pleasure of interviewing Burton Malkiel earlier this year and he continued to emphasize the importance of regular Roth contributions, especially for younger workers. Systematic contributions to a retirement plan act as dollar cost averaging, and doing so with Roths is often more effective than traditional contributions. Again, while this provision is effective for 2023, employees will not have the option if their employer has not updated plan documents and payroll systems.
We are updating our 401(k) at Lange to allow our employees to take advantage of this option and I hope all employers will do the same.
It is understood that if your employer offers matching contributions to your retirement plan, you must contribute at least the amount necessary to receive the full amount the employer is willing to match. Under both the old law and the new law, the employee’s contribution can be to a Roth or traditional account. After paying taxes on a Roth matching contribution, it will grow income tax-free and with no taxes due when the money is withdrawn. Traditional contributions will be made on a pre-tax basis, and taxes will be due when the money is withdrawn.
An employer matching contribution provides an immediate positive return on your investment and is the easiest way to maximize your retirement savings. It is a win-win scenario.
For employees who want to contribute as much as possible, let me frame the “Roth versus a traditional contribution” scenarios. Assume the employer has a 50% matching policy and the employee contributes $30,000 per year in 2023 ($22,500 maximum plus $7,500 to catch up if age 50 or older).
The employer contribution would be $15,000. If the employer contribution goes to the traditional portion of the plan, the employee, in effect, receives $10,000 in immediate purchasing power due to the 33% income tax liability when the funds are withdrawn. If the employer’s share goes to Roth, then the employee receives $15,000. The employee will have to pay tax on the contribution (cannot deduct the contribution), but in effect, the contribution is $5,000 higher when measured in purchasing power, not including tax-free growth on the contribution.
SEPS and SINGLE
SECURE 2.0 also expands the opportunity for some employees to save in a Roth account. One such opportunity, starting in 2023, is to allow employee contributions to SIMPLE IRAs and SEPs to be Roth, and similarly, employees can also (if offered by the plan) treat SEP contributions from their employer like Roth. I usually prefer a 401(k) plan to a SIMPLE or SEP, but I still welcome the change.
Student Loan Matching
Beginning in 2024, employers will be able to offer matching contributions for employees who are repaying student loans without additional employee contributions. In these circumstances, the employer’s match may be based on the qualifying employee’s student loan payments; it will be as if the loan payments were elective deferrals in the plan. Again, it’s up to the employer to allow this option, but it would be a great benefit to help an employee participate in an available employer match that they might not otherwise be saving. It is highly imaginable that these people are overwhelmed with debt and are unable to put aside additional money to save for retirement. On the other hand, this will cost the employer money if he chooses to add this option to his retirement plan.
No RMD for Roth 401(k)s and Roth 403(b)s
Finally, starting in 2024, SECURE 2.0 aligns employer-sponsored Roth plans with Roth IRAs and now employer plans will also be exempt from RMD requirements (just like Roth IRAs) for as long as the participant is alive. This avoids the extra effort and hassle of rolling over a 401(k) or 403(b) to a Roth IRA just to avoid the RMD. The process will be much simpler and won’t force an employee out of an employer’s plan who might otherwise want to stay.
Higher age for RMDs (and additional time for Roth planning)
Currently, the age for RMD is 72 (prior to the SECURE Act, the age for RMD was 70½). Under SECURE 2.0, the ages of RMDs have changed again:
- If you were born before 1950, RMDs began at age 70½
- If you were born in 1950, RMDs start at age 72
- If you were born between 1951 and 1959, RMDs start at age 73
- If you were born in 1960 or later, RMDs start at age 75
Note: There is a discrepancy within the invoice that needs to be corrected. For those people born in 1959, the bill inadvertently says they have two ages to start taking their RMDs: 74 and 75. The table above reflects how experts perceive the intent of the bill. Stay tuned for a technical change in the future. For some, you will now have an additional three (3) years for additional planning considerations, including accelerating more Roth conversions and/or smoothing Roth conversions over a period of time to reduce the Income Related Monthly Adjusted Amount (IRMAA) for Medicare charges, net investment income taxes, and possibly capital gains tax brackets.
The important part about aging RMDs from a Roth conversion standpoint is that obviously there will be a longer window for lower-cost Roth IRA conversions.
In conclusion, employers please update your documents to better serve your employees. For those of you who are still working, assuming Roth accumulations make sense for you, when your employer offers the Roth option for the employer’s share, strongly consider taking advantage of it.
