Retirement planning is a critical aspect of everyone’s financial journey. Nothing in recent memory has changed the retirement savings and distributions rules as The SECURE 2.0 Act of 2022 did when it went into effect on December 29, 2022.
As the successor to the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, SECURE 2.0 is designed to build upon and expand the provisions of the original act. It also presents obstacles and advantages for advisors looking to help their clients prepare for retirement and manage their estates. One crucial aspect to consider is tax planning.
Technology is becoming a key advantage for advisors to navigate the tax and estate implications of SECURE 2.0 and ultimately help their clients best plan for retirement while managing the complexities of required minimum distributions (RMDs).
SECURE 2.0 tax planning changes
The SECURE laws highlight the importance of integrating rebalancing, trading, and tax planning into retirement and estate planning, particularly for the following:
The tax-free alternatives to conventional individual retirement plans have become even more appealing. This year, employers can modify their plans, permitting employees to select after-tax Roth contributions for employer-matching and non-elective contributions rather than pre-tax contributions.
In the Roth option, the contributions are made using already taxed dollars and are invested in various assets like stocks, bonds, and funds. While there are no deductions for these contributions, the accumulated gains can be withdrawn tax-free once the individual reaches at least age 59½ and has maintained the plan for a minimum of five years.
Carefully managing qualified accounts or converting them to Roth accounts can lead to substantial tax savings for families, especially considering the new 10-year rule for inheritance.
Individuals now have a slightly extended timeframe to allow their savings to appreciate before they are required to withdraw funds from most retirement accounts, even if they are still employed. Since RMDs are subject to ordinary tax rates, clearly understanding when these distributions must be taken becomes essential.
The 2019 legislation increased the required age for RMDs from 70½ to 72. In 2033, the age for RMDs will rise to 75. Roth IRA owners are not obligated to take RMDs, while individuals with Roth 401(k)s will need to make a distribution in 2023. However, that will be the final year for such requirements. Starting in 2024, these savers can allow their funds to grow tax-free for their lifetime.
For retirees, navigating the complexities of required minimum distributions (RMDs) can be daunting. Failing to take these distributions on time can result in hefty penalties. That’s where tax management and tax-smart rebalancing can help.
SECURE 2.0 introduced new guidelines for RMDs, granting increased flexibility to aid individuals in planning for extended careers and retirements. RMDs offer a source of retirement income, but they also pose a challenge in deciding which assets to sell to meet the required distributions.
Fortunately, there’s a beneficial solution to the RMD predicament: using them to rebalance your investment portfolio. This strategy allows advisors to fulfill IRS requirements while reducing the client’s risk exposure, especially during market downturns.
SECURE 2.0 provides the flexibility to utilize RMDs anytime during the year. The decision on when to rebalance portfolios with RMDs depends on whether a client needs the money for their living expenses. If yes, then scheduling monthly or quarterly distributions may be advised. If not, opting for a single annual lump-sum distribution may make more sense.
Starting this year, the penalty for not taking an RMD is reduced by half, from 50% to 25% of the amount not withdrawn. If the account owner rectifies the situation by withdrawing the previously missed RMD amount and submits a corrected tax return in the second year after the RMD was missed or before the IRS imposes a penalty, the penalty is further reduced to 10%.
Individuals who withdrew funds from their IRAs before 59½ were subjected to a 10% penalty based on their regular tax rate. However, SECURE 2.0 introduced new exceptions to ease this burden.
Those residing in federally declared disaster areas can withdraw up to $22,000 from a retirement plan without facing any penalty, and the resulting tax owed can be paid over a period of three years. Other penalty-free withdrawals are now available for those facing a terminal illness, a financial emergency, or domestic abuse, or have an emergency savings account linked to their retirement plan or need funds to cover long-term care expenses.
Starting this year, individuals 50 and older can contribute an additional $7,500 annually to their 401(k) accounts, and in 2025 increases to $10,000 per year for 60- to 63-year-olds and will be adjusted each year according to inflation.
For 2023, individuals earning more than $145,000 annually can make contributions to a plan on a pre-tax basis, but starting in 2024, all such contributions must be made using after-tax dollars.
Also, this year, IRAs permit a $1,000 catch-up contribution limit for individuals 50 and over. Starting in 2024, this limit will be indexed and potentially increased annually due to inflation or federally determined cost-of-living adjustments.
Starting in 2024, individuals with 529 college savings plans can reallocate up to $35,000 of any remaining funds to a Roth IRA. That means surplus money initially intended for a child’s education (including kindergarten through 12th-grade expenses) can be converted into retirement funds while avoiding any tax implications for both the account holder and the beneficiary. To be eligible, the 529 plan owner must have maintained the account for at least 15 years and adhere to the yearly Roth contribution limits.
The role of technology in retirement planning
Technology has transformed how advisors approach retirement planning, making it more personalized to client needs and empowering them to take informed actions to achieve clients’ retirement and tax goals. With the introduction of SECURE 2.0, technology will play a more vital role in strengthening retirement savings and security.
One of the critical components of retirement planning is portfolio rebalancing and trading to maintain clients’ desired asset allocation and risk levels without constant manual intervention. Rebalancing and trading platforms optimize investment strategies while considering individual risk tolerance and financial goals.
Rather than an annual event centered solely on tax season, advisors can apply tax-sensitive rebalancing approaches throughout the year to ensure your clients’ investment policies and tax efficiency goals are consistently met as they navigate the impact of SECURE 2.0 rules. By rebalancing at least quarterly, advisors can harvest their clients’ material losses during the year, avoid material capital gains distributions, and adjust the location of assets in retirement accounts for maximum tax benefit.
By leveraging the capabilities of intelliflo solutions, financial advisors can optimize their investment strategies and help their clients focus on enjoying the rewards of a well-planned retirement. With technology and outsourcing expertise as powerful allies, we can provide your clients with a clear path toward financial freedom and a prosperous retirement journey.