Omnibus Spending Bill Focuses Primarily
On Retirement Planning Enhancements
On December 23, 2022, Congress passed the Consolidated Appropriations Act of 2023. The sprawling year-end spending “omnibus” package includes two important new laws that could affect your financial planning: The Setting Every Community Up for Retirement Enhancement (SECURE) 2.0 Act (also known as SECURE 2.0) and the Conservation Easement Program Integrity Act.
SECURE 2.0 addresses a wide array of areas that make major changes to retirement planning, including:
Catch-Up Contributions
Beginning January 1, 2025, individuals who are ages 60 to 63 can make catch-up contributions to 401(k) plans and SIMPLE plans up to the greater of $10,000 or 50% more than the regular catch-up amount. The increased amounts are indexed for inflation after 2025. (The annual dollar limit on catch-up contributions is $7,500 for 2023, up from $6,500 for 2022.)
The law also changes the taxation of catch-up contributions, though, which could reduce the upfront tax savings for those who max out their annual contributions. Catch-up contributions will be treated as post-tax Roth contributions. Previously, you could choose whether to make catch-up contributions on a pre- or post-tax basis. An exception is provided for employees whose compensation is $145,000 or less (indexed for inflation).
Tax-Free Rollovers from 529 Plans to Roth IRA
The new law permits a beneficiary of a 529 college savings account to make direct rollovers from a 529 account in his or her name to a Roth IRA without tax or penalty. This provides an option for 529 accounts that have a balance remaining after the beneficiary’s education is complete. The 529 account must have been open for more than 15 years and other rules apply. The provision is effective for distributions beginning in 2024.
Required Minimum Distributions (RMDs)
The first SECURE Act generally raised the age at which you must begin to take RMDs — and pay taxes on them — from traditional IRAs and other qualified plans from 70½ to 72. The new law increases the age to 73, starting January 1, 2023, and boosts it to 75 on January 1, 2033. This change allows people to delay taking RMDs and paying tax on them.
The law also relaxes the penalties for failing to take full RMDs, reducing the 50% excise (or penalty) tax to 25%. If the failure is corrected in a “timely” manner, the penalty would drop to 10%.
Qualified Charitable Distributions (QCD)
QCDs have gained popularity as a way to satisfy RMD requirements while also fulfilling philanthropic goals. With a QCD, you can distribute up to $100,000 per year directly to a 501(c)(3) charity after age 70½. You can’t claim a charitable deduction, but the distribution is removed from taxable income.
Under the new law, you also can make a one-time QCD transfer of up to $50,000 through a charitable gift annuity or charitable remainder trust (as opposed to directly to the charity). The law also indexes the annual IRA charitable distribution limit of $100,000 for inflation.
Annuities
Annuities can help reduce retirees’ risk of depleting their savings before they die. But RMD regulations have interfered with the availability of annuities in qualified plans and IRAs. For example, the regulations prohibit annuities with guaranteed annual increases of only 1% to 2%, return of premium death benefits and period-certain guarantees. SECURE 2.0 removes these RMD barriers to annuities.
The law also makes qualified longevity annuity contracts (QLACs) — inexpensive deferred annuities that don’t begin payment until the end of the individual’s life expectancy — more appealing. Among other things, it repeals the 25% cap on the maximum annuity purchase and allows up to $200,000 (indexed for inflation) from an account balance to be used to purchase a QLAC.
Matching Contributions on Student Loan Payments
The law also aims to help employees who miss out on their employers’ matching retirement contributions because their student loan obligations prevent them from making retirement contributions. It allows them to receive matching contributions to retirement plans based on their qualified student loan repayments. Employers can make matching contributions to 401(k) plans or SIMPLE IRAs. These provisions are effective for contributions made for plan years beginning January 1, 2024.
Automatic Enrollment
Beginning in 2025, new 401(k) plans must automatically enroll participants when they become eligible. However, the employees may opt out. The initial contribution amount is at least 3% but no more than 10%. Then, the amount is automatically increased every year until it reaches at least 10% but no more than 15%. Existing plans are exempt, and the law provides exceptions for small and new businesses.
Part-Time Employee Eligibility
SECURE 2.0 lowers the hurdles for long-term, part-time employees to participate in 401(k) plans. They’ll still need to work at least 500 hours before becoming eligible but they’ll have to work for only two consecutive years, rather than the three years required by the first SECURE Act. The provision takes effect for plan years beginning January 1, 2025.
Small Business Tax Credits
To incentivize small businesses to establish retirement plans, SECURE 2.0 creates or enhances some tax credits. For example, it increases the startup credit from 50% to 100% of administrative costs for employers with up to 50 employees. An additional credit is available for some non-defined benefit plans, based on a percentage of the amount the employer contributes, up to $1,000 per employee.
Cracking Down on Conservation Easements
The retirement provisions in the omnibus law are partially offset by the law addressing conservation easements. Current law generally allows taxpayers to claim a charitable deduction for qualified donations of real property to charity. According to the IRS, though, promoters have twisted the relevant tax provision to develop abusive “syndicated” conservation easements that use inflated appraisals and partnership arrangements to reap “grossly inflated” deductions.
Going forward, the Conservation Easement Program Integrity Act disallows charitable deductions for qualified conservation contributions if the claimed deduction exceeds 2.5 times the sum of each partner’s relevant basis in the partnership making the contribution. An exception is granted if the contribution meets a three-year holding period test, substantially all of the partnership is owned by family members or the contribution relates to the preservation of a certified historic structure.
These are only some of the provisions in the new law. A number of prominent tax provisions were left out of the omnibus package, however, with Republicans and Democrats unable to agree on rolling back a requirement in the Tax Cuts and Jobs Act of 2017 for amortizing research and development expenses in exchange for extending the expanded Child Tax Credits provided last year under the American Rescue Plan Act. Also left on the chopping block was an extension of 100% bonus depreciation on purchases of assets by businesses, which will phase out initially to 80% and then go back to regular depreciation in 2027. Another tax provision from the Tax Cuts and Jobs of 2017 that didn’t get delayed was the cap on deductibility of interest expenses, which took effect in 2022.
The entire omnibus law is sure to generate additional questions and guidance. We’ll keep you apprised of the developments.
The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.