David T. Mayes is a CERTIFIED FINANCIAL PLANNERTM professional and IRS Enrolled Three Bearings Fiduciary Advisors, Inc., a fee-only advisory firm
The Consolidated Appropriations Act of 2023, which cleared Congress just before Christmas, included important updates to retirement related provisions in the tax code. These updates build upon the Setting Every Community Up for Retirement Enhancement (SECURE) Act that was enacted three years ago. You may recall that the original SECURE Act included a significant take away in that non-spouse beneficiaries of retirement accounts would no longer be able to stretch withdrawals over their lifetimes. While SECURE 2.0 does not contain such a watershed change, it does offer plenty of planning opportunities for retirement savers and retirees.
One of the most notable updates included in the new law is an additional pushback in the age at which required withdrawals from retirement accounts must begin. Originally, Required Minimum Distributions (RMDs) were slated to begin once a retirement account owner reached age 70 ½, though the first withdrawal could be delayed until April 1 of the following year. The first SECURE Act pushed the RMD age out to 72 for those who turned 70 ½ in 2020 or later. SECURE 2.0 sets the RMD age threshold at 73 for individuals who turn 72 in 2023 and provides for an additional pushback in the RMD age to 75 for those who reach this milestone in 2033 or later. Note that individuals who turned 72 in 2022 are not impacted by the change and must take their first RMD by April 1, 2023, if they have not done so already. The age at which Qualified Charitable Distributions (QCDs) can be made from an IRA is not impacted by the RMD age updates. These charitable withdrawals can still be made by account owners who have reached age 70 ½ with the benefit being that QCDs are excluded from taxable income making this a tax-wise charitable donation strategy for taxpayers who are not able to itemize deductions on their tax returns.
While the pushback in the RMD age is unlikely to have a meaningful impact on retirees who will be counting on retirement account withdrawals to meet living expenses, it does provide planning opportunities for those who can delay such withdrawals. In these cases, the later RMD start date may allow for a few more years of Roth conversions designed to hedge against future tax rate increases and reduce future required withdrawals.
The penalty for withdrawing less than the RMD amount has also been favorably altered under the new law. SECURE 2.0 reduces the penalty from 50% of the shortfall to 25% and allows for a further reduction in the penalty to 10% if the shortfall is corrected before the earliest of the date a Notice of Deficiency is mailed to the account owner, the date the additional tax is assessed by the IRS, or the last day of the second tax year after the additional tax was imposed. It will still be possible to request full abatement of the penalty from the IRS, but this new provision offers an incentive for taxpayers to simply correct the issue as soon as it is recognized that an RMD fell short.
n another RMD-related provision, SECURE 2.0 now allows for surviving spouses to consider a third way to handle inherited retirement accounts. Existing rules allowed spouse beneficiaries to treat the deceased spouse’s IRA as their own or to treat the account as an inherited IRA. The latter option allowed surviving spouses to delay the start of RMDs until the deceased spouse would have reached RMD age. For survivors who are older than their spouse, this approach allowed for RMDs to be deferred. Once the deceased spouse’s RMD age is reached, the survivor then has the option to transfer the inherited IRA into their own IRA. Starting in 2024, surviving spouses will have the additional choice to be treated as if they were the deceased spouse. This would also delay RMDs until the deceased spouse would have reached RMD age and the RMDs, once needed, would be computed using the Uniform Lifetime Table rather than the Single Life Table that applies to non-spouse beneficiaries. This will result in smaller RMDs. Further, if the surviving spouse dies before reaching RMD age, the beneficiaries will be treated as if they were the original account beneficiaries allowing “Eligible Designated Beneficiaries” to stretch withdrawals over their life expectancy rather than being stuck with SECURE 1.0’s ten-year withdrawal rule.