Secure Act 2.0 and Your Retirement Plan

The House passed the Secure Act 2.0 earlier this year on a nearly unanimous vote. This important bill was tucked inside the 4,000-page $1.7 Trillion (with a T) “omnibus” spending bill from Congress and it directly affects your retirement plan.

The government has taken notice many Americans are unprepared for retirement. According to one study, by 2050 Americans face a $137 trillion retirement income gap (the difference between what savers should have and what they’ve actually saved). However, an underfunded retirement isn’t an issue isolated to Americans. Retirees in six major economies, including the United States, might outlive their retirement savings by an average of eight to twenty years if estimates hold true.

To ensure you have sufficient savings, you need to know some of the rules that govern retirement plans. Plan your retirement savings strategy well into the future by being aware of the laws that are in place today and how they may change in the future.

The Secure Act 2.0 is built on the back of the original Secure Act, and brings with it some important changes and updates. Before we dive into the details of Secure Act 2.0, here’s a quick refresher on the original law.

Secure Act 1.0 is Now in Effect

The Setting Every Community Up for Retirement Enhancement Act (SECURE ACT) became law in December 2019 and was an important piece of legislature for the retirement landscape. The purpose of the Secure Act was to strengthen the nation’s retirement system and was intended to make small adjustments to the rules governing retirement accounts. The hope is that access to retirement plans improves, and that this access might help address the retirement crisis.

Notable features of the original Secure Act included:

• Increasing  RMD age from age 70½ to age 72
• Removal of Stretch IRAs (Inherited IRA)
• Required inclusion of some part-time employees in retirement plans (this affects Solo 401k qualification)
• Ability to withdraw funds for birth & adoption expenses

What Secure Act 2.0 Means for Your Solo 401k

There are many changes in Secure Act 2.0, most of them beneficial if you have a Solo 401k plan or are considering setting up a Solo 401k for your small business. Because the government is concerned with the current state of retirement savings, they’ll do whatever to incentivize you on saving more. This might mean allowing you to put more money away, or continuing growing your money by keeping it in the retirement plan for longer.

The passing of Secure Act 2.0 hopes to bring greater access to retirement plans for employees, but also greatly benefits small business owners, solopreneurs, and freelancers. There are some notable updates to Secure Act 2.0.

Increase RMD Age

As established by the original 2019 SECURE Act, required minimum distributions (“RMDs”) generally must begin by age 72. Before the passage of the original Secure Act (prior to January 1, 2020), the age at which RMDs were required to begin was 70½.

Secure Act 2.0 has upped the RMD age again. Starting in 2023, you don’t have to take Required Minimum Distributions (RMDs) until you hit age 73. That means your money can grow in a tax-deferred structure like an IRA or 401k for longer. This can yield more retirement savings because it gives your investments more time to grow and compound.

Under Secure Act 2.0, RMDs increase to:

• 73 for a person who attains age 72 after December 31, 2022 and age 73 before January 1, 2033, and
• 75 for an individual who attains age 74 after December 31, 2032.

Effective for distributions made after December 31, 2022, for individuals who attain age 72 after that date. Make sure you’re working closely with your CPA if you’ll hit the RMD date soon to determine your exact RMD beginning date.

Bigger Catch-up Contributions

Catch-up contributions are a way for you to contribute more money to your IRA or 401k plan as you age. Currently, anyone age 50 and over can make catch-up contributions, and usually the annual catch-up contribution limits are indexed for inflation.

If you’re age 50 or older, you can still make the standard catch-up contribution to your Solo 401k plan. Starting in 2025, you can contribute $10,000 if you’re age 60-63. Congress wants to incentivize you to save more so you are less financially dependent on their programs.

You can put an extra $6,500 in your 401k if you’re age 50 or older. The catch-up contribution limit is effective for taxable years beginning after December 31, 2024.

Secure Act 2.0: Withdraw $1,000 Penalty Free

Currently it’s tough to get funds out of your retirement plan without paying a penalty. If you have an IRA, the only way to get access to your retirement funds is via a distribution. Current law imposes a 10% penalty on early withdrawals before normal retirement age from tax-preferred retirement accounts.

If you have a Solo 401k plan, you can take a participant loan, but you may want to have an alternative to access your funds.

The Secure Act 2.0 allows a one penalty-free withdrawal of up to $1,000 per year for “unforeseeable or immediate financial needs relating to personal or family emergency expenses.” This withdrawal would not be subject to the 10% early withdrawal penalty.

The withdrawal needs to be repaid within three years and you can only make one withdrawal per three-year repayment period if the first withdrawal has not been repaid. In other words, it’s like a very small participant loan with a shorter repayment period.

The $1,000 penalty free is eligible for distributions made after December 31, 2023.

Tighter Solo 401k Qualifications

The current Secure Act stipulates that if your business must offer participation in your company 401k plan if your business has a part-time employee who’s:

• Worked at least 500 hours per year for at least three consecutive years and
• has met the minimum age requirement (age 21) by the end of the three-consecutive-year period.

This affected some small business owner who otherwise would have qualified for a Solo 401k plan and needed to determine how they were going to move forward with their business.

The Secure Act 2.0 shortens that timeline from 3-consecutive years to 2-consecutive years. Therefore, part-time workers might be eligible to participate in a company 401k plan sooner. This is important to consider if you’re a small business owner who may have part-time employees.

The Secure Act 2.0 provision would generally effective for plan years beginning after December 31, 2024.

Bottom line – if your business has had the same part-time employee(s) for 2+ years – you no longer qualify for a Solo 401k. But, all is not lost. If possible, you might be able to reconfigure your business structure. Especially in today’s “gig economy” many business owners might consider hiring a contractor instead of an employee to grow your business. Bonus: your contractors then become eligible for their own Solo 401k as well.

More Lenient Prohibited Transaction Rules for IRAs

Historically, prohibited transactions in an IRA could be catastrophic. If an IRA owner or beneficiary was found to have engaged in a prohibited transaction with respect to the IRA, the IRA would lose its tax-favored status. That means it ceases to be an IRA as of the first day of the taxable year in which the prohibited transaction occurs.

In other words, the IRA is treated as distributing to the individual on the first day of that taxable year the fair market value of all of the assets in the account.

The Secure Act 2.0 updates stipulate that in this same instance, each IRA of the individual shall be treated as a separate contract. That could mean if you have multiple IRAs and commit a prohibited transaction inside one IRA account, the remainder might not need to be completely distributed.

Secure Act 2.0: No More RMDs for Roth 401ks

This is a landmark element of Secure Act 2.0. Under current laws, an investor must begin taking Required Minimum Distributions (RMDs), even in a Roth 401k plan. Investors have long thought this to make little sense, since the Roth 401k funds can ultimately be withdrawn tax-free, if the funds have sat in the Roth 401k for 5+ years and the plan participant is above age 59.5.

To avoid an RMD on a Roth 401k, many investors elected to move money out of their Roth 401k to a Roth IRA. With the passing of Secure Act 2.0, an investor may elect to leave funds in the designated Roth 401k account so those funds can continue to grow without getting hit by RMDs. This is especially powerful for investors hoping to utilize the mega backdoor Roth strategy!

Conclusion

Remember that 401ks were originally designed to be employee benefit plans to ensure economic stability for Americans in your golden years. With the looming retirement crisis, it makes sense Congress will do what they can to incentivize savers to increase their savings now. Understandably, many of the SECURE Act 2.0 provisions are geared toward benefitting you in your 60s, 70s, and beyond. But no matter your age, this still matters to you now. Make a plan to grow your retirement wealth, so you can happily live out your golden years with financial security.