Over the next decade, the Secure 2.0 Act will change rules on when federal retirees must pull from their savings and how these withdrawals are calculated.
The law, which includes dozens of provisions, passed on Dec. 29 as part of the $1.7 trillion omnibus spending bill and is a consolidation of several bipartisan bills that build off a similar law from 2019. Taken together, the legislation is intended to make retirement planning easier and less penalty-ridden, according to lawmakers.
“The Finance Committee has worked in a bipartisan way to improve the retirement system, building on our success in 2019, and I’m pleased our legislation has been included in the year-end spending package,” said Sen. Ron Wyden, (D-Ore.), who previously chaired the Senate Finance Committee, in a Dec. 20 statement.
One of the provisions affects required minimum distributions, or mandatory annual withdrawals from tax-deferred savings accounts, like a traditional Thrift Savings Plan or IRA. Federal retirees, like retirees from the private sector, must withdraw portions of their savings each year.
“The policy behind this rule is to ensure that individuals spend their retirement savings during their lifetime and not use their retirement plans for estate planning purposes to transfer wealth to beneficiaries,” according to the bill text.
Prior law based how much an individual must withdraw as an RMD on the total balance of the traditional and Roth Thrift Savings Plan.
Because RMD percentages are based on the entire account instead of just the traditional TSP, retirees may deplete their savings faster by taking out a larger chunk, said Chris Kowalik, founder of ProFeds and a federal employee retirement benefits expert, in an interview.
That will change come 2024. The new law lifts the pre-death distribution requirement for Roth accounts in employer plans, like 401(k)s or the TSP.
That also helps build generational wealth, Kowalik said, because beneficiaries can leave the Roth account tax free to their children.
One-year delay for RMD withdrawals
The law also gives some retirees one year to delay mandatory withdrawals by raising the start age to 73 from 72 in 2023. The age to begin taking RMDs will increase again to age 75 in 2033.
If a retiree turned 72 before Jan. 1, that individual will continue taking RMDs as scheduled. But if the retiree turns 72 this year and has already scheduled the required withdrawal, he or she may want to consider updating their withdrawal plan, Fidelity Investments wrote in a blog post.
Kowalik cautioned that while this looks like good news, it only kicks the RMD can down the road. For some retirees taking out that money anyway to cope with the high cost of living, the change might be moot.
“This is just one more year they get to delay, but in reality, they’re probably going to take as much, if not more, out of their accounts even though they’re not told they have to,” she said. “Because they need the money to live on. Or to go have fun in retirement and go do the things they want to do.”
There’s another catch that Kowalik warned retirees to look out for.
RMDs are taxed when they are withdrawn. By pushing up the age of withdrawal, that’s one fewer year the government has to collect its due, she said.
If a retiree delays taking a distributions, Kowalik said there’s risk of compressing remaining withdrawals into fewer years.
“People who don’t plan could end up paying more in taxes because they have to withdraw more over a shorter period from accounts that had several more years to compound,” said Michael Hunsberger, owner of Next Mission Financial Planning, LLC, in an article for Wealthtender.
On the other hand, the new RMD rule gives the gift of more time to strategize retirement — for those who can afford to wait.
Earlier this month, the TSP, the primary retirement savings and investment plan for federal employees and service members, mailed updates to RMD calculations to those who will turn 73 or older this year.
Changes to withdrawal penalties and other highlights
The law also reduces the penalty for failing to take an RMD to 25% of the mandatory withdrawal, down from 50%. That penalty drops to 10% if the error is corrected in a “timely manner” for IRAs.
The Secure 2.0 Act also gives small businesses a tax credit if they open benefits up to military spouses, who legislators noted are often not employed long enough to be eligible for or vested in a company retirement plan. The law now grants small employers a tax break if they make military spouses immediately eligible for plan participation within two months of hire, offer them any matching or nonelective contribution they would normally be eligible for at two years of service, and make them 100% vested in all employer contributions.
The legislation also makes reference to high consumer prices in the last year and requires the secretaries of the departments of Labor and the Treasury to study the impact of inflation on retirement savings and submit a report to Congress within 90 days.
Other highlights of the law (a summary is here) include:
- Expanding automatic enrollment in retirement plans
- Higher catch-up contributions limit to apply at ages 60, 61, 62 and 63
- Penalty-free withdrawals for certain emergencies, cases of domestic abuse, qualified disasters and individuals with terminal illness
- First responders, such as law enforcement officers, firefighters, paramedics, and emergency medical technicians, can exclude from gross income certain service-related disability pension or annuity payments after they reach retirement
- A retirement savings lost-and-found online searchable database to be managed by the Department of Labor to help savers, who might have lost track of their pension or 401(k) plan, to search for the contact information of their plan administrator
