Hosted by Kevin J. Zywna, CFP® and Allison K. Dubreuil, CFP®
Allison Dubreuil, Wealthway Financial Advisors: We wanted to start to address some of the Secure Act 2.0 changes that came our way at the very end of last year some take effect immediately this year. Some take effect down the road. I think there were over 100 provisions in this act. And a lot of them are still very much up to interpretation. But we do want to talk about a couple of them that affect current retirees’ retirement accounts, and some tax breaks so that you can see which ones might impact you personally.
Kevin Zywna, Wealthway Financial: Yes, one of the largest pieces of legislation that has impacted personal financial planning and retirement planning in a long time is the Secure Act 2.0. It is voluminous in its provisions. We are not going to attempt to tackle them all tonight, but we’ve combed through most of them and brought with us today, the ones that we think are most relevant to most of our listeners.
Allison Dubreuil, Wealthway Financial Advisors: So, supporters of this legislation say that they’re designed to encourage more people to save more for retirement. Of course, there are others that have expressed concern that some of it’s not going to really impact a lot of people. It’s geared towards higher income earners. We’re not going to debate the law, the law is upon us. And so, we’re just going to give you some insight into the mechanics and what you need to do or what you need to change going forward.
Kevin Zywna, Wealthway Financial: Know what no matter whatever law change there is, there’s always somebody who’s saying it benefits high income people disproportionately, which is very rarely ever true. They come out of the woodwork whenever there’s a change.
Required Minimum Distribution Changes
Allison Dubreuil, Wealthway Financial Advisors: So, the big change that we are getting questions about is the change to the required minimum distribution. So, if you don’t know about required minimum distributions, they state that once you reach a certain age, you have to start withdrawing money from your tax sheltered retirement accounts. Essentially, the IRS or the government can start getting their tax revenue on funds that you have been deferring from tax. So up until this point, the age was 70 and a half, then with the Secure Act 1.0, it changed to age 72. Now with Secure Act 2.0, you don’t have to start taking required minimum distributions until age 73, unless you’ve already been taking them. If you have already been taking required minimum distributions, you just have to keep doing it. But if you are under age 73, you don’t have to start. So that’s one benefit.
Kevin Zywna, Wealthway Financial: What about people who turned 72 this year?
Allison Dubreuil, Wealthway Financial Advisors: Yes, good question. So, we had a bunch of clients that were all geared up and ready to have to start this and they had their plans in place. So, know, if you turn 72, this year, you do not have to take your distribution, you can wait until the year you turn 73 or next year. Then this age is actually going to move out again in the future, just to make it more confusing. Once we reach, I think 2025 or 2024, the RMD will move out even further. So, we’ll just focus on this year. And this year, you don’t have to start taking required minimum distributions until age 73. First question, let’s start with how much is the RMD?
Kevin Zywna, Wealthway Financial: So usually, the starting point of your required minimum distributions from your traditional IRA accounts and 401Ks and 403Bs, and TSPs. All those retirement savings plans that you received a tax break on the way in, now you have to pull a certain amount of money out, to claim it as income on your taxes, and then pay the appropriate amount of tax on it. So, it usually starts out about 3.6% of your previous year ending account balance. So usually a relatively nominal amount, but that percentage creeps up a little bit every year the older you get. It’s based on life expectancy. So, the older you get, the greater that percentage becomes. And it is still officially up to the taxpayer in order to determine how much comes out and that it does come out. But nowadays with technology, a lot of custodians, the companies that house your IRA – be it a bank or brokerage company or mutual fund company, have pretty well locked that in so that they are sending you notices well in advance that tell you the dollar amount that you have to take out and reminding you that it must be taken out before the end of the calendar year.
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What To Do With Your Required Minimum Distribution
Allison Dubreuil, Wealthway Financial Advisors: And so, once you determine if you have to take something out, then your options are pretty much threefold. You can take it into your bank and spend it. You can use it to live on – which a lot of people need to do. If you don’t need it to live on, then you could reinvest it. So, it can’t stay in the tax protected wrapper of the IRA or 401K, but you could reinvest it into a brokerage account that can be invested for growth and used for future spending. Or the third option with your required minimum distribution is you can donate it if you don’t need it. Or if you are charitably inclined and you usually make donations anyway, then donating directly from your IRA or 401 K is a way to make your donations more tax efficiently because then it will be completely excluded from taxable income. So, your three options, once you have to start taking required minimum distributions, are: spend it, reinvest it, or donate it, but don’t miss it.
Kevin Zywna, Wealthway Financial: Right because if you don’t take it, then you’ve got a tax penalty on your hands. Now that’s one of the things that’s changing as well with Secure Act 2.0. Currently, it’s onerous if you fail to take your required minimum distribution the penalty is 50% of what should have come out of your tax protected IRAs and 401Ks and so forth. So, if you were supposed to take out $10,000, failed to do it, your tax penalty is $5,000. That’s painful. That is now being reduced, though, from 50% to 25% of the amount you should have taken out. Still aggressive, but not as bad as 50%. And eventually, over the next several years, it’s going to be reduced to 10%. Which is relatively nominal at that point.
Allison Dubreuil, Wealthway Financial Advisors: Yes, there’s a 10% penalty if you miss it, but rectify the situation within two years. It says in a quick timeframe or something like that. And that’s two years. Timely manner. That they define as two years. Which I think is kind of funny. That’s the beat of the IRS, I guess. But hopefully you have an advisor that’s managing this for you, or a custodian that is alerting you to this. Hopefully this is not going to be a surprise and you won’t have any trouble with penalties.
Kevin Zywna, Wealthway Financial: Alright, we’re talking about Secure Act 2.0 and some of the provisions that may apply to our listeners. We’re talking about Secure Act 2.0 and some of the provisions that may be relevant to you. There have been some modifications and enhancements to help make saving for retirement a little bit easier.
New Provision Allowing An Early Emergency Distribution From Your Retirement Account Without Penalty
Allison Dubreuil, Wealthway Financial Advisors: The first one we talked about was required minimum distributions or the delay of them. So now you don’t have to start required minimum distributions until age 73. So that can help people keep more of their money invested and savings vehicles. One of the other new provisions beginning next year is that you’re now going to be allowed to take an early “emergency distribution” from your retirement account to cover unforeseeable or immediate financial needs. That can be a distribution of up to $1,000, that can only be taken once during the calendar year. And you’re not subject to the usual 10% penalty that normally applies if you take money out of a retirement account before age 59 and a half. But if you don’t repay it, then you’re not allowed to do another one of these emergency distributions for three years.
Kevin Zywna, Wealthway Financial: Yes, this falls squarely under the heading just because you can doesn’t mean you should. So yes, you can withdraw $1,000 in a year for an emergency situation from your retirement fund. But your retirement fund is probably one of the last places you want to withdraw from for an emergency situation. That is a short term withdrawal of a relatively small amount of money. That’s what your emergency fund is for. And that’s one of the basic foundational pillars of a good financial plan is to start by having an emergency fund – roughly defined as somewhere between three to six months of your household expenses. So that’s what your emergency fund is for. If for some reason that was all exhausted and you didn’t have a credit card with $1,000 limit for a short term need, then I suppose, as a last resort, a retirement plan could help bail you out. But we also know from real world practical life experience that once people start dipping into those retirement funds, they rarely get them back in time. And it can create some snowball effects with fines, fees, and taxes. And really retirement funds are for retirement, not for emergencies.
Allison Dubreuil, Wealthway Financial Advisors: Yes, just really puts you behind the eight ball if you start withdrawing from those accounts. You’re limited in how much you can put in each year anyway. And for most people, it’s a stretch to get as much in there as possible. So, withdrawing it is just really setting you back. So, there are other reasons that have existed before this new law that would allow you to make a withdrawal from a retirement plan without penalty. And that can be in case of a disability. I mean, that might be a valid reason, things like a first time home purchase, is allowed. If you have some certain medical bills. So, there are some exceptions. But again, it still should be your last resort, if you do your planning right with the emergency fund. And then, of course, short term debt to kind of bridge the gap there. All right. So, we’ve already established emergency expenses from your 401K. Not a good idea.
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New Provision Expands Automatic Enrollment Into Retirement Savings Plan
Automatic enrollment is a good idea. So, this new law provision expands automatic enrollment. What automatic enrollment means is that if you go to work for an employer, they can automatically enroll you in the 401K plan at a certain amount. And then they can automatically increase your contributions very slightly each year, so that you start saving, and then you increase your savings gradually over the years. Now, you can opt out of any of this. This is not mandatory, but it has shown to have some success in getting people saving. Just like ripping the band aid off, just do it right away.
Kevin Zywna, Wealthway Financial: Yes, it’ll be mandatory for the employer to set up, according to the plan documents. But it will not be mandatory for the employee to have to accept it. So, like Allison said, the employee can opt out of the automatic enrollment and the automatic increases. But to that, we would say, the biggest impediment to people saving anything for retirement or enough for retirement is just the inertia of getting started and getting into the habit of saving. So, this will force the habit upon a majority of the American workforce. And we know also from professional experiences, once you get the ball rolling, once you start the habit, once you get used to dealing without that 3% of your paycheck going into a retirement fund. And once you see some critical mass start to build up in that fund that you get excited about. Then good financial habits start to take over. And pretty soon, you’re a lot further along and saving for retirement than you ever expected to be, and you otherwise would be, left to your own devices.
Allison Dubreuil, Wealthway Financial Advisors: Yes. So, we say rip the band aid off. Don’t wait until you have the extra money. You’ll never have the extra money. Get enrolled right away and accept those automatic increases this year and each year. If you don’t have automatic increases, maybe you put one in yourself each year. You’re going to go up 1% and watch your account balance grow. So, any savings is good savings. It’s never too late to start. Try to max out your 401Ks, or your TSP, 403B’s, or any retirement plan whenever you have the opportunity.
Kevin Zywna, Wealthway Financial: Yes, so we’ll talk about some of the increases in the amount that you can contribute to – those company sponsored retirement plans and also some of the catch-up provision. For people who are age 50 and older you can contribute higher amounts than the regular federal amounts that the rest of us are subject to.
Required Minimum Distribution Changes Based On Age Clarified
We’re going to go out to Virginia Beach and speak with Beverly. Good evening, Beverly, you’re on Dollars & Common Sense.
Caller: I just turned 72 last month on Christmas Eve, and I didn’t know I could wait till 73. So, I guess no regrets. I’ve already requested to receive my first required minimum distribution, and they’re going to be mailing it to me – that’s for 2022. And then I guess, later this year, they’ll send me another one for this year. So did I make a mistake is my question.
Allison Dubreuil, Wealthway Financial Advisors: Because you just turned 72 in 2022. Is that what you said? Beverly? And you still were subject to the required minimum distribution rules that applied in 2022? I don’t think you made a mistake.
Caller: That’s what I was worried about when I heard you said you could wait until you’re 73.
Allison Dubreuil, Wealthway Financial Advisors: Yes, starting in 2023. So, anyone that had to take their distributions last year, in 2022, they still had to take it and they will have to take it every year going forward. So, I think you did exactly right.
Caller: Good. Okay. Is it too late for me, at my age, to convert that to a Roth?
Allison Dubreuil, Wealthway Financial Advisors: Well, good question. So, what were you hoping to accomplish with converting to a Roth?
Caller: Well, because I don’t see taxes going down in the near future. I don’t have to be psychic to know that. I just thought that. I don’t know, depending on how much they’d clobber me for taxes it might be smart to do it. You pay now or you pay later. And I just thought my reasoning was to do that now and then just have another bucket of tax free, later on. I do already have one Roth, which was Charles Schwab. But I like Roth. I’d rather just get things done now and not worry about it later.
Allison Dubreuil, Wealthway Financial Advisors: Okay? Well, you’re not too old, how it would work, if you wanted to do a conversion is first you would have to take your required minimum distribution that cannot be converted. But once you satisfy your required minimum distribution, then you can do a conversion. So, the money after the required minimum distribution that comes out of the IRA would could go right into a Roth IRA, you’d pay tax on it. But once in the Roth, like you said, it would grow tax free. It does require a little bit of analysis. We do a lot of in depth analysis on Roth conversions to see whether they make sense and it does take some time to recoup the money that you’re essentially pre paying on taxes. We usually don’t find people break even or make up that prepayment of taxes until late in their 80s. So that’s just something to consider as well, whether that would make sense to you, or you would actually see the benefit of that down the line.
Caller: Time is not on my side right now.
Allison Dubreuil, Wealthway Financial Advisors: Well, it could be. Statistically, we’re living longer. You could have 20-30 years, hopefully.
Caller: I’m grateful that I did the other Roth with Charles Schwab some time ago. And I’m not touching that. I just retired actually, June of last year, too. And I have no debt. I paid off my mortgage the same month. So, I’m debt free. And right now, I’m basically living on my social security and my rental income that I have. So, I haven’t touched any of my investment yet. So, I guess I’ll just stay the course.
Kevin Zywna, Wealthway Financial: Right. Well, thank you. Thanks for the call. Beverly, we appreciate it. It’s good insight and perspective. And so, a couple clarifying points there. When it comes to a Roth conversion, it depends on the amount that you’re going to convert to. While you may think taxes are as low as they’re going to be. If the amount of conversion is large enough, that’s everything that comes out in the conversion process is going to be taxed as ordinary income, which is at the highest rates that exist in the tax code. And there are brackets to those rates. So too much of a conversion runs you up the ladder, they call it and then instead of getting taxed at the 20% bracket, you could be taxed at the 25 or the 28 and the 32, and so forth, up to like the unbelievable 38%. So anyway, the amount that you convert has as a bearing on two because the more you convert, in any given one year, the higher the rates are going to be. So that’s something to be mindful of. Thanks for the call. We appreciate it.
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New Provision Increases Catch-Up Contribution Amounts To Retirement Savings Plan
Allison Dubreuil, Wealthway Financial Advisors: We’ve been talking about Secure Act 2.0 updates. There are over 100 provisions, but we’re just highlighting a few that will impact a lot of people. So, we’ve talked about required minimum distributions. We’ve talked about emergency loans from 401Ks, which are not a good idea. Automatic enrollment. One of the good changes is the increase to contribution catch-ups. So, if you are contributing to your 401K or TSP or 403B, or any employer sponsored retirement plan, and you’re over the age of 50, you’re allowed to make extra catch-up contributions and they increased the amount of the catch-up so everyone can contribute $22,500. But if you’re over 50, you can contribute an additional $7,500 to your retirement plan. So that’s a pretty good amount and then the new law also provides for that to increase even further once you reach age 60. That’s supposed to go up to $10,000 in a couple of years. So, know that if you’re over 50, you can put extra amounts in your retirement plans, you can also put extra amount in your IRAs and Roth IRAs. We would encourage you to try to do that if you have the ability.
Kevin Zywna, Wealthway Financial: Beginning in year 2025, is when the increase in the catch-up provision will go from $7,500 a year right now, to $10,000 a year in 2025. I think it’s going to be indexed for inflation beyond that, so every year, they’ll probably be a little bit of increase right now, total amount $30,000, between the regular contribution limit and the catch-up. That’s when people would start making real headway. If you can get to that number, especially the younger you are. And the sooner you can get to the maximum contribution limits, the better off you are going to be long term for retirement savings. But if you waited, started late, and you’re just ramping up, hopefully, most people their highest earning years are among their latest working years. So, if you’re in your 50s, and your 60s, probably at peak earning, that’s the time to start shoveling in the maximum amount to those company sponsored retirement plans. So, you can make sure you have a nice, comfy, secure retirement.
Allison Dubreuil, Wealthway Financial Advisors: One little caveat, well, I shouldn’t say one, there are so many caveats with this. A caveat is now there are going to be income limits for these catch-up provisions. If you make more than $145,000 a year, then it’s not that you can’t make the catch-up provision, but it will have to be after tax dollars. So, you’ll have to pay tax on the money and then it can go into the retirement plan as Roth, which means it will be tax free going forward. So, it’s not the worst thing in the world to build that Roth bucket like Beverly was saying. It’s a good idea to have some money that’s tax free going forward, but it probably is going to be taxed at the high a higher tax rate if you’re earning over $145,000. So, something to be aware of. Many people aren’t even aware that if they are contributing Roth dollars, so if you’re doing after tax dollars to your 401K, your employer is going to be matching in pretax. So there’s oftentimes a combination of pretax money and after tax money in your 401K. And that’s not necessarily a bad thing, you just want to keep track of it.
Kevin Zywna, Wealthway Financial: To interject here, throughout all of this, a lot of the tax provisions relating to retirement savings, already were kind of irregular and not lined up, not symmetrical. Things have become more complicated with this Secure Act 2.0. So, it’s going to be much more difficult for the average person to stay up on top of all the nuances, all the unique sort of provisions of the code in order to take full advantage of it. So, you got your work cut out for you if you want to do it yourself. But eventually, professionals like us will get this stuff locked down, built into our computer systems, our modeling, and then we’ll take a lot of the guesswork out for you. So, you do maximize all your opportunities. Just be aware of that going forward.
New Database Where You Can Search For Lost Retirement Savings
Allison Dubreuil, Wealthway Financial Advisors: We’ve been talking about 401K plans and company sponsored retirement accounts. And before we leave that topic, I did want to bring up one other new provision. There’s going to be a new database where you can search for lost retirement savings. Now, I don’t know how someone loses retirement savings.
Kevin Zywna, Wealthway Financial: It happens all the time.
Allison Dubreuil, Wealthway Financial Advisors: So, there will now be a database that you can try to find your last savings. But let’s talk about that. So, I guess you would have to leave a job and just kind of leave that money sitting there and not do anything with it, and then forget about it. And then all of a sudden, you’re like, ‘where’s my money?’
Kevin Zywna, Wealthway Financial: I think a lot of them are small amounts. Usually less than $5,000. In a retirement plan, people don’t think it’s really enough to make a dent, they just kind of leave it behind. A lot of times $5,000 is the minimum threshold where a plan provider, your company will say, ‘look, if my employee hasn’t claimed this money, they haven’t rolled it over, they haven’t withdrawn it. It’s still sitting there after two years, then we don’t want that on our books. That costs us money, we’re going to push it out of the plan.’ Usually, they send it to another 401K plan provider who then fees it to death. And you’re getting like $25 fee every month, and it just gets churned up to nothing. But if it didn’t go to one of those and is truly abandoned, then there is going to be a new database to help you find your money.
Allison Dubreuil, Wealthway Financial Advisors: When you leave an employer, we always recommend continuing to consolidate. We think fewer buckets are better. It’s more efficient, it’s more effective, and you can manage it and keep track of it. We recommend that when you leave employment that you do something with the 401K. You can move it into maybe your new employers 401K. (If they let you do that.) You can roll it into an IRA that you manage. And so, each time you leave a job, you just keep moving it into an IRA. Your IRA builds up over the years. The third is under the ‘just because you can do it doesn’t mean you should’ category. You can cash it in. A lot of people just do that if it’s $1,000 – $2,000 and pay the tax and the penalty – 10% penalty and income tax on that money. You’re not going to put that money back in. You’re just getting more behind the eight ball. Even if it’s a small amount. It’s something. We would recommend keeping it and trying to consolidate over the years. All right, so I think we covered most of the 401K provisions that are relevant at this point. Really quickly, I did want to touch on a 529 update. 529 accounts are college savings plans where you can put money in. In Virginia, if you use the Virginia Plan, you get a state tax deduction for contributions, the bonds grow tax deferred, and then if used for college expenses, on the other end, the money comes out tax free. But what if you have too much in your college account? And you don’t need it all? Or what if your student doesn’t go to college and pursues other paths?
Kevin Zywna, Wealthway Financial: Or they get a scholarship or work study. Means you didn’t spend as much as you thought you would.
Allison Dubreuil, Wealthway Financial Advisors: Right, all the things that could happen. Now you have the option of moving the funds into a Roth IRA. So, there are rules and restrictions around it. It’s a little bit complicated. We probably won’t go into that just now. But know that if you have extra money in a 529 that you don’t need for college, you can move some of it, up to $35,000, into a Roth IRA that will stay pretax protected and will be tax free in retirement for the beneficiary. That’s a nice gift for a young person.
Kevin Zywna, Wealthway Financial: The key is it has to be in the name of the beneficiary and the beneficiaries. Typically, your child who was going to college or any institution of higher learning that qualifies for 529, doesn’t have to be college. But it’s typically the child who’s the beneficiary, which means it needs to go in a Roth IRA, in the name of the child. But the big hitch here is that the 529 plan has to have been open for 15 years or more.
Allison Dubreuil, Wealthway Financial Advisors: So you pretty want to open the 529 plan when the child is born. You just start the clock; you don’t even have to put anything in.
Kevin Zywna, Wealthway Financial: Put in 100 bucks, just to get the clock ticking.
Allison Dubreuil, Wealthway Financial Advisors: Then you have the option. Then you threaten them that they cannot use that money or touch that money until retirement, and it doesn’t even exist to them.
Kevin Zywna, Wealthway Financial: That’s a good point. Know that the parent is typically the owner of the 529 plan, which means they have control. But the owner of the Roth IRA would be your child. Who’s hopefully at 23-24 and at that point in time, but then it gets out of your parents’ control and moves into the child’s control at an impressionable desperate age for money. So, you have influence. You have to keep close tabs on it.
Allison Dubreuil, Wealthway Financial Advisors: That’s all the time we have for Secure Act 2.0. There will be more coming out I’m sure about that.
Kevin J. Zywna, CFP®