401(k) and IRA changes after a retirement law overhaul

Key takeaways:

• The Secure 2.0 Act, introduced in 2022, brought numerous changes to 401(k) and IRA rules, impacting retirement savings strategies.
• Required Minimum Distribution (RMD) ages have been increased, with new rules for beneficiaries and reduced penalties for missed RMDs.
• New provisions allow for higher retirement plan contributions, including larger catch-up contributions and inflation adjustments for IRA limits.
• The new law adds more penalty-free exceptions for 401(k) early withdrawals, including emergency expenses.
• Small employers now have more incentives to offer retirement plans, with tax credits and automatic enrollment options to encourage savings.

The IRS has released its final regulations regarding retirement plans and IRA Required Minimum Distributions (RMDs). Changes to 401(k) and IRA rules could significantly impact your retirement savings and overall financial strategy. It’s time to reassess your plan to ensure you’re maximizing your benefits. 

In December 2022, President Biden signed the Secure 2.0 Act, a bipartisan law introducing numerous changes to retirement policy. The Act is part of the Secure 2.0 initiative, aimed at reshaping retirement savings, incentivizing employer contributions, and rewarding personal contributions to retirement accounts. This article summarizes some of the critical changes you need to be aware of for your retirement planning, regardless of your age.

There are three types of beneficiaries under the RMD rules, each with different requirements:

1. Eligible Designated Beneficiary: Includes the Participant’s spouse, minor child (under 21), disabled or chronically ill individuals, or someone not more than 10 years younger (e.g., a sibling).
   • If the Participant died before their Required Beginning Date, they can either base RMDs on their own life expectancy or take the full amount within 10 years
   • If the Participant died after their Required Beginning Date, RMDs are based on the longer of their own or the Participant’s life expectancy
2. Non-Eligible Designated Beneficiary: Includes individuals who do not qualify as an Eligible Designated Beneficiary (e.g., non-spouse beneficiaries or those more than 10 years younger).
   • If the Participant died before their Required Beginning Date, the beneficiary must take the entire amount within 10 years, with no annual RMDs required
   • If the Participant died after their Required Beginning Date, the beneficiary must take annual RMDs for the first nine years and distribute the full amount by the 10th year (starting in 2025)

3. Non-Designated Beneficiary: Includes non-individual entities like estates or charities, or individuals not designated under the plan.
   • Must take the entire amount within five years of the Participant’s death.

Key changes to RMD rules for Non-Eligible Beneficiaries and surviving spouses

Non-Eligible Designated Beneficiaries

The most significant change in the regulations concerns Non-Eligible Designated Beneficiaries—individuals who aren’t spouses, minor children, disabled or chronically ill individuals, or those within 10 years of the participant’s age. 

If a participant dies after starting their required minimum distributions (RMDs), beneficiaries must now follow a stricter rule. Starting in 2025, they will need to take annual RMDs for the first nine years of the 10-year distribution period. Previously, they could wait to withdraw the entire account balance in the 10th year, but doing so could create a large tax bill since the entire amount would be taxed in that year. The new requirement spreads out distributions over nine years, potentially reducing tax burdens by avoiding a large, lump-sum withdrawal in year 10.

For Non-Designated Beneficiaries (like an estate or charity), the rule remains that they must withdraw the entire balance by the end of the fifth year after the participant’s death.

What you need to do: Participants must formally designate beneficiaries for their retirement accounts. Failing to do so could lead to less-favorable distribution rules, like the five-year rule for Non-Designated Beneficiaries.

Surviving spouses

Surviving spouses who are sole beneficiaries can transfer the funds to their own IRA and use their own life expectancy for RMDs. If the IRA owner dies on or after the RMD start date, the spouse has the option to either treat the IRA as his or her own (distributed across his or her own life expectancy table) or continue using the original owner’s expected lifespan. If the participant dies prior to starting RMDs, the spouse can treat the IRA as his or her own and take the entire balance by the fifth year following the death, or use his or her own life expectancy table (beginning after the deceased owner would’ve turned age 70.5). 

Rules on taking money out and getting lifetime payouts 

• Starting in 2023, the RMD age increased from 72 to 73 and will rise again to 75 on January 1, 2033. The IRS has extended transition relief for RMDs in response to Secure 2.0. IRA owners turning 72 in 2024 will have a required beginning date of April 1, 2026, instead of April 1, 2025. Applicable ages:
  • Born before July 1, 1949: 70 ½ 
  • Born on or after July 1, 1949, but before 1951: 72
  • Born between 1951 through 1959: 73
  • Born after 1959: 75
• The penalty for missed RMDs has decreased from 50% to 25%, or 10% if corrected within two years.
• Withdrawing money from 401(k)s or other pre-tax retirement accounts before age 59 ½ historically incurred a 10% penalty. The legislation includes new exceptions and enhances previous ones, including allowing anyone with a personal or family emergency to withdraw up to $1,000 penalty-free.

Rules to encourage savings

• Workers will be enrolled into newly created 401(k) and 403(b) plans in 2025 automatically, with some exceptions for small businesses. The savings rate will begin at between 3-10% of their pay scale, increasing by 1% each year until it reaches 10-15%. 
• Employers can now set up rainy-day emergency savings accounts within 401(k) plans. Non-highly compensated employees can automatically allocate a percentage of their income (up to $2,500) to pay for emergency expenditures, benefiting from tax- and penalty-free withdrawals.
• From 2027, the government will contribute $1,000 each year to eligible retirement accounts to encourage low- to moderate-income workers to save for retirement. 
• Subject to income limits and phase-outs, the Secure 2.0 Act will replace the nonrefundable Saver’s Credit. A federal matching contribution will be deposited directly into your IRA or retirement plans.
• Employers can now hand out a small gift card or cash payment to encourage employees to sign up for and regularly contribute to a 401(k)-type retirement plan. 
• Employers can now offer Roth matching contributions into an employee’s 401(k) account instead of just accounts set up on a pretax basis. 

READ MORE: IRA to Roth conversion: Should you change your retirement plan this year? 

Increase in retirement plan contributions

Retirement savings vehicles, such as IRAs and 401(k) plans, got inflation-adjusted contribution limits for the first time in 2023. Click here to view the latest retirement contribution limits. Secure 2.0 includes several other provisions to increase contribution limits in the coming years, for example:

• Starting in 2025, those aged 60-63 will be eligible for a larger catch-up contribution. 
• IRA catch-up contributions are now indexed to inflation, raising the existing $1,000 cap for the first time in over a decade. 
• A new, higher contribution cap linking 401(k) catch-up limits to inflation will apply to people between 60 and 63 beginning in 2025.

Lifetime income provisions

• With the IRA Charitable Rollover, IRA owners who are 70 ½ or older may take a one-time withdrawal of up to $50,000 to fund a charitable remainder trust or charitable gift annuity. From a tax perspective, the withdrawal doesn’t count as income and can count toward any RMD amount for the year. 
• The retirement legislation now enables more people to take advantage of deferred annuities in the form of qualified longevity annuity contracts (QLACs). 401(k) participants or IRA owners looking for guaranteed income in retirement could use up to $200,000 from their account to buy the annuity that would make guaranteed payments for life, an increase on the existing limitation of $145,000 or 25% of the retirement account balance. 

READ MORE: How secure is your retirement plan? 

Incentives for employers to offer retirement plans

Small employers that don’t currently offer retirement plans can take advantage of the small employer retirement plan startup tax credit. Depending on the number of eligible employees, the credit covers 100% of the initial costs (up to $5,000) for three years. 

An additional credit is available for five years to small employers that match employee contributions.

What about solo 401(k)s? 

Under the new law, self-employed individuals who want to establish an individual or solo 401(k) have until they file their tax return the following year to open and fund the account (as opposed to having to set it up by December 31).

Wondering if you have old retirement funds from a previous employer?

Please visit the link below to register with the National Registry of Unclaimed Retirement Benefits. You’d be surprised how easy it is to forget about funds you saved at an old job.

Let the professionals run your retirement plan 

Retirement saving should always be a top priority—you can’t borrow money to pay for retirement, so it’s essential to plan for the end of your working years. But with retirement plan rules changing frequently, it’s not always easy to keep track and optimize your plan accordingly. Please reach out to schedule a financial planning meeting with one of our professionals so that we can help you maximize your retirement benefits.