SECURE Act 2.0, RMDs, and Roth Conversions

A few years back we had the SECURE Act. Because I know you have no desire for me to rehash this legislation, I will instead just link the original article from roughly three years ago breaking down the highlights. 

Now, for some time Congress has been working on an update to this SECURE Act. The new one has creatively been titled SECURE Act 2.0. I told you it was creative. 

The current status of SECURE Act 2.0 is “in process.” It passed the House and will most likely pass the Senate yet this year (at least as I write this). Odds are the final version will change, however, I wanted to touch on a key portion of SECURE Act…The Sequel. 

Before we get there, let me hit on a couple of what I consider not to be the key items. 

First, there will be extra catch-ups allowed for employees age 62 through 64. Right now anyone 50 or over can contribute an extra $6,500 to their 401ks ($3,000 to SIMPLEs). This version of SECURE increases the 401k catch-up to $10,000. Again, only for when you are 62 through 64. Apparently 65 year olds all retire on the day before they turn 65 and are not allowed to contribute. I am not sure if they can continue to do the “traditional” catch-up of $6,500, but I am assuming they can. The higher catch-up for SIMPLE participants is $5,000. This is weird, however, it does allow you to put a bit more away. But, it gets weirder. 

One section of SECURE 2 requires all catch-ups to be made to Roth accounts. Yes, even if you are not doing a Roth 401k contribution right now you will be forced to. However, and this is the really weird part, not all employers even offer Roth 401k options right now. Not sure how this is going to happen, but this is where the language stands right now. Last data I saw (which is a few years old), showed 60% of employers have Roth 401k options. 

I am going to mention just a couple of other items before I get to the key part. These other items actually make quite a bit of sense. Both catch-up and QCD amounts would be indexed to inflation. Right now these are set regularly by the government and aren’t necessarily tied to inflation. Catch-ups refer to the $6,500 amount for those at least 50-years old I mentioned earlier. QCDs refer to Qualified Charitable Distributions. This is what I refer to as the Charitable RMD (Required Minimum Distribution). Right now, you can take up to $100,000 of RMD and do a QCD with it. Simply, you donate the RMD directly to the charity(ies) of your choice. Again, passage of this Act will change that maximum QCD amount annually based on inflation. 

There are a few other items in the proposed SECURE Act 2.0 that I am not going to address. Maybe I will once the legislation passes, but right now it is not the focus for my clients. With that, let’s get to the good stuff. Another change in RMD age. 

Again, RMD stands for Required Minimum Distribution. The simplest example is this is the age at which Uncle Sam says “Thanks for saving all your money in tax-deferred accounts (TDAs) all these years and not paying taxes. However, now is the time for you to take a minimum amount out and pay us our taxes. We don’t care what you do with the distribution after you pay your taxes, although spending it would help the economy.” Basically, the balances in your 401ks and Traditional IRAs now are going to be subjected to distributions based on their total values and your expected longevity. 

The first version of SECURE changed the RMD age from 70 ½ to 72. Not a big change. Even though we are less than three years from the passage of SECURE Act, this updated version would increase RMD age to 75. Technically it is phased in and the 75 RMD rule would only apply if you turn 70 in 2030 or later. 

This actually is kind of a nice change, at least in my opinion. You may be figuring it is because you get to delay paying taxes to Uncle Sam. Well, I think it is because you get to accelerate paying taxes to Uncle Sam. Stay with me. 

A common conversation I have with clients is once you are fully in retirement and are in RMD age (72 now), there are not a whole lot of basic places where we can minimize our tax bills. You know – try not to tip Uncle Sam. 

Let’s just imagine you have saved up $3 million in tax-deferred accounts (TDA). This isn’t just some arbitrary number either. It is the average client size within my practice. Regardless, you are now 80 and your RMDs may easily be $400,000 a year. Fully taxable. And then throw on some Social Security and/or taxable pension income on top of that. Suddenly you are in the 35% or 37% income tax bracket, even though you were never in that bracket during your working years. It is simply because you saved diligently and had some nice tax-deferred growth. Oh, we won’t even mention the top tax rate of 39.6% assuming the current income tax brackets do not get extended. 

So, if you follow conventional wisdom (which is what the average financial advisor does), you will wait until the last possible moment to start your RMDs. Yes, this keeps you from having to pay taxes sooner. Yes, it keeps the money in a tax-deferred state hopefully still growing. And, yes, it also keeps paying your old-school advisor who charges you under an archaic AUM (assets under management) method where they only get paid on assets they manage (notice that if you take money out of your accounts they get paid less – sounds like a conflict of interest to me). However, waiting can actually make things worse for you. 

I won’t get into the details here, but study after study shows for those retirees who have sizable tax-deferred accounts it makes more sense to take money out of these tax-deferred accounts earlier than RMDs. There are a myriad of reasons, but it often comes down to controlling your distributions, filling up tax brackets, paying taxes now at a lower overall rate, and more. This ends up actually increasing the overall value of your retirement portfolio meaning it will last longer through retirement. As strange as it sounds, by accelerating your tax bills you actually pay less in total taxes during your entire retirement and increase the probability of not running out of money. And this does include Roth Conversions.

 As a reminder, a Roth Conversion is simply taking tax-deferred account money and moving it into a “never-be-taxed-again” account. It is not as simple as just moving it over as there is a tax recognition that happens with Roth Conversions. However, done properly it provides you a resource to tap some tax-free funds in retirement. 

This seems like a good place to stop as I have thrown more at you than I planned. Again, RMD age may change soon and increase another 3 years to age 75. However, it may be more beneficial for you to take money out of your RMD-eligible accounts before Uncle Sam forces you to. This helps keep from tipping Uncle Sam and also improving the probability of a successful retirement for you. 

This is a concept where you need to consult with your CFP®. Not everyone approaches taxes in as much depth as I do. Personally, I use multiple advanced software programs to help run these analyses for my clients and there are always conversations with their CPAs. Please note I will be talking more about Roth Conversions and other tax-savings ideas in the future. In the meantime, remember my mantra– It’s not what you make; it’s what you keep.

I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.