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You Just Got More Control Over Your Retirement Account: Delayed RMDs and Beyond

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In December, the Biden Administration signed into law the Secure 2.0 Act, a fairly sweeping update to how the government handles tax-advantaged retirement accounts.

Like the previous retirement bill passed in 2019, SECURE (Setting Every Community Up For Retirement Enhancement), Secure 2.0 is based on a large number of relatively small changes to retirement statutes. Although it has some novel policies, such as allowing employers to use student loan payments as a basis for matching retirement contributions, most of this bill makes adjustments to existing laws and policies.

Among these changes, the Secure 2.0 law will update how savers and retirees can access their money. With new rules on both required minimum distributions (RMDs) and early withdrawals, this law gives investors significantly more control over how and when they access their retirement accounts.

For more help strategizing your retirement based on this new legislation, consider matching with a vetted financial advisor for free.

Later, Easier Required Minimum Distributions

Pre-tax retirement accounts such as 401(k) and IRA accounts require their owners to begin withdrawing money at a certain age. The exact amount you must withdraw each year varies based on your age and a formula set by the IRS. If you don’t make these minimum withdrawals, known as required minimum distributions or RMDs, you face significant tax penalties.

The purpose of RMDs is to allow the government some certainty that it will begin collecting taxes on your retirement account. Tax-advantaged retirement accounts like a 401(k) allow you to invest money before paying taxes on it, and you pay taxes when you withdraw that money later. So the government wants to make sure that you pay those taxes at some point. Previously, the IRS required you to begin taking required minimum distributions at age 72.

The Secure 2.0 law will update this age. Starting in 2023, you do not have to begin taking required minimum distributions until 73. Effective 2033, this age will raise to 75.

This is very good news for some future, and even potentially current, retirees. Many retirees in their late 60s and even early 70s are still healthy and financially liquid. At this age, they’re the most likely to still have significant assets without needing to dip into a retirement account. Many other retirees in their early 70s may still choose to work. The flexibility to keep your money in a tax-advantaged retirement account for an additional three years may allow it to grow significantly before you begin making withdrawals.

This is compounded by the reduced penalties for not taking out your required minimum distributions. Previously, investors who did not take out their RMDs received a fine worth 50% of the amount that they did not withdraw. This penalty has now been reduced to 25%, and is further reduced to 10% for investors who corrects the mistake in a future year and reports the full value of the withdrawal on their taxes.

While it’s very rare for investors to have an opportunity worth paying a guaranteed 25% loss, the 10% penalty bracket opens up opportunities. Risky opportunities, to be sure, but returns higher than 10% are quite possible, making this penalty potentially worth planning around.

More Early Withdrawal Options With SECURE 2.0

For low- and even middle-income workers, retirement savings often come at the cost of setting aside emergency funds. Many households end up putting off saving for retirement altogether in the face of more urgent concerns.

The Secure 2.0 law will try to address that in two ways.

First, beginning in 2024 employers can offer a Roth-style emergency savings fund. Employees with a qualifying program can contribute up to $2,500 to these funds, and in some cases, their employers may be allowed to match contributions. Although employer contributions and investment growth can raise the balance, an employee can’t contribute more money to this emergency fund until the balance falls below $2,500.

Employees can then withdraw money from this emergency fund up to four times per year tax- and penalty-free.

Individuals can also now make up to $1,000 per year in emergency withdrawals from their tax-advantaged retirement accounts without paying taxes or penalties. They must replace the money within three years and cannot take another emergency withdrawal until they do, but no proof of hardship is necessary beyond self-attestation (basically, the individual’s word).

Finally, Secure 2.0 expands the basis for making penalty-free early withdrawals from tax-advantaged retirement accounts. In particular, victims of recent or ongoing domestic abuse can now withdraw up to $10,000 from their retirement accounts (or 50% of the account’s value, whichever is less) without penalties or fees. They must pay the money back within three years or new penalties will apply, but otherwise there are few restrictions on freely accessing this money.

Additionally, patients who have a terminal illness or other terminal diagnosis can withdraw money from their retirement account penalty free. If the patient survives, he too must return the money within three years or pay new penalties and taxes, but otherwise no restrictions apply.

Together, from lighter rules on required minimum distributions to greater flexibility to use retirement funds for an emergency, these new provisions give investors significantly more control over their retirement accounts.

The Bottom Line

The Secure 2.0 law, passed at the end of 2022, expands access to retirement accounts through broader required minimum distribution rules and more options to make early withdrawals. For more help determining what this means for your retirement strategy, consider matching with a financial advisor for free now.

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