There were two major tax policy events in 2022:
(1) The Inflation Reduction Act (aka IRA) focused on raising corporate tax revenue while incentivizing investment in clean energy as well as funding the IRS; and (2) the Secure 2.0 Act focused on retirement.
Both of these combined are not likely to have a major impact on high-net-worth households. However, there are quite a few changes, especially in Secure 2.0, that we are incorporating into our wealth planning, especially for clients in or near retirement.
KEY CHANGES SECURE 2.0
***Starting in 2033, 75 will be the age for Required Minimum Distributions (RMDs) from IRAs, 401(k)s and other retirement accounts. This change affects planning for people who are in their 60s or younger now, since 73 will continue to be the age at which RMDs begin through 2032. Those about to take (or currently taking) RMDs should know that the penalty for not taking the annual RMD has been halved — to 25% — starting this year. And this can be lowered to 10% if the shortfall is corrected within two tax years after the missed RMD.
Lots More Possibilities for Roth IRAs
***Money in 529 Savings Plans can be transferred to Roth IRAs starting in 2024. While limited in scope, this is probably the best Roth conversion opportunity we have seen to date. The transfer is tax-free (not included in beneficiary’s income) and penalty-free. The conditions:
- The 529 account must have been open for at least 15 years, and contributions made to the 529 within the last 5 years, plus any earnings on them, are not eligible to rollover.
- The beneficiary of the 529 Plan and the Roth IRA must be the same, and that person must have sufficient earned income.
- The lifetime rollover limit is $35,000
- The annual limit equals the IRA maximum contribution ($6,500 for 2023); the amount rolled over plus any IRA contributions the beneficiary may have made cannot be higher than the beneficiary’s earned income for the year.
Some clarification from the IRS is needed. For example, does the 15-year account seasoning period reset when a new beneficiary is named? Since there are currently no limits on naming new beneficiaries, their age, etc. perhaps rollovers to multiple beneficiaries can occur.
***If you have a funded Roth 401(k) at work, you will no longer be required to take Required Minimum Distributions (RMDs) from that after you retire. People generally fund their Roth 401(k)s with after-tax dollars. Beginning in 2024, you will be able to keep the money in those accounts indefinitely and pass it on to your heirs tax-free.
***Those over 50 with more than $145,000 in annual compensation, must put “catch-up” retirement contributions ($7,500 max in 2023) into their employer’s Roth 401(k). That means that 401(k) catch-up contributions must be funded with after-tax dollars. Previously, catch-up contributions could go into pre-tax accounts. This is effective in 2024, but will be based on your compensation in 2023. This could require some employers to make plan changes.
***Employer matching contributions may go into employee Roth 401(k) accounts. All employer funds treated as Roth must be immediately 100% vested. However, the employer’s Roth contribution will be included in the employee’s gross income for the year and taxed.
***Starting this year, people with self-employment income can set up SIMPLE Roth or SEP Roth IRAs, funded with after-tax contributions. Previously, SIMPLE and SEP plans could only include pre-tax funds. There is an administrative aspect of this that is still being worked out. Actual implementation may be complicated until employers, custodians, and the IRS have in place the necessary policies and procedures.
INFLATION REDUCTION ACT
The Inflation Reduction Act of 2022 raises taxes on US corporations, funds the IRS, provides companies and households with tax credits and other incentives to invest in clean energy, and lowers prescription drug prices for seniors.
Starting in 2023, a 15% minimum tax is being imposed on companies with at least $1 billion in annual financial statement income. Corporate stock buybacks (with some exclusions) will be hit with a 1% excise tax.
For households, there are extended credits for solar panels, the purchase of certain electric vehicles and chargers as well as green home renovations. For those over 65 and on Medicare, a key change is that out-of-pocket costs for prescription drugs covered by Medicare Part D will be capped at $2,000 annually (adjusted for inflation) starting in 2025. Since the start of 2023, people who take insulin and have Medicare prescription drug coverage, have their out-of-pocket cost capped at $35 for a month’s supply.
A possible impact for higher-income households is the attempt to reduce the tax gap by investing $80 billion over 10 years in the IRS. The Inflation Reduction Act claims that a higher-staffed and equipped IRS would collect an extra $203 billion over 10 years (a net gain of approximately $125 billion in tax revenue).