Tag: retirement savings

Impact of the 2023 Appropriations Bill on Retirement Savings

In the last week of 2022, President Joe Biden signed into law the Consolidated Appropriations Act of 2023. The $1.7 trillion omnibus spending bill covers a huge range of topics, from spending in support for Ukrainian defense to the social media apps federal employees are allowed to download on their government-issued devices (hint: not TikTok). However, this blog will focus on the impact of the legislation on retirement savings policies, especially 401(k)s.

The retirement-related portion of the omnibus billed is dubbed the “SECURE 2.0 Act of 2022” and builds upon an act passed in 2019. Its goal is to expand the number of Americans saving for retirement and increase the amount they save. Some of the most important provisions of the legislation include:

  1. Mandated Automatic Enrollment
  2. Increased Limits for Catch-up Contributions
  3. Higher Age Threshold for Required Minimum Distributions

Mandated Automatic Enrollment

Effective for plan years beginning after 2023, 401(k) and 403(b) sponsors must automatically enroll employees in plans once they become eligible to participate in the plan. Previously, eligible employees had to elect to enroll. Under the new law, employees must opt out of enrollment if they do not wish to participate.

Generally, the amount of the automatic contribution must be set between 3 and 10%, depending on the employer’s policies.

Increased Limits for Catch-up Contributions

As we have discussed in a previous blog, the maximum catch-up contribution for 2023 is $7,500.

However, the SECURE 2.0 Act allows an additional increase in the contribution amount for participants aged 60 through 63. The additional increase is effective for tax years after 2024. For most plans, this second catch-up limitation would be $10,000. Furthermore, like the standard catch-up amounts, these limitations will also be subject to adjustments for inflation.

Higher Age Thresholds for Required Minimum Distributions

Under current law, plan participants are required to begin taking required minimum distributions (RMDs) at age 72. Under the SECURE 2.0 Act of 2022, the age at which participants must begin taking RMDs is increased over a period of ten years. Starting in 2023, the age is increased to 73 for individuals who turn 72 after 2022 and age 73 before 2033. For individuals who turn 74 after 2032, RMDs must begin at age 75.

 

These provisions aim to increase the rate at which Americans save for retirement. If you have questions about saving for retirement, please call our office at 480-392-6801.

When does it make sense to convert a Traditional IRA to a Roth IRA?

We all know that contributing to retirement accounts early and often is good advice, but many of our clients question whether it is more beneficial to invest in a traditional IRA or Roth IRA. The answer to this is different for every client and depends upon the expected cash flows during their working years and their retirement years. The good news is that any money contributed to a retirement account is a proactive step to protecting your future. Furthermore, either option will provide tax benefits, and the timing on when those benefits are reaped is the primary difference.

While it is impossible to predict the future, the ability to convert a Traditional IRA to a Roth IRA is a little-known option that can be a powerful source of tax savings for investors who understand the rules.

Unfortunately, taxpayers in the middle of their careers too frequently experience a temporary but dramatic slump in their income. This could be due to unforeseeable factors like the global pandemic that disrupted economies around the world in 2020, contributing to widespread unemployment and loss of business income. In other years, people experience unexpected illnesses like cancer, either for themselves or a loved one, and take a needed break from focusing on work. Former W-2 employees may experience dips in income in the first year that they start a business. However, any of these circumstances can provide a sharp investor with an opportunity to generate tax savings.

In a Traditional IRA, contributions are tax deductible in the year in which they are contributed. The tax bill will be lowered in the current year, and the investor will pay taxes in the future when the funds are withdrawn from the retirement account. On the other hand, contributions to a Roth IRA do not provide a tax deduction in the year contributed; but if the funds are withdrawn after at least five years and over age 59 1/2, no additional taxes will be due.

An investor who has an existing Traditional IRA and experiences a dramatic drop in income may consider converting the account to a Roth IRA. Because of the conversion, they will be required to pay income taxes on the previously tax deferred amount. However, because the taxpayer is in a much lower income bracket than in other years, the tax rate may be significantly lower than at another point in the investors life.

Furthermore, they will take advantage of other features of the Roth IRA:

  • No required minimum distributions
  • Tax-free income for heirs

There are several important factors to consider before deciding to convert an IRA:

  • What is the taxpayer’s normal effective tax rate, and what is the effective tax rate expected to be in the low-income year?
  • Will the taxpayer have adequate funds to pay the tax due as a result of the conversion?
  • Will the increase in taxable income affect the taxpayer’s ability to qualify for programs such as government marketplace health insurance or children’s financial aid for college?

Once the taxpayer determines that converting their IRA from a traditional to a Roth is the most beneficial course of action, they can explore financial institutions. Things like the historic rate of return on investments and the fees charged by the institution will affect their decision to either continue investing with their current institution or moving the funds to another one. The conversion process requires filling out paperwork with the financial institution. At tax time, the taxpayer (or their accountant) will submit a Form 8606.

While converting from a traditional IRA to a Roth IRA will not make sense for everyone, it can be an effective tool for some taxpayers to take advantage of significant drops in their income to generate future tax savings. If you have any questions about this strategy, reach out to your tax preparer or call our office at 480-392-6801.

Want to read more about retirement investing? Check out these past blog posts: