Tag Archives: Self-employment

SECURE 2.0 Comment Letter

SECURE 2.0, passed in December 2022, made dozens of changes to the rules governing tax-advantaged retirement accounts.

When Congress passes a major tax law change, the IRS and Treasury issue regulations and other guidance regarding the change. Practitioners and taxpayers often provide the IRS and Treasury comment letters bringing issues and concerns to the government’s attention.

I wrote a comment letter (which you can read here) to the IRS and Treasury addressing facets of the following provisions:

SECURE 2.0 Section 115

SECURE 2.0 Section 314

SECURE 2.0 Section 317

SECURE 2.0 Section 326

SECURE 2.0 Section 331

SECURE 2.0 Section 603

SECURE 1.0 Section 113

Follow me on Twitter: @SeanMoneyandTax

This post (and the linked-to comment letter) is for entertainment and educational purposes only. They do not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2024 Solo 401(k) Update

There are some new developments in the world of the Solo 401(k). Here are the highlights:

New Solo 401(k) Employee Contributions Limit for 2024

The IRS announced that for 2024, the employee deferral limit for all 401(k)s, including Solo 401(k)s, will be $23,000. 

Solo 401(k) Catch-Up Contributions Limit for 2024

The IRS also announced that for 2024, the employee deferrals catch-up contribution limit remains $7,500. As a result, those aged 50 or older can contribute, in employee contributions, a maximum of the lesser of $30,500 ($23,000 plus $7,500) or earned income. 

New Solo 401(k) All Additions Limit for 2024

The new all-additions limit for Solo 401(k)s is $69,000 (or earned income, whichever is less). For those aged 50 or older during 2024, the $66,000 number is $76,500 ($69,000 plus $7,500). 

Wither Roth Employer Contributions?

One of the changes SECURE 2.0 ushered in was allowing Roth employer contributions to 401(k) plans, including Solo 401(k)s. Interestingly enough, three of the largest institutions offering Solo 401(k)s, Fidelity, Schwab, and Vanguard, have not added that feature to their Solo 401(k)s. Vanguard’s website goes so far as to affirmatively state it will not add the Roth employer contribution feature to their Solo 401(k) at this time. 

I mention this development to inform the reader, not to criticize Solo 401(k) providers. If you’ve read some of my other work, you may know I don’t think a lack of Roth employer contributions in Solo 401(k)s is a problem.

UPDATE March 2, 2024: Today I learned that Schwab now offers Roth employee contributions (a change) and Roth employer contributions (also a change). Based on this January 21, 2024 post, I suspect this change occurred prior to the federal district court’s publishing of its decision in Texas v. Garland on February 27, 2024.

Ambiguity on New Schedule C Solo 401(k) Funding Deadline

UPDATE December 14, 2023: I Tweeted a thread about the provision that allows Schedule C solopreneurs to establish and fund a new Solo 401(k) with an employee deferral contribution after year-end. There is at least some concern that if one is diligent enough to establish a new Solo 401(k) prior to year-end they might not get the benefit of Section 401(b)(2)‘s funding deadline extension. If that is true (and to my mind this is an ambiguous issue), then the solopreneur establishing the new Solo 401(k) prior to year-end would need to either fund the employee contribution prior to year-end or elect to make an employee deferral contribution prior to year-end.

UPDATE March 2, 2024: There’s new uncertainty when it comes to the new Solo 401(k) establishment deadline for Schedule C solopreneurs looking to make a first-time employee contribution. A federal district court in Texas held on February 27, 2024, in Texas v. Garland, that the House of Representatives did not have a sufficient Quorum when it passed the Omnibus, which includes SECURE 2.0 and the Solo 401(k) deadline extension in SECURE 2.0 Section 317. Here’s my X/Twitter thread on the case and here’s my YouTube video on the case. Stay tuned to my YouTube channel for future updates!

2024 Update to Solo 401(k): The Solopreneur’s Retirement Account

Solo 401(k): The Solopreneur’s Retirement Account explores the nooks and crannies of Solo 401(k)s. On page 16 of the paperback edition, I provide an example of the Solo 401(k) limits for 2022 if a solopreneur makes $100,000 of Schedule C income. Here is a revised version (in italics) of the example (with the footnote omitted) applying the new 2024 employee contribution limit:

Lionel, age 35, is self-employed. His self-employment income (as reported on the Schedule C he files with his tax return) is $100,000. Lionel works with a financial institution to establish his own Solo 401(k) plan and choose investments for the plan. Lionel can contribute $23,000 to his Solo 401(k) as an employee deferral (2024 limit) and can choose to contribute, as an employer contribution, anywhere from 0-20% of his self-employment income.

Lionel’s maximum potential tax-advantaged Solo 401(k) contribution for 2024 is $41,587! That is a $23,000 employee contribution and a $18,587 employer contribution. Note there’s no change in the computation of the employer contribution for 2024 in this example. 

On page 18 I provide an example of the Solo 401(k) contribution limits factoring in catch-up contributions. Here’s the example revised for 2024:

If Lionel turned 50 during the year, his limits are as follows:

  • Employee contribution: lesser of self-employment income ($92,935) or $30,500: $30,500
  • Employer contribution: 20% of net self-employment income (20% X $92,935): $18,587
  • Overall contribution limit: lesser of net self-employment income ($92,935) or $76,500: $76,500

Amazon Reviews

If you have read Solo 401(k): The Solopreneur’s Retirement Account, you can help more solopreneurs find the book! How? By writing an honest, objective review of the book on Amazon.com. Reviews help other readers find the book!

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2023 Year-End Tax Planning

It’s that time of year again. The air is crisp and my favorite football team is surging. That can only mean one thing when it comes to personal finance: time to start thinking about year-end tax planning.

I’ll break it down with three categories: Urgent, Year-End Deadline, and Can Wait Till Next Year. I will also provide some thoughts on 2024 tax planning that can/should be done before year-end in 2023.

As always, none of this is advice for your particular situation but rather it is educational information. 

Urgent

By urgent, I mean those items that (i) need to happen before year-end and (ii) may not happen if taxpayers delay and try to accomplish them late in the year. 

Donor Advised Fund Contributions

The donor advised fund is a great way to contribute to charity and accelerate a tax deduction. My favorite way to use the donor advised fund is to contribute appreciated stock directly to the donor advised fund. This gets the donor three tax benefits:

  1. A tax deduction for the fair market value of the contributed appreciated stock,
  2. Elimination of the built-in capital gain on the contributed appreciated stock, and
  3. Tax-free treatment of the income earned inside the donor advised fund.

In order to get the first benefit in 2023, the appreciated stock must be received by the donor advised fund prior to January 1, 2024. This deadline is no different than the normal charitable contribution deadline.

However, due to much year end interest in donor advised fund contributions and processing time, different financial institutions will have different deadlines on when transfers must be initiated in order to count for 2023. Donor advised fund planning should be attended to sooner rather than later. 

Taxable Roth Conversions

For a Roth conversion to count as being for 2023, it must be done before January 1, 2024. That means New Year’s Eve is the deadline. However, taxable Roth conversions should be done well before New Year’s Eve because 

  1. It requires analysis to determine if a taxable Roth conversion is advantageous, 
  2. If advantageous, the proper amount to convert must be estimated, and 
  3. The financial institution needs time to execute the Roth conversion so it counts as having occurred in 2023. 

Remember, generally speaking it is not good to have federal and/or state income taxes withheld when doing Roth conversions!

Roth Conversion Example: See slides 8 through 10 of this slide deck for an example of a Roth conversion in retirement. You might be surprised by just how little federal income tax is owed on a $23,000 Roth conversion.

Example Where I Disfavor Roth Conversions: I present an example of a 73-year old married couple with $400K in deferred retirement accounts and $87K in 2023 gross income. I would not recommend they do end-of-year Roth conversions. This spreadsheet computes the taxable Social Security with and without a $10K Roth conversion.

Gotta Happen Before 2026!!!

You will hear many commentators say “do more Roth conversions before tax rates go up in 2026!” If this were X (the artist formerly known as Twitter), the assertion would likely be accompanied by a hair-on-fire GIF. 😉

I disagree with the assertion. As I have stated before, there’s nothing more permanent than a temporary tax cut. You do your own risk assessment, but mine is this: members of Congress like to win reelection, and they are not going to want to face voters without having acted to ensure popular tax cuts, such as the reduction of the 15% tax rate down to 12% and the increased standard deduction, are extended. 

I recommend that you make your own personal taxable Roth conversion decisions based on your own personal situation and analysis of the landscape and not a fear of future tax hikes.

Learn all about the Pro-Rata Rule here.

Adjust Withholding

This varies, but it is a good idea to look at how much tax you owed last year (line 24 on the Form 1040). If you are on pace to get 100% (110% if 2022 AGI is $150K or greater) or slightly more of that amount paid into Uncle Sam by the end of the year (take a look at your most recent pay stub), there’s likely no need for action. But what if you are likely to have much more or much less than 100%/110%? It may be that you want to reduce or increase your workplace withholdings for the rest of 2023. If you do, don’t forget to reassess your workplace withholdings for 2024 early in the year. 

Backdoor Roth IRA Diligence

The deadline for the Backdoor Roth IRA for 2023 is not December 31st, as I will discuss below. But if you have already completed a Backdoor Roth IRA for 2023, the deadline to get to a zero balance in all traditional IRAs, SEP IRAs, and SIMPLE IRAs is December 31, 2023

Solo 401(k) Planning

There’s plenty of planning that needs to be done for solopreneurs in terms of retirement account contributions. Even though Schedule C solopreneurs can now establish a Solo 401(k) after year-end (up to April 15th), it is absolutely the case that it is better to do the planning upfront. For those Schedule C solopreneurs with a Solo 401(k) established, December 31st is the deadline to make 2023 employee deferral contributions or make a 2023 deferral election as an alternative to making the payments in 2023. December 31st is also the 2023 employee deferral contribution for solopreneurs operating out of S corporations.

The Solo 401(k) can get complicated. That’s why I wrote a book about them and post an annual update on Solo 401(k)s here on the blog. 

Year-End Deadline

These items can wait till close to year-end, though you don’t want to find yourself doing them on New Year’s Eve.

Tax Gain Harvesting

For those finding themselves in the 12% or lower federal marginal income tax bracket and with an asset in a taxable account with a built-in gain, tax gain harvesting prior to December 31, 2023 may be a good tax tactic to increase basis without incurring additional federal income tax. Remember, though, the gain itself increases one’s taxable income, making it harder to stay within the 12% or lower marginal income tax bracket. 

I’m also quite fond of tax gain harvesting that reallocates one’s portfolio in a tax efficient manner. 

Tax Gain Harvesting Example: See slide 15 of this slide deck for an example of tax gain harvesting in retirement.

Tax Loss Harvesting

The deadline for tax loss harvesting for 2023 is December 31, 2023. Just remember to navigate the wash sale rule

RMDs from Your Own Retirement Account

The deadline to take any required minimum distributions from one’s own retirement account is December 31, 2023. Remember, the rules can get a bit confusing. Generally, IRAs can be aggregated for RMD purposes, but 401(k)s cannot. 

RMDs from Inherited Accounts

The deadline to take any RMDs from inherited retirement accounts is December 31st. For some beneficiaries of retirement accounts inherited during 2020, 2021, and 2022, the IRS has waived 2023 RMDs. That said, all beneficiaries of inherited retirement accounts may want to consider affirmatively taking distributions (in addition to RMDs, if any) before the end of 2023 to put the income into a lower tax year, if 2023 happens to be a lower taxable income year vis-a-vis future tax years. 

Can Wait Till Next Year

Traditional IRA and Roth IRA Contribution Deadline

The deadline for funding either or both a traditional IRA and a Roth IRA for 2023 is April 15, 2024. 

Backdoor Roth IRA Deadline

There’s no law saying “the deadline for the Backdoor Roth IRA is DATE X.” However, the deadline to make a nondeductible traditional IRA contribution for the 2023 tax year is April 15, 2024. Those doing the Backdoor Roth IRA for 2023 and doing the Roth conversion step in 2024 may want to consider the unique tax filing when that happens (what I refer to as a “Split-Year Backdoor Roth IRA”). 

HSA Funding Deadline

The deadline to fund an HSA for 2023 is April 15, 2024. Those who have not maximized their HSA through payroll deductions during the year may want to look into establishing payroll withholding for their HSA so as to take advantage of the payroll tax break available when HSAs are funded through payroll. 

The deadline for those age 55 and older to fund a Baby HSA for 2023 is April 15, 2024. 

2024 Tax Planning at the End of 2023

HDHP and HSA Open Enrollment

It’s open enrollment season. Now is a great time to assess whether a high deductible health plan (a HDHP) is a good medical insurance plan for you. One of the benefits of the HDHP is the health savings account (an HSA).

For those who already have a HDHP, now is a good time to review payroll withholding into the HSA. Many HSA owners will want to max this out through payroll deductions so as to qualify to reduce both income taxes and payroll taxes.

Self-Employment Tax Planning

Year-end is a great time for solopreneurs, particularly newer solopreneurs, to assess their business structure and retirement plans. Perhaps 2024 is the year to open a Solo 401(k). Perhaps their business is growing such that an S corporation election makes sense. The best time to be thinking about these sorts of things for 2024 is late in 2023. Often this analysis benefits from professional consultations.

Additional Resource

Please see my November 11, 2023 ChooseFI Orange County year-end tax planning presentation slide deck.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Saving Social Security and Medicare

America has a retirement savings problem. To varying degrees, Social Security and Medicare support retirees. Other than for the very wealthy, a significant diminution in either program would materially hurt retirees. 

Most can agree with a simple proposition: over the long term, there are fiscal holes in Social Security and Medicare

I have seven proposals to address the problem. These proposals won’t solve funding problems for all time, but will move the needle significantly towards securing Social Security and Medicare. All the tax related proposals tax those who have benefited the most from the American economy and a very favorable investment tax climate. 

Before I get started, I would like to encourage the reader to endeavor to reduce his or her dependence on these programs by building up their own retirement assets and/or income streams. That said, as a practical matter both Social Security and Medicare are very important to the retirements of the vast majority of Americans. 

Who Pays to Save Social Security and Medicare?

PROPOSAL ONE: No changes to the Social Security and Medicare eligibility ages.

Some propose to increase the eligibility age for Medicare and/or Social Security full retirement age.

I believe that to be a horrible idea, for a myriad of reasons. Over the long term, there are fiscal holes in Social Security and Medicare. By definition, someone in the world must pay for those holes. If we eliminate more outlandish possibilities such as billing invading extraterrestrials and foreign plunder, most of the cost must be made up by some cohort or cohorts of Americans. Raising the eligibility ages to fix the holes simply decides that Americans in their mid-to-late 60s of all income and wealth levels are the cohort of Americans who must pay for those holes.

But why? Are 60-somethings particularly well off compared to other cohorts? I don’t believe they are, and many in their mid-to-late 60s are far worse off than the average American citizen. 

I’m not the only commentator to oppose increasing Social Security eligibility ages.

My three tax proposals below are hardly perfect. But at least they put the onus on filling the holes on those who (i) have benefited most from the recent American economy and (ii) have most benefited from America’s very favorable investment and endowment tax environment. Why shouldn’t the people who have benefited the most, and would be harmed by tax increases the least, fix the Social Security and Medicare holes?

Further, my three tax proposals have a significant advantage over delaying eligibility ages. Delaying eligibility ages is a delayed fix! If enacted in 2023, my three proposals go to work (in full!) on January 1, 2024. 

Any delay of the eligibility age will likely be at least somewhat delayed. No politician is going to vote to raise a 66 year old’s Social Security full retirement age overnight from age 67 to age 70. There’s zero chance of that. That’s demonstrated by this proposal, which proposes to increase Social Security eligibility ages by 3 years and admits that the proposal would not save money for at least 10 years! 

Would you be happy if you called a plumber to fix a leak in your sink and he responded, “Sure, happy to help, I’ll swing on by in 10 years.” No!

Further, I am not going to advocate for a politically untenable solution, and I wouldn’t recommend any politician do so either. There are plenty of solutions that can be implemented short of solutions that are guaranteed to be wildly unpopular with the electorate. 

One piece of evidence demonstrates just how unpopular cutting Social Security and Medicare are. A recent Axios-Ipsos poll (see the bottom of page 9) found that Americans generally oppose Social Security and Medicare cuts by a 7 to 2 margin. Any highly unpopular solution will ultimately be counterproductive. 

A group of Republican Congressmen argue Social Security eligibility ages should be increased in the future to account for increased life expectancy (see the bottom of page 88 of this file). I believe their argument is mistaken for two reasons. First, some increases in life expectancy are attributable to diminished infant mortality instead of increased lifespan in old age. Second, in 2020 and 2021, American life expectancy decreased.

PROPOSAL TWO: No Increase to the FICA Tax Rates (Employee and Employer)

Historically, there have been many payroll tax increases to fund Social Security and Medicare. I believe, in today’s economy, a simple payroll tax rate increase would be unfair and would hurt many Americans who have not benefited from the surge in financial markets the way the affluent have. In a world where working class workers have not experienced real significant salary increases in decades, while the stock market has soared over several decades, we can’t simply increase payroll taxes on everyone and call it fair.

Further, it might be tempting to only increase the payroll tax rates paid by employers. But this runs into two big problems. First, it’s a tax on job creation. I, for one, want employers of all sizes creating more jobs in the United States. Increasing the tax rates employers pay for Social Security and Medicare increases incentives to offshore jobs and shifts towards automation. Count me against that.

Second, increasing employer tax rates is a tax hike on the self-employed. The self-employed face many challenges. They are not a cohort that should shoulder the burden of closing the fiscal holes in Social Security and Medicare.

Tax Increases to Save Social Security and Medicare

PROPOSAL THREE: Increase the additional Medicare tax on earned income from 0.9% to 2.0% Use half the tax (1.0%) fund Medicare and half the tax (1.0%) fund Social Security.

PROPOSAL FOUR: Increase the Medicare surtax on net investment income from 3.8% to 5.0%. Use the increase (1.2%) to fund Social Security. 

These two proposals have several advantages. They incrementally increase taxes on the most successful in America in order to close the shortfalls in Social Security and Medicare. They are not taxes on employers hiring more employees, so they do not discourage hiring. Further, these two tax proposals leverage off existing taxes such that implementation of the proposals should be relatively easy. 

PROPOSAL FIVE: Impose a new 25% excise tax on net investment income of college endowments with $1 billion or more in assets as of year end.

This new tax would replace the tiny 1.4% excise tax on some college endowments enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2018

Congress can allocate tax collections between Social Security and Medicare as they best see fit. 

Once subject to the tax, a college endowment would be subject to it going forward until the endowment can demonstrate its year-end assets have been under $750 million for three consecutive years. 

Net investment income for this purpose would be the endowment’s Section 1411(c)(1)(A) income, less the following limited expenses: salaries and benefits for employees primarily working for the endowment (limited to $20,000 per month per employee), endowment tax return preparation fees, endowment legal fees, office supplies and equipment (printers, copiers, scanners, etc.) for the endowment, and computer software for the endowment (limited to $1 million per year). Capital gains and capital losses would be netted and no net capital loss could be taken, though any net capital loss would carry forward without limit to subsequent years. 

As the excise tax taxes endowments of financial assets, dorms, classrooms, and other buildings used by the university in their educational mission would not be endowment assets for purposes of the new excise tax. 

Estimated payments would be due the same dates as individual estimates are due (and the same underpayment penalties would apply), and the net investment income of any controlled endowment entity (domestic or foreign) would also be included in the endowment’s net investment income. 

These tax-free hoards have enjoyed incredibly favored treatment long enough. Some of these endowments now exceed $1 million per student, more than enough to fund many students without collecting a dollar of tuition. 

Most colleges do not pay income tax on tuition and donations received. I don’t propose to change that, but it’s time these colleges, which mostly serve a select privileged few, pay a significant tax on their investment income. Considering these endowments are worth vast sums of money, that tax should be equal to the rate paid by highest income individuals on long term capital gains, 25% (20% long term capital gain rate plus 5% net investment income tax under my proposal).

You might think this is unfair to colleges. But let’s imagine we were tasked with creating the entire U.S. federal tax system from scratch. If I proposed to subject waiters and factory workers to both income taxes and payroll taxes on their entire salary, while exempting colleges from taxation on tuition collected and donations received, and then added a 25% net investment income tax on large endowments, you’d probably say “Wow, you’re being unfair to waiters and factory workers and too generous to colleges.” 

I don’t propose a revolution in tax policy, but rather a fair, equitable, and incremental tax change that increases the tax burden on those most able to bear it in order to combat funding shortfalls in Social Security and Medicare. 

Stabilizing The Federal Government’s Finances

PROPOSAL SIX: Significant reductions in military and foreign spending

Practically all Americans reading this are owed Social Security and/or Medicare benefits! That makes you a creditor of the U.S. government. 

Your creditor’s financial health matters to you. It’s time your creditor got its house in order. Your creditor’s house is not in order for many reasons, including spending that is consistent with neither the founding nor the history of our great republic.

Incredibly enough, the United States has nearly three times as many foreign military bases as it has embassies. It’s time to ditch the bases and bring the troops home for many reasons. Having so many military and other government personnel overseas is contrary to the great history of our republic. As John Quincy Adams said, “America does not go abroad in search of monsters to destroy.” Today’s historically out-of-whack military and foreign spending is destabilizing the government’s finances. It’s time to cut military and foreign spending significantly and redeploy that money to reduce the deficit and secure the financial stability of the federal government. 

A financially stable government is much more likely to be able to successfully meet its Social Security and Medicare obligations. 

Some might argue that neither our current level of military spending nor Social Security and Medicare are consistent with the founding and history of our country, so shouldn’t both be cut? Jeffrey Sachs has observed that there is some popular support for cutting America’s foreign military involvement. On the other hand, there is very little appetite among the electorate for reductions to Social Security and Medicare. There’s no reason to consider wildly unpopular options when there are much more popular options on the table. 

Self-Help

PROPOSAL SEVEN: Change Your Health

Not every change to improve the Social Security and Medicare system needs to come from Congress.

Over the years I have become more and more convinced that almost everything we learned about health and nutrition is wrong. It is time for each of us to radically take charge of our own healthcare. We need to do this regardless of the fiscal state of Social Security and Medicare. But my hope is this shift will reduce spending on Medicare. 

I have seen my health improve by focusing on eating high quality animal fats and proteins, avoiding seed oils (which are very new in human history), and dramatically reducing sugar consumption. One reason I continue with that focus is that, as discussed by Doctors Ken Berry and Lisa Wiedeman, sugar feeds cancer! See also Dr. Ken Berry discussing this further. Avoiding certain foods can dramatically improve health outcomes and reduce medical spending (including Medicare spending). 

My hope is that more and more Americans will become aware of the role of diet in health, and that will, over time, reduce long term medical expenses, including the expenses paid for by Medicare. Eventually, this renewed health will hopefully lead to longer life spans and increase future Social Security payments. If this happens, it hurts Social Security many years in the future. That much delayed good problem to have will hopefully be more than compensated for by earlier (and hopefully permanent) reductions in Medicare costs. 

Conclusion

As the federal government racks up more and more debt, and the clock ticks towards financial peril for both Social Security and Medicare, it’s time to take action to preserve and protect these programs. 

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute medical, accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal medical, accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The above does not represent the opinion of anyone other than the author, Sean W. Mullaney. The author was not compensated by any individual or entity for writing this blog post, and this blog post does not necessarily reflect the views of any current or former employer of Sean W. Mullaney.

SECURE 2.0 and the FI Community

Congress just passed a very long retirement tax bill, colloquially referred to as SECURE 2.0 or the SECURE Act 2.0. The FI community is interested in anything affecting tax-advantaged retirement accounts. This post dives in on the impact of SECURE 2.0 on the FI community. 

SECURE 2.0 Big Picture

SECURE 2.0 tinkers. It contains dozens of new rules. It’s easy to get lost in the weeds of the new rules, but I don’t recommend it. Many new rules have very little impact on financial planning for those in the FI community.

Here’s one example: SECURE 2.0 eliminates (effective 2024) required minimum distributions (“RMDs”) from Roth 401(k)s during the owner’s lifetime. Since Roth IRAs never had RMDs during the owner’s lifetime, and Roth 401(k)s are easily transferable to Roth IRAs at or after retirement, this is a rule change without much practical impact for most from a planning perspective.

However, there are two main takeaways those in the FI community should focus on when it comes to SECURE 2.0. First, SECURE 2.0 makes traditional, deductible retirement account contributions even more attractive. Second, SECURE 2.0 sets what I refer to as the Rothification Trap. Don’t fall into the Rothification Trap!

Traditional Retirement Account Contributions Are Even More Attractive

In the classic traditional versus Roth debate, SECURE 2.0 moves the needle towards traditional deductible retirement account contributions. Why?

SECURE 2.0 delays the required beginning date for RMDs! Starting in 2023, RMDs must begin at age 73, buying those born from 1951 through 1959 one more year to do tax-efficient Roth conversions prior to being required to take RMDs. But for most of the readers of this blog, the news is much better. Those born in 1960 or later now must take RMDs starting at age 75.

This is a big win for the FI community! Why? Many in the FI community will have artificially low taxable income in retirement prior to having to take RMDs at age 75. That increases the window for Roth conversions while a retiree otherwise has low taxable income. 

Delaying RMDs makes traditional FI tax planning even more attractive, particularly for those born after 1959. Retirees will have through the year of their 74th birthday to make Roth conversions to (i) get tax rate arbitrage on traditional retirement accounts and (ii) lower RMDs when they are ultimately required.

The planning runway to do Roth conversions prior to taking RMDs just got three years longer. This gives both early retirees and conventional retirees that much more of an opportunity to do Roth conversions at low income tax rates prior to being required to take RMDs. There are three additional years of progressive tax brackets to absorb efficient Roth conversions and reduce future RMDs. 

Rothification Trap

Be aware of the Rothification Trap!

SECURE 2.0 promotes even more in the way of Roth contributions. It allows employees to elect to have their employer 401(k) and other workplace plan contributions be Roth contributions, effective immediately. See Section 604 of SECURE 2.0. Plans will have to affirmatively add this feature (if they so choose), so it won’t be immediately effective in most cases. I predict that at least some plans will offer this option. I suspect some plans will not offer this option, since Roth employer contributions must be immediately vested. Some employers will be hesitant to eliminate vesting requirements for employer contributions, though it must be remembered that some employers immediately vest all employer contributions.

In addition, effective starting in 2023, SEP IRAs and SIMPLE IRAs can be Roth SEP IRAs and Roth SIMPLE IRAs. See Section 601 of SECURE 2.0. 

Here’s the thing: for those planning an early retirement, Rothification is a trap! The name of the game for those thinking about early retirement is to max out deductions while working and later do Roth conversions in early retirement. This maximizes deductions while one is subject to their highest marginal tax rate (their working years) and moves income to one’s lower taxable income years (the early retirement years). The combination of these opportunities creates tax rate arbitrage. 

I’m worried some in the FI community will say “I really love Roth, so I’ll make all my contributions–IRA, employee 401(k), and employer 401(k))–Roth now!” I believe that path is likely to be a mistake for many in the FI community, for two reasons. First, this foregoes the great tax planning opportunity presented by deducting retirement contributions at one’s highest lifetime marginal tax rates while working and then converting to Roths at low early retirement tax rates. 

Second, it sets one up to have difficulty qualifying for Affordable Care Act Premium Tax Credits. In order to qualify for Premium Tax Credits, which could be worth thousands of dollars in early retirement, one must have income above their state’s applicable Medicaid threshold. For example, in 2023 a family of four in California with a modified adjusted gross income (“MAGI”) of less than $39,750 would qualify for MediCal (California’s Medicaid) and thus get $0 Premium Tax Credits if they choose to use an Affordable Care Act insurance plan. Most early retirees will want to be on an ACA plan instead of their state’s Medicaid insurance for a variety of reasons. 

In a low-yield world, an early retiree with only taxable accounts and Roth accounts may find it difficult to generate sufficient MAGI, even with tax gain harvesting, to avoid Medicaid and qualify for a Premium Tax Credit. The earlier the retirement, the more likely having only taxable accounts and Roth accounts will eventually lead to an inability to generate sufficient MAGI to qualify for Premium Tax Credits. 

Rothification Trap Antidote

How might one qualify for the Premium Tax Credit in early retirement? By doing Roth conversions of traditional retirement accounts! If there’s no money in traditional retirement accounts, there’s nothing to Roth convert. 

I discussed the issue of early retirees not having enough income to qualify for Premium Tax Credits, and the Roth conversion fix, with Brad Barrett on a recent episode of the ChooseFI podcast (recorded before SECURE 2.0 passed). 

Previously, I’ve stated that for many in the FI movement, the “dynamic duo” of tax-advantaged retirement account savings is to max out a traditional deductible 401(k) at work and max out a Roth IRA contribution (regular or Backdoor) at home. Now that SECURE 2.0 has passed, I believe this is still very much the case. 

At the very least, those shooting for an early retirement should strongly consider leaving employer contributions to 401(k)s and other workplace retirement plans as traditional, deductible contributions. This would give them at least some runway to increase MAGI in early retirement sufficient to create enough taxable income to qualify for a Premium Tax Credit. 

401(k), 403(b), and 457 Max Contributions Age 50 and Older

The two most significant takeaways from SECURE 2.0 out of the way, we now get to several other changes members of the FI community should consider. 

First, for those age 50 and older, determining one’s maximum workplace retirement account contributions is about to get complicated. By 2025, there will be up to three questions to ask to determine what one’s maximum retirement contribution, and how it can be allocated (traditional and/or Roth), will look like:

  1. What’s my age?
  2. What was my prior-year wage income from this employer?
  3. Does my employer offer a Roth version of the retirement plan?

Specifically, the changes to 401(k) and other workplace employee contributions are as follows:

Increased Catch-Up Contributions Ages 60, 61, 62, and 63

SECURE 2.0 Section 109 (see page 2087) increases workplace retirement plan catch-up contributions for those aged 60 through 63 to 150% of the regular catch-up contribution limit, starting in 2025.

Catch-Up Contributions Must be Roth if Prior-Year Income Too High

Starting in 2024, 401(k) and other workplace retirement plan catch-up contributions (starting at age 50) must be Roth contributions if the worker made more than $145,000 (indexed for inflation) in wages from the employer during the prior year. Interestingly enough, if the employer plan does not offer a Roth component, then the worker is not able to make a catch-up contribution regardless of whether they made more than $145,000 from the employer during the previous year. Hat tip to Josh Scandlen and Jeffrey Levine for making this latter point, which the flow-chart I featured in the originally published version of this post missed. Sorry for the error as we are all learning about the many intricate contours of SECURE 2.0, myself included!

I do anticipate that many 401(k) plans that do not currently offer a Roth component will start to offer one to allow age 50 and older workers to qualify for catch-up contributions (even if they now must be Roth contributions for those at higher incomes).

From a planning perspective, I still believe that catch-up contributions will make sense for many required to make them as Roth contributions. In such a case, the option is either (i) make the Roth catch-up contribution or (ii) invest the money in a taxable brokerage account. Generally speaking, I believe that it is advantageous to put the money in a Roth account. However, one can easily imagine a situation where someone is thinking about an early retirement and does not have much in taxable accounts such that it might be better to simply invest the money in a taxable account.

Note that the prior-year wage restriction on deducting catch-up contributions does not appear to apply to the Solo 401(k) of a Schedule C solopreneur, but it does appear to apply to the Solo 401(k) of a solopreneur operating out of an S corporation.

No Changes to Backdoor Roths

In another win for the FI community, the Backdoor Roth IRA and the Mega Backdoor Roth are not changed or curtailed by SECURE 2.0.

Rolling 529 Plans to Roth IRAs

SECURE 2.0 has a notable provision allowing up to $35,000 of a 529 plan to be rolled over to the Roth IRA of the beneficiary. I agree with Sarah Brenner that this rule is not one to get too excited about. Why I feel that way is another story for another day. That day is February 15, 2023, when my post on the 529-to-Roth IRA rollover drops on the blog

SECURE 2.0 and the FIRE Movement on YouTube

Resources

Sarah Brenner’s helpful summary: https://www.irahelp.com/slottreport/happy-holidays-congress-gifts-secure-20

The Groom Law Group goes through SECURE 2.0 section by section: https://www.jdsupra.com/legalnews/secure-2-0-hitches-a-ride-just-in-the-9280743/

Final Omnibus (which contained SECURE 2.0) text: https://www.appropriations.senate.gov/imo/media/doc/JRQ121922.PDF

Jeffrey Levine’s detailed blog post on SECURE 2.0: https://www.kitces.com/blog/secure-act-2-omnibus-2022-hr-2954-rmd-75-529-roth-rollover-increase-qcd-student-loan-match/

Jeffrey Levine’s detailed Twitter thread on SECURE 2.0: https://twitter.com/CPAPlanner/status/1605609788183924738

My video about the two biggest problems with SECURE 2.0: https://www.youtube.com/watch?v=Zsy1SQXogAg

My December 2022 SECURE 2.0 Resources post: https://fitaxguy.com/secure-2-0-resources/

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

SECURE 2.0 Resources

Here is the bill text for SECURE 2.0.

SECURE 2.0 Big Picture

SECURE 2.0 tinkers, almost in an unprecedented fashion. Instead of repealing obviously bad retirement tax rules, it adds to them! I suspect that for many Americans, SECURE 2.0 will have only a marginal impact on their retirement savings and financial planning. This version of SECURE 2.0 has some aspects of what the House passed much earlier in 2022, but there are many significant additions and changes.

I discuss what I believe to be the two biggest problems with SECURE 2.0

Some Highlights (or Lowlights)

  • Increased catch-up contributions for those aged 60-63, effective starting in 2025
  • Denial of catch-up contribution deduction for those with prior-year income over $145,000, effective starting in 2024
  • Delay RMDs to age 73 for a decade, then delayed to age 75. This change is effective starting in 2023.
  • Increased auto-enrollment for workplace retirement plans
  • Roth options for (i) SIMPLE IRAs, (ii) SEP IRAs, (iii) employer contributions to employer plans such as 401(k)s
  • Minor emergency withdrawals from retirement accounts. Limited to one distribution per year of no more than $1,000, effective starting in 2024
  • $2,500 of contributions to emergency side accounts for workplace retirement plans, effective starting in 2024
  • Elimination of RMDs from Roth 401(k)s during the owner’s lifetime
  • Allowing Schedule C self-employed individuals to adopt a Solo 401(k) after year-end and make employee contributions (first year only), effective starting with the 2023 plan year
  • Indexing for inflation of the $1,000 annual catch-up contribution to traditional IRAs and Roth IRAs
  • Reform to penalties for missed RMDs
  • No change to the Backdoor Roth IRA rules and no change to the Mega Backdoor Roth IRA rules
  • Expansion of the exceptions to the 10% early withdrawal penalty

Resources

Bill text

Jeffrey Levine’s excellent Twitter thread on the particulars of SECURE 2.0: https://twitter.com/CPAPlanner/status/1605609788183924738

Jeffrey Levine’s breakdown of SECURE 2.0 on Kitces.com: https://www.kitces.com/blog/secure-act-2-omnibus-2022-hr-2954-rmd-75-529-roth-rollover-increase-qcd-student-loan-match/

My breakdown of SECURE 2.0 and the FI Community: https://fitaxguy.com/secure-2-0-and-the-fi-community/

My mini Twitter thread on minor emergency withdrawals: https://twitter.com/SeanMoneyandTax/status/1605117417721434113

My mini Twitter thread on new employer plan emergency accounts: https://twitter.com/SeanMoneyandTax/status/1605119482803863552

My Plan

I have a retirement tax reform plan that I believe is better and simpler than SECURE 2.0.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2023 Solo 401(k) Update

There are some new developments in the world of the Solo 401(k). Here are the highlights:

SECURE 2.0 First Year Establishment Deadline for Schedule C Solopreneurs

Section 317 of SECURE 2.0 provides that for the 2023 year and later, a solopreneur reporting their business income and deductions on Schedule C can open a Solo 401(k) after year-end and make employee contributions as long as the Solo 401(k) is established and funded before the tax return filing deadline for the year. See page 2262 of the Omnibus bill.

SECURE 317’s deadline extension does not factor in any extensions.

Thus, for 2023, the deadline to establish and make employee contributions for the first year of a Solo 401(k) is April 15, 2024. However, the deadline to establish and make employer contributions for the first year of a Solo 401(k) is October 15, 2024.

UPDATE December 14, 2023: I Tweeted a thread about the provision that allows Schedule C solopreneurs to establish and fund a new Solo 401(k) with an employee deferral contribution after year-end. There is at least some concern that if one is diligent enough to establish a new Solo 401(k) prior to year-end they might not get the benefit of Section 401(b)(2)‘s funding deadline extension. If that is true (and to my mind this is an ambiguous issue), then the solopreneur establishing the new Solo 401(k) prior to year-end would need to either fund the employee contribution prior to year-end or elect to make an employee deferral contribution prior to year-end.

Note that Section 317 of SECURE 2.0 does not apply for 2022 and does not apply to years beyond the first year of a Solo 401(k).

Based on the wording of SECURE 2.0 Section 317, it is not initially clear if spouses who work in the Schedule C business qualify for the new deadline. I believe the IRS and Treasury may issue regulations clarifying this point.

New Solo 401(k) Employee Contributions Limit for 2023

The IRS announced that for 2023, the employee deferral limit for all 401(k)s, including Solo 401(k)s, will be $22,500. 

New Solo 401(k) Catch-Up Contributions Limit for 2023

The IRS also announced that for 2023, the employee deferrals catch-up contribution limit increased from $6,500 (2022) to $7,500. As a result, those age 50 or older can contribute, in employee contributions, a maximum of the lesser of $30,000 ($22,500 plus $7,500) or earned income. 

New Solo 401(k) All Additions Limit

The new all-additions limit for Solo 401(k)s is $66,000 (or earned income, whichever is less). For those aged 50 or older during 2023, the $66,000 number is $73,500 ($66,000 plus $7,500). 

2023 Update to Solo 401(k): The Solopreneur’s Retirement Account

On sale now, Solo 401(k): The Solopreneur’s Retirement Account explores the nooks and crannies of Solo 401(k)s. On page 16 of the paperback edition, I provide an example of the Solo 401(k) limits for 2022 if a solopreneur makes $100,000 of Schedule C income. Here is a revised version (in italics) of the example (with the footnote omitted) applying the new 2023 employee contribution limit:

Lionel, age 35, is self-employed. His self-employment income (as reported on the Schedule C he files with his tax return) is $100,000. Lionel works with a financial institution to establish his own Solo 401(k) plan and choose investments for the plan. Lionel can contribute $22,500 to his Solo 401(k) as an employee deferral (2023 limit) and can choose to contribute, as an employer contribution, anywhere from 0-20% of his self-employment income.

Lionel’s maximum potential tax-advantaged Solo 401(k) contribution for 2023 is $41,087! That is a $22,500 employee contribution and a $18,587 employer contribution. Note there’s no change in the computation of the employer contribution for 2023 in this example. 

On page 18 I provide an example of the Solo 401(k) contribution limits factoring in catch-up contributions. Here’s the example revised for 2023:

If Lionel turned 50 during the year, his limits are as follows:

  • Employee contribution: lesser of self-employment income ($92,935) or $30,000: $30,000
  • Employer contribution: 20% of net self-employment income (20% X $92,935): $18,587
  • Overall contribution limit: lesser of net self-employment income ($92,935) or $73,500: $73,500

Amazon Reviews

If you have read Solo 401(k): The Solopreneur’s Retirement Account, you can help more solopreneurs find the book! How? By writing an honest, objective review of the book on Amazon.com. Reviews help other readers find the book!

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

2023 Retirement Tax Reform

An Open Letter to the Members of the 118th Congress

Dear Senators and Congressmen,

Congratulations on your victories in the Senate and House elections. I write with respect to one aspect of your legislative endeavors in the 118th Congress: reforming our tax-advantaged retirement savings system. As you will see, much of it is antiquated and in need of reform.

Before I discuss the problems, allow me to briefly recite my qualifications to write you this letter. My primary qualifications are that I am an American citizen and taxpayer. My secondary qualifications include:

  • I am a financial planner and advise clients on retirement planning and saving.
  • I am the author of a book on one of the tax-advantaged retirement savings accounts, Solo 401(k): The Solopreneur’s Retirement Account.
  • I am a CPA (licensed in California and Virginia) and I have a Juris Doctor degree and a LLM in Taxation degree. My background is on my LinkedIn page.
  • I write a four year-old blog (fitaxguy.com) focused on tax planning for individuals, particularly the use of retirement accounts. 

The views expressed in this open letter are mine only. I have not been compensated for writing this letter and my views are not necessarily the views of any of the clients of my financial planning firm. 

Problems with the Current Retirement Savings System

Limits Are Unequal and Unfair

There’s a myth that Congress and IRS inflation adjustments determine the retirement plan contribution limits every year. If one looks at the Internal Revenue Code and the IRS website, they’d walk away with that belief.

But is that really true? It turns out that one’s employer often defines just how much an employee can get into tax-advantaged retirement accounts every year. In practice, the current system disproportionately benefits a privileged few.

Here are two examples (using 2023 limits) that prove my point in a stark fashion. Josh is a 50 year-old employee of a large Fortune 500 company with a $300,000 salary. Josh maxes out contributions to his traditional 401(k) at work and maxes out his Backdoor Roth IRA and Mega Backdoor Roth (available through his employer’s 401(k)). Further, Josh receives a 3% match in his employer 401(k). Here are what his annual retirement savings contributions look like:

401(k) Employee Deferral: $30,000

401(k) Employer Match: $9,000

401(k) Mega Backdoor Roth: $34,500

Backdoor Roth IRA: $7,500

Total traditional deductible contributions: $39,000. Total Roth contributions: $42,000. Total contributions: $81,000.

Sarah, single, is a 50 year-old non-profit executive director with a $150,000 annual salary and no workplace retirement plan. Under today’s rules, Sarah can only contribute a maximum of $7,500 to a deductible traditional IRA. That’s it! She may be able to make a partial Roth IRA contribution or a Backdoor Roth IRA contribution, but if she does, it reduces her maximum allowed deductible traditional IRA contribution. Thus, her total contributions are, at a maximum, just $7,500 for the year.

Sadly, there are many more workers in the latter situation than in the former situation. 

Because of their choice in employers, Josh gets to put more than 10 times the amount Sarah can into tax-advantaged retirement accounts.

Yes, that is today’s reality. It makes absolutely no sense. Long term, a system that disproportionately rewards workers at some employers and barely covers workers at other employers is not sustainable. 

Where you work should not increase your tax-advantaged retirement account contributions by more than 10 times!

Many retirement provisions benefit a very select few. Most of the time, those select few are among the people who need the least amount of help in achieving a successful retirement. Retirement tax advantages should have broad applicability and should not disproportionately reward any particular subgroup, particularly very small subgroups. 

Other Retirement Account Problems

  • Complexity and confusion (Ever fill out a Form 8606?)
  • Penalties and penalty exceptions that are outdated and not entirely rational
  • Remedies for problems with retirement accounts are neither taxpayer nor IRS friendly

Goals for Retirement Account Reform

Here are the goals I believe the 118th Congress should have in enacting retirement account reform.

  • Reduce complexity and confusion. Simplify the mechanisms of retirement savings. “Backdoors” should be eliminated because retirement savings should occur through direct, simple transactions. 
  • Increase retirement savings, particularly among Americans who have struggled economically over the past three years.
  • Effective yet modest changes. While it is tempting to throw out all the rules, a complete rewrite of the rules would create tremendous confusion and likely reduce, rather than increase, tax-advantaged retirement savings. 
  • Democratize retirement account contributions while acknowledging the role employers can play in offering retirement savings for employees. That said, there should be at least some shift of dollars away from contributions to employer plans towards contributions to individual retirement accounts.
  • Reform cannot simply be a massive tax cut. The federal budget cannot afford a massive tax cut. 
  • Special advantages available to very limited groups should be reduced and eliminated.
  • Remove punitive rules and traps for the unwary. 
  • There are too many penalties in the retirement account system that are too high, too punitive, and too confusing. My proposal attempts to reduce the number of penalties, give the IRS and taxpayers more common sense tools to mitigate them, and make the rules simpler and fairer. 
  • Reduce the competition between funding expenses attendant to having a child and funding retirement savings. 
  • Avoid slogans. Our tax rules are now far too complicated to say “everyone gets a tax cut” or “no one below X income will have a tax increase.” Besides, slogans belong to the politics of the 80s and 90s. 

While my primary audience is the members of the 118th Congress, please allow me to direct a quick word to my fellow American taxpayers who might lose out on an opportunity described below and thus might oppose these proposals. I ask potential opponents of this proposal this question: how sustainable is a retirement system that gives a select few Americans 10 times the tax-advantaged savings capacity as other Americans? 

Why fight to preserve your special tax break when the myriad special tax breaks make the entire system less and less sustainable? Does my proposal make everything entirely fair? Surely not, but, as you will see below, it makes the system much fairer and simpler. I believe that will make the system more sustainable over the long run, which is good for everyone. 

Lastly, retirement savings are far from the only component of the U.S. tax system needing legislative change. But, as you can see from my secondary qualifications above, retirement savings are of particular interest to me, so I’ll mostly limit my commentary here to tax law changes on retirement savings. 

Retirement Tax Reform Proposals

Expanded Universal Roth IRAs and Closing Backdoors

1. Eliminate the MAGI Limitation on annual Roth IRA contributions. Why is there an income limit on contributing to a Roth IRA, which does not produce a tax deduction? Further, removing the income limitation will align the United States Roth account rules with Canadian tax-free savings account rules. Canada does not have an income limit on the ability to contribute. Why should the United States? This proposal also ends the Backdoor Roth IRA. 

2. Increase annual IRA contribution limit (traditional and Roth) to $10,000, then index annually. It is time to shift retirement savings towards individuals. This will help expand individual and spousal contributions to retirement accounts, particularly Roth IRAs, and give individuals more control over their own retirement savings. This proposal makes individuals less reliant on their employer to offer a good retirement savings plan. 

In the 10 year budget window, proposals 1 and 2 will cost some money, but I suspect not a whole lot. In fact, this expansion of Roth IRAs might make Roths more attractive and cause some taxpayers to direct what would have been traditional, deductible 401(k) contributions to their Roth IRA, increasing tax revenue in the early years. 

3. Eliminate nondeductible contributions to IRAs and qualified plans, effective January 1, 2024. This ends Mega Backdoor Roth IRAs as of January 1, 2024. The Mega Backdoor Roth benefits only those few whose employers offer it and can afford to make after-tax contributions. The Mega Backdoor Roth, which only came to prominence starting in 2014, turbocharges the unfair advantages the retirement account system currently confers on a select few Americans (such as Josh in the example above).

As a result of eliminating the Mega Backdoor Roth, most of these contributions will be diverted to taxable accounts, which is not a horrible outcome for those currently taking advantage of the Mega Backdoor Roth. Further, those losing the Mega Backdoor Roth under this proposal gain expanded access to Roth IRAs under proposals 1, 2, and 4. 

4. Increase age 50 or older IRA (traditional and Roth) annual catch-up contribution from $1,000 to $2,000, index for inflation annually. The current $1,000 annual catch-up contribution limit is not enough move the needle in terms of likelihood of financial success in retirement. 

Eliminate Traditional Retirement Account Basis

5. Eliminate IRA Basis / after-tax 401(k) basis, effective January 1, 2027. The Pro-Rata Rule is an unnecessarily complicated rule for retirement account withdrawals. It has even created litigation. Basis record keeping is challenging and creates confusion. Enough already! 

This proposal eliminates retirement account basis recovery as of January 1, 2027. To be fair to those with retirement account basis, this proposal allows elective withdrawal of basis amounts from traditional retirement accounts (including inherited traditional retirement accounts) to taxable accounts during the 2024, 2025, and 2026 tax years. Any elective withdrawals of basis for the year would not count towards RMDs and could not be converted to Roth accounts. Regular withdrawals, RMDs, and Roth conversions in the year of an elective withdrawal of basis could not access existing basis. 

Eliminating basis eliminates page 1 of the Form 8606. This simplifies traditional retirement account withdrawals, inheriting traditional retirement accounts, and Roth conversions. In turn, this makes the retirement account provisions easier for the IRS to administer and easier for taxpayers to understand. 

Simplify and Rationalize Retirement Account Rules

6. Unify Roth account nonqualified withdrawal treatment such that the current Roth IRA nonqualified distribution rules apply to nonqualified Roth 401(k) distributions. The rules for Roth 401(k) nonqualified distributions are confusing, and can be avoided by rolling into a Roth IRA. Why not make them consistent?

7. Change the age for HSA catch-up contributions to age 50. Catch-up contributions to all accounts should kick-in at one, and only one, age. Make it age 50 for all accounts by changing the HSA catch-up contribution kick-in age from 55 to 50. Unifying the HSA/IRA/401(k) catch-up contribution age at age 50 makes the rules simpler. 

8. Unify rules for taking RMDs from traditional retirement accounts. Under this proposal, so long as the total required is taken during the year, it doesn’t matter which account (401(k), 403(b), IRA) or accounts the distributions come from. 

9. Eliminate NUA tax treatment. Net Unrealized Appreciation allows for employer stock in a 401(k) to get preferential tax treatment. As workers are already heavily economically tied to their employer (because of their salary and benefits), NUA treatment encourages something that probably should be discouraged (investing significantly in the stock of one’s own employer). Further, the NUA rules are complex. Removing them simplifies the tax code. 

10. Simplify treatment when spouses inherit a retirement account. Currently, there are three options and planning choices to be made when a spouse inherits a retirement account. The death of a spouse is challenging enough without having to make a complicated tax planning decision. New rule to simplify this: all retirement accounts inherited by spouses are deemed to be the inheriting spouse’s own retirement account as of the first spouse’s death. To prevent any early withdrawal penalties to surviving spouses under age 59 ½ due to this change, add a new 10% early withdrawal penalty exception: being widowed prior to age 59 ½. This new penalty exception applies to all widows and widowers for all pre-age 59 ½ retirement account distributions regardless of whether the widow/widower inherited a retirement account.  

11. Clarify the SECURE Act to provide that if the 10 year rule applies to an inherited account, RMDs do not apply to the account, other than in the final year of the 10 year window. The IRS came out with overly complicated proposed regulations requiring RMDs for many inherited accounts even though the 10 year rule applies to them. This clarification repeals the needlessly complicated proposed regulations, and the government’s interests are already adequately protected by the 10 year rule. 

12. Adopt a supercharged version of SECURE 2.0 Section 321. Allow the self-employed (generally those reporting self-employment income on Schedule C or through partnerships) to both establish a Solo 401(k) after year-end and make employee contributions to their Solo 401(k) before the tax return deadline for the taxable year. This eliminates the election required under Treas. Reg. Sec. 1.401(k)-1(a)(6)(iii). There’s no reason for a self-employed individual to have to make an election with themselves to make a retirement account contribution. This change would make the contribution deadline rules for self-employed employee contributions the exact same as the contribution deadline rules for self-employed employer contributions for every year (not just for the first year as Section 321 proposed to do). 

Combat Mega Retirement Accounts and Limit Benefits for the Very Rich

13. Eliminate (as of enactment) new tax-advantaged retirement account investments in private equity, venture capital, and companies 10% or more owned (by vote or value) by the account owner. These investments have allowed a very select few to accumulate hundreds of millions of dollars in IRAs. IRAs and qualified plans are best when they provide growth and capital preservation from diversified assets to fund retirement. They were never intended to create 9 figure-plus hoards of wealth sheltered from taxation. 

14. Required Accumulation Distribution (RAD) of 20 percent of the amount over $5M anytime all traditional accounts (IRAs and qualified plans) exceed $5M (indexed for inflation) at year-end for the following year prior to age 72. RAD of 20 percent of the amount over $5M anytime all Roth accounts (IRAs and qualified plans) exceed $5M (indexed for inflation) at year-end for the following year. Under this proposal, there would be no penalty on any RAD. RADs from Roths are treated as qualified distributions. This is much simpler than the Build Back Better proposals on mega retirement accounts. RADs from traditional accounts cannot be converted to Roth accounts. 

The hope is that after a while, there will be few, if any RADs. In a world without private equity and venture capital type investments in retirement accounts it will be quite difficult to accumulate in excess of $5M (adjusted for inflation) in either type of retirement account. The RAD rules do not need to apply to traditional retirement accounts at 72 and beyond, since the owner is already subject to the RMD rules. Inherited retirement accounts would be exempt from the RAD rules.  

Examples: Joe, age 65 in 2024, has $4.9 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. He also has $4.9 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. His 2024 RAD from traditional retirement accounts is $0, and his 2024 RAD from Roth retirement accounts is $0.

Sally, age 65 in 2024, has $7 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. She also has $4 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. Her 2024 RAD from traditional retirement accounts is $400,000 ($7M minus $5M times 20%), and her 2024 RAD from Roth retirement accounts is $0.

John, age 75 in 2024, has $7 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. He also has $7 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. His 2024 RAD from traditional retirement accounts is $0 (since he is 72 or older), and his 2024 RAD from Roth retirement accounts is $400,000. Under the existing rules (unchanged by this proposal), John is subject to RMDs in 2024 totalling $284,553 ($7M divided by 24.6) from his traditional retirement accounts (though see proposal 8 giving John more flexibility in terms of which account(s) he can take the RMDs from).

15. Cap at $25,000 the maximum annual amount that can be deferred by those with salaries (W-2, self-employment income) of $400K or more per year (indexed for inflation) under a Section 409A nonqualified deferred compensation plan. This rule change is logical considering (i) the tax law’s benefits for retirement saving have been too skewed towards helping a very affluent few who need the least amount of saving help, (ii) most of the beneficiaries of nonqualified deferred compensation plans are the ones doing best economically, and (iii) the need to provide more benefits of tax-advantaged retirement savings to a larger swath of Americans. Further, those losing a tax benefit because of this rule gain a significant benefit in the removal of income limits on Roth IRA contributions and the increased contribution limits. 

For administrative convenience, the new rule would not apply to any amount deferred at any time during one year and paid out at any time during the immediately following tax year.

Proposals 13, 14, and 15 raise revenue to expand the amounts that every worker can save in Roth IRAs, and some Americans will get increased deductible traditional IRA contributions because of proposals 2 and 4. 

Penalty Reform

16. New 20% penalty on all missed RADs and reduce the missed RMD penalty to 20%. The current 50% penalty on missed RMDs is unnecessarily punitive. 

17. Unify the exceptions to the 10 percent early withdrawal penalty so there is no difference between qualified plans and IRAs. It makes no sense that under current law there are some penalty exceptions only applicable to IRAs and some penalty exceptions applicable only to qualified plans. After this change, the only “plan only” exception would be the exception applicable to nonqualified 457(b) plans.

18. Change the Rule of 55 “separation from service” qualified plan penalty exception to be a broader, fairer age 55 need-based exception. Currently a 56 year-old CEO can leave their job and qualify for the penalty exception from their 401(k) but a 57 year-old teacher cannot qualify for the exception from an IRA. How does that make sense? 

New exception: Starting in the year one turns age 55, if AGI other than the taxpayer’s and/or their spouse’s potential Rule of 55 distribution(s) is less than $70K single, $110K MFJ (indexed for inflation), then the distribution (a “Rule of 55 distribution”) from the qualified plan or IRA is penalty free. Each person would have a $70K annual maximum (indexed for inflation) that could be accessed penalty free under this new, more rational Rule of 55 exception. In between $70K and $90K ($110K to $145K MFJ) of AGI (other than the potential Rule of 55 distributions), the $70K limitation per person is ratably reduced. 

The new Rule of 55 exception would be a Rule of 50 exception for public safety employees subject to the AGI limits described immediately above.

Eliminate Loopholes Benefitting Very Few

19. Age 15 requirement for IRA (traditional and Roth) contributions. Today a very few advantaged families can fund a retirement account for young children. Sometimes this takes the form of paying an infant a salary, which is at best questionable. Even with the elimination of this loophole, the family’s total annual Roth IRA contributions may be greater under this proposal. Instead of $6,500 per person ($19,500 total for family of 3), each parent can contribute $10,000 into a Roth IRA ($20,000 total). Of note, Canada requires being at least age 18 to make contributions to a tax-free savings account.

20. Eliminate the “super HSA” by deeming all persons covered by a HDHP other than the policyholder and their spouse to be a dependent of the policyholder for purposes of determining HSA contribution limits. The super HSA allows young adults covered by their parents’ high deductible health plans to put more into an HSA than most single HSA owners can. That’s not fair and illogical, and the super HSA is a loophole created not by Congressional intent but rather by the drafting technicalities used to create HSAs in IRC Section 223. 

Reform, Expand, and Simplify Qualified Birth Distributions

21. Reform, expand, and simplify SECURE Act Qualified Birth Distributions. Repeal as written in the SECURE Act. Capped at only $5,000 and confusing in their details, the current qualified birth distribution rules are not effective for parents. The new qualified birth distribution and recontributions rules would be as follows: 

For those under age 59 ½, up to $30,000 of distributions from qualified plans, SEP IRAs, SIMPLE IRAs, traditional IRAs, and Roth IRAs per parent distributed within 18 months (9 months before and 9 months after) surrounding a birth and/or an adoption are presumed to be a qualified birth distribution (QBD) and as such (i) are not treated as distributions in the year of the distribution (and not subject to tax withholding) and (ii) can be rolled back into the account by the end of the third year following the distribution. Amounts not repaid to the account are treated as distributions from the account at the end of that third year (including for estimated tax purposes), and are excused from the 10% early withdrawal penalty (if the penalty would otherwise apply to the deemed distribution). No mandatory reporting requirements for the parents (other than for any deemed distribution at the end of the third year), but the IRS is authorized to provide a voluntary reporting form reporting qualified birth distributions and qualified birth recontributions. The new law would authorize financial institutions and plan providers to rely on taxpayer representations for both distributions and recontributions in issuing Forms 1099-R and 5498 and accepting recontributions. 

This is a good idea for several reasons. It means saving for retirement is not a hindrance to financial security when adults are considering whether to have children. Our country is facing a decline in births. This proposal helps parents use retirement accounts to help during pregnancy and after childbirth while not handicapping their retirement. People can invest in Roth IRAs, for example, knowing that the money can be available for both the initial expenses of childbirth and their future retirement. 

Unfortunately, saving for birth and saving for retirement can compete. New, more robust and parent-friendly qualified birth distributions can reduce this competition and allow retirement savings to help during pregnancy and the first nine months after birth. 

Here is an example of how it could work: Robert, age 30, is the father of Mark, born February 2, 2024. On December 1, 2023, Robert withdrew $30,000 from his Roth IRA. At the time of the distribution, Robert had previously made $23,000 of annual contributions to his Roth IRA. Robert’s recontribution deadline is December 31, 2026. On April 2, 2026, Robert recontributes $20,000 to the Roth IRA, and makes no other qualified birth recontributions. On December 31, 2026, the $10,000 Robert did not recontribute to the Roth IRA is deemed to be a distribution from the Roth IRA to Robert. Robert took no other distributions from his Roth IRA prior to December 31, 2026. Since Robert had $23,000 of previous Roth IRA contributions to his Roth IRA as of the end of 2023 and may have made further annual contributions to his Roth IRA after 2023, the deemed distribution of $10,000 is deemed to be return of old annual contributions (under the nonqualified distribution rules) on December 31, 2026 and thus not taxable to Robert. The deemed distribution reduces Robert’s previous annual Roth IRA contributions by $10,000 for purposes of the nonqualified distribution rules as applied to any future nonqualified distributions. 

As a practical matter, the combination of this proposal and proposals 1 and 2 are likely to result in most QBDs coming from Roth IRAs. Thus, most QBDs not recontributed to the Roth IRA will simply be nontaxable deemed distributions of previous Roth IRA annual contributions. 

The new QBD rules would include rules providing that retirement account direct trustee-to-trustee transfers, rollovers, and Roth conversions occurring during the QBD 18 month window are not considered QBDs so as to preserve each parent’s $30K limitation. For simplicity’s sake, each birth and adoption will be treated as a distinct event for QBD purposes. Under this simplicity convention, parents of twins can each take up to $60K of QBDs. In addition, the QBD rules will have no adverse effect on the adoption tax credit. Funds sourced from a QBD for qualified adoption expenses will remain fully eligible for adoption tax credits based on the existing adoption tax credit rules. Lastly, a birth for QBD purposes will include the birth of a baby the parents give up for adoption. 

Expand and Rationalize Remedial Measures for Retirement Accounts

22. Adopt a supercharged version of SECURE 2.0 Section 308. Enact section 308 (expanding the IRS Employee Plans Compliance Resolution System) and add a self-correction safe-harbor (available both before an IRS exam and during IRS examination activity) whereby all individual traditional IRAs and Roth IRAs, and SEP IRAs, SIMPLE IRAs, 401(k)s, and qualified plans involving 10 or fewer individuals/employees (including Solo 401(k)s) automatically qualify for self-correction and forgiveness of all penalties so long as (i) the account owner/plan sponsor implements reasonable corrections (such as refunding excess contributions and attributable earnings penalty free, subject to ordinary taxable income inclusion — in the year of the corrective distribution — for earnings and any returned contributions actually deducted on a tax return or previously excluded from taxable income), and (ii) the total amount in the plan or IRA has never exceeded $500,000 as of any year-end. For this purpose, accounts would only be aggregated for a person or plan sponsor at the same financial institution. The new rules would provide that financial institutions can rely on taxpayer representations in issuing Forms 1099-R to report corrective distributions. Financial institutions will continue to compute attributable earnings as they do under current regulations.

This proposal reduces penalties (such as excess contribution penalties) and helps ensure plans and IRAs remain qualified. Self-correction is much better for taxpayers and the IRS, particularly when accounts are relatively modest in size. Currently, the IRS offers the Voluntary Compliance Program for qualified plans. Since VCP covers very large employer plans, it is a very odd fit for Solo 401(k)s and would be an odd fit for traditional IRAs and Roth IRAs. It is much better to encourage the use of self-correction. This encourages compliance, makes correcting mistakes easier, reduces penalties, and makes the IRS’s oversight of modest sized retirement accounts easier and more effective. 

23. Repeal and reform section 403 of the SECURE Act as applied to Form 5500-EZ filings. The SECURE Act increased penalties for late filed Form 5500 Series filings by tenfold. While this may make sense for large employer plans, the increase in penalties drastically overshot the mark when it comes to small businesses filing the Form 5500-EZ. Under the new law, a self-employed Solo 401(k) owner could (theoretically) be liable for a $150,000 penalty for failing to file a two page informational tax return (the Form 5500-EZ). Such a penalty is excessive and obscene. While relief procedures are available, it is ridiculous that the penalty could be, at least in theory, so onerous. Replace the current $250 per day penalty with a flat $500 per late Form 5500-EZ penalty (capped at $2,000 per plan sponsor) that can be excused for either reasonable cause or a first time abatement distinct to the Form 5500-EZ return. Cap the IRS period to assess the penalty at four years from the original filing deadline. Further, make the new rules effective to all missed Form 5500-EZ filings regardless of when they occurred. In addition, increase the asset threshold whereby a Form 5500-EZ is required from $250,000 to $500,000 to account for the passage of time and inflation. The Form 5500-EZ would still be required at the closing of the plan under this proposal, regardless of account size. 

Repeal Traps for the Unwary

24. Eliminate the once-a-year IRA to IRA 60-day rollover limit. It’s a trap for the unwary and by eliminating it, the rules would be synchronized for all rollovers. The once-a-year limit makes no sense (as the 60-day time limit is sufficient to police money coming out of retirement accounts) and is punitive and unnecessary. 

25. Repeal the SIMPLE IRA 25% penalty for early distributions within the first two years of establishing the SIMPLE IRA. Under this rule, the 25% penalty even applies to rollovers to traditional IRAs within the first two years. It’s a trap for the unwary and should be fully repealed. 

Miscellaneous

26. Do not pass (or repeal if passed) the rest of SECURE 2.0, the EARN Act, and other related proposals, other than as discussed above. My opinion is that SECURE 2.0/EARN Act introduced changes that were at best marginally beneficial for Americans saving for retirement. Unfortunately, SECURE 2.0 has counterproductive provisions (such as eliminating the tax deduction for 401(k) catch-up contributions) and increases the complexity of the retirement account system. 

Revenue Raisers (If Needed)

My hope is that my proposals would reduce federal revenue over the 10 year budget window by only a fairly modest amount, as there are provisions that would cost the government money and proposals that would increase revenue. If this nets out to costing too much money in Congress’s judgment, I recommend the following tax increase: an increase (starting in 2024) of the top capital gain/qualified dividend income rate (currently 20%) by the amount needed to close the gap. Considering that the highest earners have done the best in recent years, and do receive benefits under the overall proposal (see proposals 1, 2, and 4), this tax increase is fair and helps many Americans save for retirement by funding expansion of Roth IRAs and reduction of penalties.

If any other tax increases are deemed necessary, I recommend that Congress consider an increase to the rate of the corporate book minimum tax and/or a tax on investment income of college endowments comprised of $1 billion or more of assets. These two proposals shift the tax burden to those who have benefited the most from the American economy in recent years. 

Landscape After Retirement Account Reform

Let’s return to Josh and Sarah. What might their tax-advantaged retirement account contributions look like after my proposed reform. Here’s Josh’s contributions:

401(k) Employee Deferral: $30,000

401(k) Employer Match: $9,000

Roth IRA: $12,000

Total traditional deductible contributions: $39,000, total Roth contributions: $12,000, total contributions: $51,000. Yes, Josh lost his Mega Backdoor Roth IRA. But, now instead of a gimmicky $7,500 Backdoor Roth IRA, he gets to simply make a $12,000 annual contribution to a Roth IRA. Further, Josh did not lose any tax deductions under my proposal. Josh can invest the difference between $81,000 (his old tax-advantaged contribution total) and $51,000 (his new tax-advantaged contribution total), $30,000, in a taxable account.

Sarah has significantly increased the amount of her contributions. She goes from a $7,500 annual contribution to a traditional deductible IRA or Roth IRA to a $12,000 traditional deductible or Roth IRA contribution. 

Perfect? No. But instead of a 10.8 to 1 ratio we have moved the needle significantly such that the ratio is now 4.25 to 1. Further, many of the retirement account rules are simpler and fairer. If Josh, Sarah, or other Americans run into problems with their retirement accounts, their remedial paths are likely to be easier to navigate and they are more likely to avoid onerous and unfair penalties. 

I believe that our retirement system would be significantly better if Congress passes and the President signs the 26 proposals I outlined above in 2023. If any of you have questions about the above, I would be happy to communicate with you and/or your staff about these proposals.

To my fellow Americans reading this letter, I’d be honored to read your comments in the comments section below. I’m sure there are other ideas that could simplify and improve retirement accounts. 

Sincerely,

Sean Mullaney

This post does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Sean on New Podcast Episodes

This week I’m on episodes of The Stacking Benjamins Show and the Earn & Invest podcast talking about taxes, retirement savings, and my new book, Solo 401(k): The Solopreneur’s Retirement Account.

I’ve also recently recorded, and will record, several other podcast episodes with some great podcast hosts, so please be on the lookout for those.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter at @SeanMoneyandTax

This post and the podcast episodes referenced in it, are for entertainment and educational purposes only. They do not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

FI Tax Guy Featured on the Optimal Finance Daily Podcast

Today and tomorrow my year-end tax planning post will be featured on the Optimal Finance Daily podcast.

Listen to today’s episode on podcast players and here.

Read my year-end tax planning blog post here.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on Twitter: @SeanMoneyandTax

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here