For many affluent individuals, retirement planning is not merely about ensuring a comfortable future, but also about preserving wealth for generations to come. Before the SECURE Act came into play in 2019, there existed a strategy to stretch qualified plan balances over the life of younger beneficiaries, enabling the continued growth of wealth. However, the SECURE Act and its subsequent iteration, SECURE Act 2.0, altered these rules significantly, mandating that these balances be withdrawn within a span of ten years post death for most non-spouse beneficiaries effectively eliminating the Stretch IRA. This alteration is poised to trigger accelerated tax bills, sometimes depleting the wealth intended for heirs.
To counteract this effect, a life insurance solution often becomes an essential component of estate planning with regard to retirement plan money. But for nearly a year, the planning community has been somewhat paralyzed due to the need for clarification on a few provisions in SECURE Act 2.0 – a law that was intended to further advance the intent of the original SECURE Act but left several questions unanswered. Fortunately, the IRS did address these concerns this past August with the release of IRS Notice 2023-62.
At Cedar Point Financial Services LLC, our team of planning specialists works with clients and their advisors to explain the recent updates and to structure solutions that take advantage of the new opportunities created by the IRS notice.
Understanding IRS Notice 2023-62
Within IRS Notice 2023-62, Section 603 of the SECURE 2.0 Act is highlighted. This section introduced a provision that required employees aged 50 or older, whose annual wages exceeded $145,000, to make catch-up contributions on a ROTH basis.
However, in response to industry requests for relief, the IRS proactively introduced an administrative transition period. This extension moves the compliance deadline to January 1, 2026, granting retirement plans an additional two years to adapt to and implement this rule. During this transition period, employees within the specified income bracket are not compelled to make ROTH-based catch-up contributions. Furthermore, plans that do not currently offer ROTH contributions will not need to introduce them until after the transition period concludes.
Weighing the Options: Pre-Tax vs. ROTH 401(k) Contributions
The extension of the compliance deadline offers affected employees the opportunity to make informed decisions regarding their catch-up contributions. Those with wages exceeding $145,000 can choose to direct their 401(k) catch-up contributions to pre-tax 401(k) accounts during the transition period. This option brings the advantage of income exclusion, resulting in immediate tax benefits. On the other hand, contributing to a ROTH 401(k) permits tax-free accumulation over the long term, potentially benefiting beneficiaries for up to a decade after the contributor's passing.
The choice between pre-tax and ROTH 401(k) contributions ultimately hinges on individual circumstances so it is important to work with advisors, such as those at Cedar Point Financial Services, LLC, who can analyze each client’s unique situation to provide tailored guidance. Fortunately, the transition period provides employees the flexibility to align their choices with their financial objectives and tax strategies.
Correcting a Glitch: Restoring Catch-Up Contribution Opportunities
Notice 2023-62 also addresses a technical oversight in the SECURE 2.0 Act. This inadvertent glitch could have potentially eliminated catch-up contributions for all employees starting in 2024. Recognizing this error, the IRS has taken corrective measures to ensure that catch-up contributions, whether pre-tax or ROTH, can continue to be made from 2024 onward. This intervention is crucial for maintaining the integrity of retirement planning options and preventing unintended disruptions for savers.
Clarity for Highly Paid Self-Employed Individuals
Another significant aspect of the notice pertains to highly paid self-employed individuals. The IRS intends to offer future guidance clarifying that those with self-employment income, rather than traditional "wages," are not subject to the mandatory ROTH 401(k) catch-up provision. This clarification is of paramount importance for self-employed individuals, ensuring they are not inadvertently caught within the scope of the provision.
Although this IRS notice has provided much-needed clarification, it remains that SECURE Act 2.0 potentially offers both opportunities and pitfalls when it comes to both retirement and wealth transfer planning. Cedar Point Financial Services LLC can help clients and their advisors to understand if changes need to be made to ensure that qualified funds are best positioned in personal planning.
The Role of Life Insurance in Wealth Replacement
To counteract the repercussions of accelerated distributions now required pursuant to the SECURE Act and to provide a tax-efficient solution for retirement plan beneficiaries, life insurance has emerged as an effective tool for wealth replacement. At Cedar Point Financial Services LLC, we recognize how life insurance can play a crucial role:
- Wealth Preservation: With the reduced ability to stretch inherited retirement accounts and defer taxes, beneficiaries likely face higher income tax burdens much sooner. A permanent cash value life insurance policy can provide beneficiaries with an income tax-free death benefit, helping to offset potential tax liabilities while optimizing the intended wealth transfer.
- Tax-Advantaged Growth: Cash value life insurance, including whole life, variable universal life, and indexed universal life, offers a tax-advantaged environment for wealth accumulation. Policyholders can build cash value over time, which can be accessed tax-free through policy loans and/or withdrawals to supplement retirement income or cover unforeseen expenses.
- Estate Planning: For those concerned about estate taxes, trust owned life insurance can provide liquidity to cover potential tax obligations without the need to liquidate other assets. This ensures a smoother transfer of wealth to heirs and helps protect the integrity of the estate.
- Flexible Beneficiary Designation: Unlike the restricted beneficiary options under the SECURE Act 2.0, life insurance allows policyholders to designate beneficiaries more flexibly. This means that beneficiaries can receive the death benefit according to the policyholder's wishes, while mitigating the new 10-year retirement plan distribution requirement upon death.
- Legacy Creation: Life insurance can be used to create a legacy by designating a charitable organization as a beneficiary. This aligns with philanthropic goals and can potentially result in estate tax benefits.
- Living Benefits: Many cash value policies include the ability to purchase low-cost riders to cover expenses stemming from long term care and critical illness needs. When qualifying to receive these benefits, a portion of the policy’s death benefit is accelerated tax-free to fund the needs.
We are Here to Help
IRS Notice 2023-62 shines a spotlight on the changes brought about by the SECURE Act 2.0, underlining the importance of reviewing and modifying retirement and estate planning strategies. Life insurance stands out as an effective tool for wealth replacement, offering beneficiaries tax-efficient solutions to mitigate the impact of newly required accelerated retirement plan distributions upon death. By carefully considering your financial situation and seeking professional guidance, you can navigate these changes and secure a more stable financial future for yourself and your heirs. At Cedar Point Financial Services LLC, we work with clients’ legal, accounting, and other advisors in developing and implementing strategies that optimize their legacies to family and community.