Despite a bruising 2022 for investors, the new year offers a number of important tax and retirement opportunities for wealth building, thanks to the passage of major legislation and a flurry of year-end tax changes.
Jeffrey Levine, the chief planning officer at Buckingham Wealth Partners, addressed some of these changes in a Kitces.com webinar Monday, speaking to some 2,000 advisors who had logged in to hear about tax hacks. (Levine is also the “lead financial planning nerd” at Kitces.com.)
He said one notable opportunity for estate and retirement planning is the year-end change allowing tax-free rollovers from 529 plans to Roth IRAs starting in 2024.
The new provision eliminates the income limits on Roth creation that have hamstrung wealthy investors and kept them from using the tax-free accounts. It was passed as part of the SECURE Act 2.0 provisions in the $1.7 trillion federal omnibus spending package that President Biden signed into law December 29.
While 529 funds are supposed to be earmarked for education expenses, the new Roth IRA transfer provision provides a workaround for parents or grandparents who worry that funds will be stranded in 529 plans by children who don’t use them. Without the provision, the growing, unused funds would be taxed at the investor’s income tax rate—and if the funds were used for ineligible expenses, the money would get hit with a 10% tax penalty.
While 529 plans are required to be funded for 15 years or more, “it appears that if someone has a plan on the books and changes beneficiary, the transfer to a Roth IRA would not start the clock again,” Levine said.
In addition, 529 plan owners with leftover account funds can also change beneficiaries to another qualifying family member, including themselves or a spouse, which increases opportunities for investors to transform their 529 plan Roth transfers into estate planning vehicles.
“This bodes well for advisors to recommend that clients open a 529 plan today. Just get the clock started. Jump-start that 529 plan clock,” Levine said.
Because the Roth IRA income limits ($153,000 for single filers and $228,000 for joint filers in 2023) do not apply to this transaction, even ultra-high-income investors who have been held back from creating Roths could do so using the 529 plan transfer.
“You can make $1 million or more a year as a beneficiary and it won’t stop you from doing this transfer, although it does appear that the beneficiary will have to have earned income in the year of the transfer to be able to effect the transfer. I expect Congress to address this at some point, but for now earned income is a requirement,” said Levine, who noted that the maximum lifetime transfer per investor is $35,000.
The point is to establish and maintain 529s early, “akin to the $1 Roth IRA,” he added, referencing the small balance you can use to start a five-year clock for using converted Roth money.
Beneficiaries of the transferred Roth IRA would be subject to the new required minimum distribution rules at age 72 or later, depending on their year of birth, but could still benefit from years or even decades of tax-free accumulation.
For example, an 18-year-old who was named as the beneficiary of a 529 plan transfer to a Roth could experience 57 years or more of tax-free growth until they have to begin taking RMDs—and they could make a $6,500 Roth IRA contribution annually to boot, Levine said.
With RMDs getting pushed back again, it impacts just about every client, he added.
For investors who were born between 1950 and 1959, the SECURE Act 2.0 pushes the required minimum distribution age to 73. For those born in 1960 or after, the new RMD age beginning in 2024 is 75.
“No one has to start RMDs in 2023,” Levine said, noting that a quirk of the legislation left “an empty year for RMDs.”
The new provisions can create a meaningful estate planning opportunity, especially for clients who are younger and don’t need the distributions, and for those surviving spouses and beneficiaries who want to stretch out RMD-free periods on inherited assets.
For example, beginning in 2024, a new SECURE 2.0 provision allows surviving spouses to be treated differently for RMD purposes, effectively delaying the distributions until the surviving spouse would have reached RMD age.
So if one spouse dies before their RMDs began, the surviving spouse can stretch out RMDs using the uniform lifetime table, which will produce much lower RMDs. “This will allow younger spouses to reflect their age, not the decedent’s, he said.”
“The election should be treated as irrevocable until we know otherwise,” Levine added. Depending on the client, “what is most important is penalty-free distributions or avoiding RMDs for as long as possible.”
In another win for investors, the IRS created a higher threshold for 0% long-term capital gains late last year. That means investors who are planning to sell assets from a taxable portfolio in 2023 will be less likely to trigger a tax bill for gains.
To address inflation, the IRS raised income thresholds for 0%, 15% and 20% long-term capital gains brackets for 2023. These rates are are applied to profitable assets that investors sell after owning them more than one year.
For the 2023 tax year, you may qualify for the 0% long-term capital gains rate with taxable income of $44,625 or less for single filers and $89,250 or less for married couples filing jointly.
Single filers with taxable income of $44,625 to $492,300 and joint filers between $89,251 and $553,850 qualify for a 15% long-term capital gains rate, while single filers with taxable income of $492,301 and joint filers with taxable income of $553,851 or over will pay a 20% long-term capital gains rate, the IRS said.
The higher income thresholds give investors more leeway to make decisions based on strategic asset allocation, rather tax avoidance, advisors said.