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Beware the Pitfalls of Secure 2.0: Wade Pfau

By Jane Wollman Rusoff

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The Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act delivers a host of beneficial changes for retirement savings. But the legislation is not without pitfalls, as Wade Pfau, co-founder of Retirement Income Style Awareness Profile and Retirement Researcher, tells ThinkAdvisor in an interview.

For example, the Secure 2.0 Act lets investors convert a 529 college savings plan to a Roth IRA.

“When it was first mentioned in the media, people reacted, ‘Oh, wow! I can convert my 529 plan to a Roth IRA!’” he said. “But you may be surprised about the many restrictive rules.”

Pfau, principal and director of retirement research at McLean Asset Management, recently released the second edition of his book “Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success” (Retirement Researcher Media, March 2023).

At nearly 500 pages and weighing about a pound and a half, the comprehensive book incorporates the latest changes relevant to retirement.

Safe to say the author answers virtually every question both consumers and financial advisors can come up with about retirement planning to date.

In the interview, Pfau, co-host of the “Retire With Style” podcast, discusses the Secure 2.0 Act’s raising of the starting age of required minimum distributions from retirement accounts from 72 to 73, the reduction in RMD penalties and lifting the RMD requirement from 401(k) plans.

He also explains other Roth 401(k) changes, as well as Secure 2.0 Act’s providing that some catch-up contributions are to be inflation-adjusted.

As for more pitfalls, here’s one about catch-ups: High earners can put them in Roth accounts only.

The Secure 2.0 Act was signed into law in December 2022 as an expansion of the Secure Act passed in 2019.

Will there be a Secure 3.0 Act? Pfau opines on that question.

ThinkAdvisor recently held a phone interview with Pfau, a professor at The American College of Financial Services for more than a decade, who earned a doctorate in economics from Princeton University. He was speaking from his base in Dallas.

Besides getting into the weeds of the Secure 2.0 Act, he furnishes some enlightening statistics about the ages that folks are claiming Social Security now, a sign that they are perhaps approaching the decision “more strategically.”

Here are highlights of our interview:

THINKADVISOR: Signed into law in December 2022, the Secure 2.0 Act brought numerous changes to retirement saving. When will they go into effect?

WADE PFAU: [The Secure 2.0 Act] created a number of changes that will be introduced at varying points. It’s crazy: Some were effective immediately; some were effective at the start of this year; some are effective at the start of next year or in later years.

Some things don’t start till 2024 or 2025, and there are even some that don’t start until 2026 or 2027.

What’s the biggest change?

It might be increasing the required minimum distribution’s [from traditional IRAs and other qualified retirement accounts] starting age from 72 to 73 because it’s a change that affects the most people.

In 10 years, the age will be 75, depending on birth year.

What other changes concern RMDs?

RMD penalties are substantially reduced. Before, if you didn’t take your RMD, there was a 50% excise tax on it.

That’s been reduced to 25% and in several cases, 10%.

When it comes to Roth 401(k)s, the Secure 2.0 Act says that no RMDs are required during the owner’s lifetime. That brings more flexibility, doesn’t it?

Yes. But that won’t start until next year [tax year 2024]. So in 2023 you still have to take an RMD on a Roth 401(k).

In the past, if you had a Roth 401(k), you had to take an RMD, but you could avoid that by doing a rollover to a Roth IRA.

Now, because there are no longer RMDs on Roth 401(k)s, you don’t have to do that.

This can be valuable for tax planning. Right?

Yes. If you want to leave money in your Roth 401(k), now you can because you don’t have to worry about RMDs.

Another positive is that now employer contributions can be made to Roth accounts. When does that begin?

This year. Before, employer contributions could only go to regular IRAs; they weren’t allowed in Roth accounts.

This is a positive change, but it will increase your taxable income. The employer puts money in, and now you have to pay taxes on it.

What other Secure 2.0 Act changes are helpful for retirement saving?

Some of the catch-up contributions that were not inflation-adjusted now will be. Also, qualified distributions for charities will start to be inflation-adjusted next year.

In the past, you didn’t get inflation adjustments on catch-up contributions or on qualified charitable distributions.

Are there any other significant Secure 2.0 Act changes but ones that are unrelated to retirement savings?

The [tax-advantaged] ABLE account [Achieving a Better Life Experience] for people with disabilities now has a relaxed age restriction: The maximum age for the start of a qualifying disability has been increased [from 26 to 46].

But that doesn’t happen until 2026. This is an example of a change that won’t go into effect for a while. There’s no clear reason why they decided that — it’s an easy change to make.

Are there any pitfalls to be aware of regarding the Secure 2.0 Act?

You can interpret as slightly negative the new rule for catch-up contributions for 401(k)s and 403(b)s starting in 2024. High earners can put them in tax-exempt Roth IRAs only.

The rule is: As of this year’s income level, if you earned more than $145,000 from your employer the previous year, your catch-up contribution amount — not your whole contribution — would be required to go into a Roth.

Why is that negative?

Usually, when you’re at a higher income level, you may want to get the tax deduction today with the idea that you may be in a lower income tax bracket in the future and pay taxes then.

The other negative is that not every employer offers the Roth option. If your employer doesn’t, you won’t be allowed to take the catch-up contribution.

The Secure 2.0 Act created opportunities to convert 529 plan funds [for college savings] to a Roth IRA starting in 2024. Any drawbacks?

When it was first mentioned in the media, people reacted, “Oh, wow! I can convert my 529 plan to a Roth IRA!”

But you may be surprised about the many restrictive rules.

For example, it counts as your Roth contribution for the year. So you can’t do this in addition to just contributing money to a Roth.

And you had to have had the account open for at least 15 years. We need Treasury guidance about this because it’s not clear [whether] if you change the beneficiary, it resets the clock on the 15 years.

Also, some people may worry: “I don’t want to put money into a 529 plan because maybe I’ll end up not needing [the funds] for my child’s education expenses.”

That’s a concern because before, there would be a 10% penalty to take the money out, whereas now, there are limited opportunities for when you can move 529 plan funds to a Roth IRA and not have to pay a 10% penalty.

Some industry members are calling for a Secure 3.0 Act. They feel more details need to be addressed, such as the issue of automatic enrollment in 401(k) plans and the default savings rate. Do you expect a 3.0 any time soon?

They could make more minor adjustments, but I don’t think there’s anything really pressing, like something they should have had in 2.0 that they didn’t include.

I think they made most of the changes they wanted to make.

It will take some time to develop a new list of changes. There aren’t things that people thought were going to be in 2.0 that were skipped.

Let’s turn to some useful ideas about Social Security that you bring up in your “Retirement Planning Guidebook.” You write that delaying benefits can work as an “investment” by helping to “improve portfolio sustainability and returns.” Please elaborate.

If you give up receiving Social Security benefits for [a certain] time, you get a permanently higher benefit. Consider the implied return on the benefit you’re giving up and the benefit you’ll subsequently receive.

Once you live into your early 80s, the implied return is starting to look pretty good. You’re getting some of those higher benefits, including beating the returns that bonds can provide.

By the time you get into your 90s, the implied return from the higher Social Security can be competitive with the stock market [returns].

For example, if you claim Social Security at 70 instead of 62, you give up eight years of benefits. But the [buildup of those benefits] will provide you with an annuity that has a larger benefit for the rest of your life starting in your 70s.

Suppose you decide that you want to delay taking Social Security until age 70 but then change your mind and want to start receiving it at 67. Is that sort of change possible?

Once you’re past full retirement age, you have an option.

For instance, if you suddenly need a big chunk of money, you can apply for Social Security retroactively for up to six months and then get six months’ worth of benefits all at once.

Fewer people are claiming Social Security at age 62 than they were in the past. Why is that?

It used to be that more than half claimed at 62. But since 2010, that [percentage] has been dropping dramatically. Now, under 30% are claiming at 62.

I think it’s because more people are getting educated about Social Security.

The other thing is that for years and years, only around 6% of people waited past their full retirement age to claim. At around 2010, that started going up. Now it’s 24%.

So people are learning that they shouldn’t just claim Social Security as soon as possible. They should think about it more strategically.

Could it be, partly, that financial advisors are recommending that clients wait?

That’s definitely going to contribute to these trends somewhat. But I don’t know how big a factor it is.

What percentage of people have a financial advisor?

And of those, what percentage are actually making suggestions about Social Security claiming?

(Pictured: Wade Pfau)

Jane Wollman Rusoff

@jrusoff2

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