Most of the literature about this Congressional Act dates to the first quarter of 2023 just after the law was enacted. We have deferred discussion because a fair number of provisions don’t come into effect until January 1, 2024. The law comes with its own ironies. Recall that in 2017 the Trump administration touted the need to simplify the tax laws and make them more understandable. That begot a silly half-page one of the Form 1040 which was finally abandoned in 2022.
Secure 2.0 also features a myriad of illusory changes which would seem to benefit the tax preparation industry more than the taxpayer. But, the changes may also benefit the family lawyer searching for a client’s retainer.
The key element here is “domestic abuse.” The Act allows plan administrators to alter their plans to permit withdrawals by individuals to fund expenses brought about by “abuse.” Curiously, the statute allows the taxpayer to “self-certify” status as an abused individual. It seems you don’t even need to file a complaint to claim the tax benefit Congress has conferred.
The tax benefit is not much. If you should avail yourself of this provision you can take up to $10,000 from your retirement account (401K/403B/457B) but not more than half the balance. On that $10,000 you will pay income tax at ordinary rates but will not be assessed the 10% early withdrawal penalty. The funds must be withdrawn within 12 months of the act of abuse. But in a world where you self-certify the abuse, what does that mean?
Next comes the plan administrator headache. The eligible taxpayer can recover the income tax if he or she repays the plan the sum withdrawn within three (3) years. Thus, the employer will need to establish a repayment management system for these withdrawals. In practical terms if the taxpayer takes the $10,000 and immediately begins to repay it over the next three years, the accountant will need to file amended returns to claim the money back. If you like to do dark thinking try this. Dependent spouse “abuses” the spouse who makes more money. The victim spouse takes a $10,000 withdrawal to move out or hire counsel. Is that not income available for support if there is a subsequent support order? Discuss.
If the $10,000 doesn’t quite fill the need, there is another provision to look at although this is capped at a measly $1,000. Section 115 of Secure 2.0 defines an “emergency expense” as an “unforeseeable or immediate financial need relating to necessary personal or family emergency expenses.” The retirement plan participant is responsible for self-certifying the qualifying event for the distribution, and only one distribution is allowed per year of up to $1,000. There is a definition of emergent need that includes what you would expect (health, death, eviction) but also includes purchase of a principal residence and educational expenses (?).
Last but not least, if you have a baby or adopt one each parent is eligible to take a withdrawal of $5,000 for a total of $10,000. Taxes apply, penalty is waived and you, too, can recover the tax amount if you repay within 3 years. But, if you are adopting your spouse’s kid you are an ineligible receiver and for some unexplained reason, retirement plans in Puerto Rico can’t play either.
Recall, this is all done to avoid the 10% early withdrawal penalty. If you take the money under Section 115 (emergency need) the amount in play is $100. And the regulations seem to say that you can’t do this if you or your kids have other resources, and you can’t take more than you will spend on the emergency; except you can take enough to pay the regular taxes associated with the withdrawal caused by the emergency.
There are also withdrawal provisions for certified natural disasters. That’s $100,000. So, we will end with a quiz question. You and your spouse are living in Lahaina, Hawaii in 2023 and you adopted a baby in May. In August, your house is caught in the fire. Distraught over the event, your spouse punches you in the head. What is your eligibility for withdrawals under Secure Act 2.0 and how much will you really save in taxes if you don’t repay in three years?
The legislation that fostered this relief was 4,000 pages long. Imagine how long the IRS will need to write the regulations addressing what amounts to waiver of a 10% early withdrawal penalty. Tax simplification indeed.