SECURE Act Includes Retirement Plan Changes, Some Effective Immediately
On December 19, 2019, the President signed the SECURE Act. SECURE includes, among other things, provisions that are intended to make retirement plans more accessible, especially to smaller employers, address changing workforce demographics, address nondiscrimination issues facing defined benefit plans, encourage guaranteed income options under defined contribution plans, and increase penalties for noncompliance with certain plan filing and notice requirements. Some provisions are effective immediately, and some may require most plan sponsors to adjust administration for 2020. The provisions most broadly applicable are discussed below.
Retirement Plan Accessibility
A number of changes make it easier or less costly for employers to adopt or maintain plans.
Credits Enhanced. Beginning in 2020, employers with no more than 100 employees who start up a new plan can receive annual credits in the first three years of up to $250 for each non-highly compensated employee eligible to participate, capped at $5000. If the plan includes (or an existing plan adds) an auto-enrollment feature, a new $500 credit is available for the first three years in which the plan has an auto-enrollment feature.
Retroactive Plan and Safe Harbor Adoption. Beginning in 2020, an employer’s adoption of a plan (except for elective deferrals) is treated as effective on the last day of a tax year if adopted by the due date of the tax return for the tax year. Previously, qualified plans had to be signed and partially funded by the last day of the initial plan year to be in effect for that year. For plan years beginning after 2019, amendments to plans without existing matching contributions to provide for a nonelective 401(k) “safe harbor contribution” may be adopted as late as 30 days before the end of the plan year, or, if the employer is willing to make a contribution of at least 4%, as late as the end of the following plan year. SECURE also eliminates the safe harbor notice requirement for plans satisfying nondiscrimination requirements through nonelective contributions.
Auto-Escalation Nondiscrimination Safe Harbor. The 10% cap on elective deferrals that result from auto-enrollment and auto-escalation for a plan that satisfies the nondiscrimination safe harbor through an auto-enrollment and escalation design (“QACA”) has been raised to 15%. The cap on auto-enrollment for the initial year remains at 10%.
“Open MEPs.” Beginning in 2021, individual account (i.e., defined contribution) plans may be maintained by unrelated employers that use a “pooled plan provider” and will not subject to the “one bad apple” rule, under which the unresolved operational issues of one employer could disqualify the entire plan. In order to be eligible for this relief from the one bad apple rule, the plan must provide for the spin-off of the portion of the plan attributable to the employer with the unresolved disqualification issues into a separate plan; and the spin-off must occur, except in certain circumstances to be identified in future guidance. If the plan has disqualifying errors that result from the failure of the pooled plan provider to perform its duties, the entire plan may be disqualified.
The pooled plan provider must agree that it is a named fiduciary of the plan and responsible for ERISA compliance and compliance with qualification requirements, and must make sure employers take actions accordingly. It must also register with the IRS and comply with requirements regarding audits of the plan. Existing multiple employer plans will not be considered pooled employer plans unless elected and the plan and pooled plan provider meet the requirements.
The participating employers maintain responsibility for selecting and monitoring the pooled plan provider and for investments, unless the pooled plan provider delegates investment to another fiduciary. In addition, they must take any actions identified by the pooled plan provider or the DOL as necessary for the proper administration of the plan.
Special provisions make these plans easier to administer: the pooled plan provider is responsible for disclosures, which may be electronic, and only one 5500 is required.
Changing Workforce Demographics
Employees are living and working longer, and the number of employees working part-time has remained high, even after recovery from the recession.
Post-70-1/2 Contributions (IRAs). Beginning in 2020, there is no maximum age for contributions to a traditional IRA. However, any contributions after age 70-1/2 will reduce the qualified charitable distribution limit.
Age for Required Minimum Distributions (RMD) Raised. The age at which distributions must begin for terminated participants (and certain active participants) in employer-sponsored plans and IRA owners has been raised from 70-1/2 to 72. The new RMD rule applies to individuals who attain age 70-1/2 after December 31, 2019.
Part-time Employees. Effective in 2021, employees who meet the plan’s age requirements, if any, and have at least 500 hours of service in three consecutive 12-month periods must be allowed to participate and make elective deferrals into employer-sponsored 401(k) plans. However, these participants may be excluded for testing purposes, and they are not required to receive a matching contribution, and, if the plan is top heavy, the special vesting and contribution requirements would not apply to them. In determining years of vesting service for a participant who is a participant solely because of the new part-time employee rules, each 12-month period in which the employee has 500 hours of service will constitute a year of vesting service. These changes do not apply to collectively bargained employees. Hours of service must be counted for purposes of eligibility to participate beginning with the first 12-month period beginning on or after January 1, 2021.
Closed Defined Benefit Plans
Absent relief, many defined benefit plans that have been closed to new participants would have been forced to freeze benefits due to discrimination issues associated with the frozen plan becoming disproportionately composed of more highly compensated employees as the participant population ages or due to a failure to meet the minimum participation requirements due to participant attrition. Under SECURE, a plan that was closed before April 5, 2017, or existed for least five years before closing, with no substantial increase in benefits, rights, or features, benefits or coverage in those five years very generally:
— will have relief from the benefits, rights, and features nondiscrimination requirements if the plan meets the nondiscrimination requirements for the plan year of closing and the two following plan years and any post-closing amendment does not discriminate significantly in favor of highly compensated employees;
— will be able to take advantage of more permissive rules for aggregating the plan with defined contribution plans for purposes of testing nondiscrimination in benefits if the plan satisfies nondiscrimination in benefits and coverage for the plan year of closing and the two following plans years and any post-closing amendment of coverage or benefits provided does not discriminate significantly in favor of highly compensated employees; and
— will be considered to satisfy the minimum participation requirements, if the plan satisfied the minimum participation requirements at the time of closing.
Providing, Communicating and Preserving Lifetime Income
Guaranteed Retirement Income Contracts. With the closure or termination of defined benefit pension plans, employees have lost access to plans that provide for guaranteed lifetime income. While employers sponsoring defined contribution plans currently can provide guaranteed lifetime options, they have been reluctant to do so due to administrative complexity and fiduciary risk.
SECURE provides a safe harbor, which, if followed, will limit the fiduciary risk associated with providing a “guaranteed retirement income contract.” The safe harbor requires receiving specific representations from the insurer and evaluating reasonableness of the costs of the annuity relative to the benefits delivered and the financial soundness of the insurer at the time the insurer is initially selected. On an ongoing basis, the fiduciary must receive and review the insurer’s representations at least annually.
Communicating Lifetime Income. SECURE will require, for retirement plan participant disclosures provided 12 months or later after final guidance is issued, disclosure of the amount of an annuity (a QJSA, assuming a spouse of equal age, and a single life annuity) that a participant’s defined contribution could provide upon retirement. This disclosure will be required annually, and the Department of Labor is directed to develop assumptions and model disclosures within one year of enactment.
Preserving Retirement Income. SECURE provides for disposition of annuity contracts, should they no longer be available under a plan. Plans may distribute the contract in kind to the participant or to an eligible retirement plan, even if there is no distribution event, so long as the distribution or rollover occurs in the 90-day period prior to the elimination of the annuity option. SECURE also seeks to protect income for retirement by eliminating plan loan treatment for loans made through a credit card or similar process; this provision is effective immediately.
Other Provisions Broadly Applicable to Plans or Employees
Limitation on Non-Spousal “Stretch IRAs.” Generally, beginning with any deaths occurring after 2019, non-spouse designated beneficiaries of participants or IRA owners will be required to take a distribution of all a participant’s defined contribution plan account or IRA within ten years of the death of the participant/owner. There is an exception for disabled or chronically ill beneficiaries and for a beneficiary who is no more than ten years younger than the participant/owner; distributions over the beneficiary’s life expectancy continue to be available to these beneficiaries, as well as the participant/owner’s spouse. In addition, the 10-year period for minor beneficiaries does not begin until the child reaches the age of majority.
Penalty-Free Withdrawal for Birth/Adoption Expenses. Beginning in 2020, participants who withdraw up to $5000 from a plan will not be subject to the 10% penalty tax on early withdrawals if the withdrawal is taken to cover birth or adoption expenses. Presumably, plans will need to be prepared to address this new exception when reporting distributions for 2020. To be exempt from the 10% penalty tax, the participant must include the name, age and TIN of the child on the participant’s tax return for the year. To avoid qualification issues, where a distribution would not otherwise be permitted under a plan, the $5000 limit must be applied to aggregated distributions from all qualified plans of the employer and members of the employer’s controlled group, and the distribution must be made within one year of the child’s birth or the date the adoption is finalized. The SECURE provision includes the ability of the participant to repay the distribution, treating it as a rollover; more guidance is needed on the tax treatment and timing of this repayment.
Reporting/Notice Noncompliance Penalties Increased.
IRS penalties for failing to file Forms 5500 and to provide certain notices to participants were increased tenfold, effective for filings and notices due after 2019.