[co-author: Offi Ekah]

The IRS released long-awaited guidance under the SECURE 2.0 Act on December 20, 2023. Notice 2024-2 (Notice) provides clarification of various provisions, including several optional features that plan sponsors have been hesitant to implement without additional guidance. Below we focus on those topics covered by the Notice most likely to impact large retirement plan sponsors and service providers.

Plan Amendment Deadlines. The Notice extends the amendment deadline for changes implemented as a result of the SECURE Act, SECURE 2.0, and the CARES Act until December 31, 2026 (December 31, 2028 for collectively bargained plans and December 31, 2029 for governmental plans) as long as the plan operates in accordance with such amendments as of the effective date of the legislation’s requirements or the effective date of the plan amendment. These amendment deadlines also apply to IRA governing documents.

Roth Matching and Non-Elective Contributions. Beginning December 29, 2022, employers could offer participants in 401(k), 403(b) and governmental 457(b) plans the option to elect that matching or nonelective employer contributions be made as Roth (after-tax) contributions. Prior to this change, employers had to make matching and non-elective contributions on a pre-tax basis, although in-plan Roth conversions allow plan participants to achieve a similar result for plans that offer that feature. Some plan sponsors have expressed interest in this feature, but few plan sponsors have implemented it, as many questions remain. The Notice clears up a number of details regarding Roth employer contributions, including:

• The participant must be fully vested in their matching or nonelective contribution (as applicable) in order to elect that it be made on a Roth basis. The Notice confirms that if an employee is only partially vested in the contribution source, the employee cannot make the Roth election. The Notice explains that benefits, rights, and features testing relief will apply in the event this feature is added to a plan with a vesting schedule.
• The same rules that apply to Roth elective deferral elections apply to Roth matching/nonelective contribution elections. The employee must make the election before the contribution is allocated to the employee’s account, and the election must be irrevocable. In addition, employees must be given the opportunity to make or change their elections at least once per year.
• Plans do not have to offer Roth elective deferrals or in-plan Roth conversions in order to add this feature to the plan. Also, plans are not required to offer this feature.
• If an employee elects to receive matching or nonelective contributions as Roth contributions, the Roth contributions are treated as an in-plan Roth rollover and reported on Form 1099-R (and not a Form W-2) for the year in which the contributions are actually allocated to the employee’s account (even if the contributions are designated for a prior year).
• Roth contributions are not subject FICA taxes, and federal income tax withholding does not apply. However, the employee may need to adjust their tax withholding to avoid owing additional income tax at the end of the year.
• The taxable income resulting from the Roth contributions is not counted as Section 415 compensation.

Terminal Illness Distributions. SECURE 2.0 amended Section 72(t)(2) of the Internal Revenue Code to include a new exception to the 10% additional tax for early withdrawals from retirement plans (including IRAs) for participants who are terminally ill. The exception applies to distributions after December 29, 2022. The Notice makes several clarifications regarding this new provision.

Importantly, a terminally ill participant is still subject to the distribution restrictions that apply to 401(k) and 403(b) accounts, and can only take a distribution if they are otherwise eligible for an in-service distribution such as a hardship distribution or a disability distribution. In addition, the Notice describes the process through which an employee must certify their terminal illness. Generally, a physician must certify that the employee has a terminal illness before the employee takes the distribution. The physician’s certification must contain statements about the individual’s terminal illness as well as a description of supporting evidence. An employee’s self-certification is not sufficient. The Notice also confirms that employees can recontribute their terminal illness distributions, subject to rules similar to qualified birth or adoption distributions.

The Notice confirms that SECURE 2.0 does not require plans to permit terminal illness distributions. For example, an employer-sponsored plan or IRA might not have a process for certification of a terminal illness and such a plan or IRA might not indicate on the Form 1099-R that an otherwise permissible distribution satisfies the terminal illness exception. Eligible participants can still claim an exemption from the Section 72(t) tax via filing Form 5329 with their income tax return.

Small Financial Incentives for Plan Contributions. Starting in 2023, employers could begin offering financial incentives to encourage employees to contribute to a 401(k) or 403(b) plan, provided that the financial incentive is de minimis and not paid for with plan assets. Previously, under the applicable regulations, matching contributions were the only incentive that could be contingent on employee contributions. However, the IRS had not yet provided guidance on what might be considered “de minimis.” The Notice explains that “de minimis” means $250 or less in value, and clarifies that plan sponsors can only provide these types of incentives to employees who are not yet contributing to the plan. Plan sponsors cannot incentivize employees to increase their contributions via these financial incentives. However, the Notice states that an incentive can be paid in installments and conditioned on continued contributions, as long as the employee initially was not contributing to the plan. In addition, the Notice confirms that such financial incentives are still treated as taxable income to the employee to the extent otherwise taxable under the Internal Revenue Code, and that any applicable withholding obligations continue to apply.

Self-Correction for Automatic Enrollment Arrangements. Under the current Employee Plans Compliance Resolution System (EPCRS), plan sponsors are granted temporary relief related to the correction of automatic enrollment and automatic escalation errors. SECURE 2.0 made this relief permanent, providing that the plan sponsor does not have to make a corrective contribution with respect to the missed deferrals if the plan sponsor corrects the missed deferral by the later of (i) 9 ½ months following the end of the plan year in which the deferral error first occurs, or (ii) the first payment of compensation made to the employee on or after the last day of the end of the month following the month in which the participant notifies the plan sponsor of the error. The plan sponsor does, however, have to make up any missed matching contributions the participant would have received had the error not occurred. The Notice explains that these corrective matching contributions must be made within a reasonable period from when the correct deferrals begin (six months following the date corrective deferrals are made will typically be considered reasonable, with special extensions that apply to errors that began before the end of 2023). The Notice also clarifies that this permanent relief can apply to both active and terminated employees.

New Plan Auto-Enrollment. Effective for plan years beginning after December 31, 2024, 401(k) and 403(b) plans established on or after December 29, 2022 are required to include an automatic enrollment feature. There are certain exceptions, including an exception for grandfathered cash or deferred arrangements that were established before December 29, 2022. The Notice provides guidance on these grandfathered arrangements, including how plan mergers might impact a plan’s grandfathered status. Generally, if two grandfathered plans are merged together, the ongoing plan will continue to be grandfathered, and will not be required to include an automatic enrollment feature. However, a merger of a plan that is not grandfathered into a plan that is grandfathered will cause the surviving plan to lose its grandfathered status, unless (i) the merger occurs within the Section 410(b)(6) transition period, and (ii) the grandfathered plan is designated as the ongoing plan that survives the merger. The Notice also clarifies that a plan spinoff will generally not cause the resulting spinoff plan to lose its grandfathered status.

The Notice also provides helpful clarifications on a number of other provisions that apply to smaller employers, including the small employer start-up costs credit, the small employer military spouse credit, increased limits under SIMPLE 401(k)s and IRAs, and details on expanding SIMPLE IRAs and SEPs to permit Roth contributions. The Notice also provides guidance on the cash balance plan amendments made by SECURE 2.0.

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