On December 20, 2019, federal legislation approving spending limits for the 2020 fiscal year was signed into law. Included in the legislation is the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”). The SECURE Act is the first law focused on retirement plans that has been enacted since the passage of the Pension Protection Act in 2006. Among other goals, the SECURE Act is designed to incite additional retirement savings and alleviate various administrative nuances. Key features of the new law include the following:
- The extension of plan participation rights to long-term, part-time employees;
- Providing various means to allow retirement funds to be held in tax-sheltered accounts for longer periods so as to better assure that individuals do not outspend their savings in retirement; and
- Implementing new rules to induce employers, and particularly small employers, to establish retirement plans for employees.
The majority of the new provisions will become effective for plan years, or for distributions, as applicable, occurring on or after January 1, 2020.
Those provisions of the SECURE Act that will be of particular interest to employers, and to their employees, are discussed below.
Allowing Long-Term Part-Time Workers to Participate in 401(k) Plans
Current Law. A retirement plan can by design provide for the exclusion of part-time employees who do not complete a year of service (i.e., employees who work less than 1,000 hours during an annual period measured from the date of employment). It has been observed that because women are more likely than men to work part-time, these exclusion rules unfairly deprive women of a means for preparing for their retirement.
New Law. 401(k) plans must now provide for a dual eligibility requirement under which an employee must be allowed to participate no later than upon the completion of either (i) a one year of service requirement (the current rule); or (ii) three consecutive years of service during which the employee completes at least 500 hours of service. The particulars of the new rules include those noted below.
- This new participation requirement only applies to the right of the eligible part-time employee to make elective deferral under a 401(k) plan.
- An employer is not obligated to make matching or non-elective employer contributions on behalf of the eligible part-time employees, even if such contributions are made on behalf of full-time employees.
- A plan can continue to impose a minimum age requirement in regard to the elective deferral feature (not to exceed age 21).
- The new participation requirements do not apply to employees within a collective bargaining unit.
- If an employer chooses to make matching or non-elective employer contributions on behalf of the eligible part-time employees, the employee is to be credited with a year of vesting service for purposes of any employer contributions that may be made on behalf of the participant for each 12-month period for which the employee has at least 500 hours of service.
- An employer may elect to exclude the part-time employees from applicable nondiscrimination rules, including the Actual Deferral Percentage (ADP) test, and from the top-heavy rules.
- The new special participation rules will cease to apply to a part-time employee as of the first day of the plan year beginning after the plan year in which the employee completes a year of service under the general rules.
Effective Date. These changes to the 401(k) plan rules become effective for plan years beginning on or after January 1, 2021.
Changes Preserving Retirement Savings
The SECURE Act includes a number of provisions designed to allow participants to keep funds in their retirement savings accounts for longer periods to better avoid the outspending of the savings.
A. New Required Minimum Distribution Age
Current Law. Code Section 401(a)(9) generally requires a participant in a qualified plan or an IRA owner to begin taking distributions upon reaching age 70½ (with the first distribution being due by April 1 following the plan year in which such age is attained). Age 70½ was first used in the retirement plan context in the early 1960s and has never been adjusted to take into account increases in life expectancy.
New Law. The required minimum distribution age is changed from age 70½ to age 72, effective for individuals who attain age 70½ after December 31, 2019.
B. Repeal of Maximum Age for Traditional IRA Contributions
Current Law. An individual who has attained age 70½ is prohibited from making contributions to a traditional IRA.
New Law. An increasing number of individuals now continue to work beyond customary retirement age, sometimes not by choice. To allow older workers to continue to save for their retirement, the maximum age prohibition is repealed.
Effective Date. The new rules are effective for contributions made for taxable years beginning after December 31, 2019.
C. Estimated Lifetime Income Disclosure for Defined Contribution Plans
Current Law. Employers presently are not required to provide plan participants with information as to how long their plan account balances are expected to last once they retire and begin receiving distributions upon retirement.
New Law. The new law requires that defined contribution plans furnish a lifetime income disclosure to participants at least once every 12 months. This disclosure notice would essentially provide an estimate of the monthly income the lump sum balance in the retirement account could generate over the participant’s expected lifetime.
The SECURE Act directs the Department of Labor (“DOL”) to issue model lifetime income disclosures, and to prescribe assumptions that may be used in converting participant account balances to lifetime income stream equivalents.
Effective Date. The new notice requirement will become effective upon DOL’s publication of an interim final rule or other related publications.
D. Fiduciary Safe Harbor for Selection of Lifetime Income Provider
Current Law. An initiative of the DOL is to make it more accommodating for employers to offer lifetime income options. Lifetime income options essentially offer an annuity to retiring participants. The payments under these annuities are guaranteed, predictable, and typically set to extend throughout a participant’s life (and often that of his or her surviving spouse as well).
Employers have been hesitant to offer lifetime income annuity options due to potential fiduciary liability for the selection of the annuity provider. Anticipating the financial solvency of the provider 20 or more years down the road when the income payments will continue to be made after retirement is difficult.
New Law. As a means of providing some protection to employers to allow them to view these lifetime income annuity options more favorably, the SECURE Act creates a new fiduciary safe harbor for employers who opt to include a lifetime income investment option in their defined contribution plan. Specifically, a fiduciary will be deemed to have satisfied its fiduciary requirements with respect to the financial capability of the insurer if the fiduciary receives certain written representations from the insurer, including that the insurer will undergo a financial examination by the insurance commission of the domiciliary state at least every five years.
Removing ambiguity about the applicable fiduciary standard eliminates a roadblock to offering lifetime income benefit options under a defined contribution plan.
Effective Date. This new safe harbor became effective upon the enactment of the law (December 20, 2019).
E. Timing of Distributions to Beneficiaries
Current Law. Benefits payable to a deceased participant’s beneficiaries can, in some cases, be paid over the beneficiary’s life expectancy.
New Law. As a revenue producing measure, the new law generally requires that survivor benefits payable from a defined contribution plan or IRA are to be made by the end of the 10th calendar year following the year of death of the participant or IRA owner.
The 10-year distribution requirement does not apply if the designated beneficiary is (i) a surviving spouse, (ii) disabled or chronically ill, (iii) an individual who is not more than 10 years younger than the participant or IRA owner, or (iv) a child of the participant or IRA owner who has not reached the age of majority.
Effective Date. The new rules are generally effective for distributions required by reason of a participant’s death after December 31, 2019 (after December 31, 2021, for governmental and certain collectively bargained plans).
F. Changes to 401(k) Safe Harbor Rules
The SECURE Act changes the rules governing non-elective 401(k) safe harbor contributions with an eye toward providing flexibility, improving employee protection, and facilitating adoption of new plans.
Current Law. An employer that intends to use the safe harbor 401(k) contribution rules for a plan year must provide a notice to participants before the beginning of the plan year. An employer generally may not adopt a safe harbor feature after a plan year has commenced.
- The new law eliminates the obligation of an employer intending to make qualified non-elective contributions (QNECs) to provide safe harbor notice requirement each year. A notice is still required for plans providing for qualified matching contributions.
- The new law also permits a plan to be amended to become a safe harbor QNEC plan at any time before the 30th day before the close of the plan year. A plan may also be converted to a QNEC safe harbor plan after that time if:
- the amendment provides for a non-elective contribution of at least 4% of compensation (rather than at least 3%) for all eligible employees for that plan year, and
- the plan is amended no later than the last day for distributing excess contributions for the plan year (that is, by the close of following plan year).
Effective Date. Effective for plan years beginning after December 31, 2019.
Changes Encouraging Adoption of Plans
A. Pooled Employer Plans
Current Law. Under current DOL rules, only “closed” multiple employer plans (“MEPs”) are permitted. To qualify as a MEP, the participating employers must share common organizational traits, such as being in the same industry or area or being members of the same trade association.
New Law. The SECURE Act removes the common nexus requirements and allows open MEPs for employers that don’t share common traits to be administered by the pooled plan provider. Specifically, the new law permits the establishment of “pooled plans” by authorized “pooled plan providers” to allow participation in the plan by unrelated employers. The pooled plan providers will need to register with the DOL and meet a myriad of other conditions. Importantly, the law expressly provides that the failure of one participating employer in the plan to comply with the applicable IRS qualification standards will not disqualify the entire plan and adversely affect the other participating employers (the “one bad apple” liability risk).
Effective Date. The pooled plan rules will apply to plan years beginning on or after January 1, 2021.
B. Increase to Small Employer Plan Start-Up Credit
Current Law. An eligible employer with 100 or fewer employees may receive a nonrefundable income tax credit for qualified start-up costs of adopting a new qualified retirement plan. The amount of the credit for a tax year is limited to 50% of the first $1,000 of qualified start-up costs incurred in that year. In other words, the maximum amount of the credit is $500 for each of the first three years of a plan. No credit is available after the third year.
New Law. The SECURE Act increases the amount of the start-up credit for each of the first three years to the greater of $500, or $250 for each non-highly compensated employee who is eligible to participate in the plan (not to exceed $5,000).
Effective Date. The increased credit is available for taxable years beginning on or after January 1, 2020.
C. Small Employer Automatic Enrollment Credit
Current Law. Automatic enrollment is shown to increase employee participation and result in higher retirement savings. There is no tax credit available for establishing an automatic enrollment feature in a plan.
New Law. The law includes a new tax credit of up to $500 per year to small employers (no more than 100 employees in the preceding year) to defray start-up costs for new section 401(k) plans and SIMPLE IRA plans that include automatic enrollment. The credit is also available to employers that convert an existing plan to an automatic enrollment design.
The credit is in addition to the plan start-up credit and will be available for three years.
Effective Date. The new credit is available for taxable years beginning on or after January 1, 2020.
D. Extended Deadline for Adopting a Plan
Current Law. An employer must generally adopt a qualified retirement plan for a plan year no later than the last day of the plan year.
New Law. An employer may now generally adopt a qualified retirement plan for a plan year by the due date (including extensions) of filing the employer’s tax return for the taxable year. A 401(k) feature of the plan, however, will still need to be adopted before elective deferrals are permitted.
Effective Date. This new rule is effective for taxable years beginning on or after January 1, 2020.
E. Combined Form 5500 Annual Reports for Group of Plans
Current Law. A Form 5500 annual report is required to be filed for each separate retirement plan.
New Law. The new law directs the IRS and DOL to effectuate the filing of a consolidated Form 5500 for similar plans. Plans eligible for consolidated filing must be defined contribution plans, with the same trustee, the same named fiduciary (or named fiduciaries) under ERISA, and the same administrator, using the same plan year, and providing the same investments or investment options to participants and beneficiaries. The change will reduce aggregate administrative costs, making it easier for small employers to sponsor a retirement plan and thus improving retirement savings.
Effective Date. The change is effective for Form 5500 annual reports to be filed for plan years beginning after December 31, 2021.
F. In-Service Withdrawals for Childbirth or Adoption Expenses
Current Law. Qualified retirement plans, including 401(k) plans, may allow participants to receive an in-service distribution in the case of a hardship or upon reaching age 59½.
New Law. The new law now permits, but does not require, plans, as well as IRAs, to allow for withdrawals for expenses related to the birth or adoption of a child. The withdrawal is limited to $5,000 for any qualified birth or adoption, and must be made within one year following the birth or legal adoption. The withdrawal will be taxable, but will not be subject to the 10% early distribution tax.
Subject to certain requirements, the in-service distributions may also be recontributed to an eligible retirement plan or an IRA that will accept rollovers. The recontribution does not need to be made to the same plan or IRA from which the withdrawal was made. Presumably, the recontribution will be treated as an after-tax contribution (because the withdrawal was previously taxed).
Effective Date. This new in-service withdrawal change becomes effective on January 1, 2020, for withdrawals made on or after that date.