The SECURE Act Brings New Opportunities for Workplace Retirement Plans
By now, most employers know that the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became law on December 20, 2019, as part of a federal budget and spending bill (H.R. 1865). The SECURE Act is landmark legislation that affects the rules for creating and maintaining workplace retirement plans for all employers — including for-profit and tax-exempt employers of all sizes. In a nutshell, the SECURE Act eases employers’ administrative burdens for operating workplace retirement plans and encourages plan participation. Some of the SECURE Act changes in the law are most beneficial to smaller employers, while other provisions address changing workforce demographics, such as longer life expectancies and long-term part-time employees in what is often called the “gig” economy.
Whether you currently offer your employees a retirement plan (or are planning to do so), you should consider how these new rules may affect your workplace retirement savings program (or your decision to create a new one). We have summarized some of the planning opportunities under the SECURE Act for employer-sponsored retirement plans with broad applicability.
Different Effective Dates For Plan Documents vs. Plan Operations
The SECURE Act makes 30 changes to retirement plan law, affecting tax-qualified defined benefit (DB) plans (such as cash balance plans and traditional pension plans) and defined contribution (DC) plans (such as 401(k) plans, employee stock ownership plans (ESOPs), 403(b) plans and 457(b) plans) and individual retirement accounts (IRAs). Some of these changes are effective immediately, while others are effective in plan or tax years beginning on or after January 1, 2020, 2021, 2022, or later. Generally, amendments to written plan documents are not required until the last day of the 2022 plan year (2024 for governmental plans). However, plan administration must be updated to reflect the SECURE Act’s provisions by the applicable effective date of each change, even if the plan amendment deadline is later.
Employers can expect to hear from their retirement plans’ third-party administrators (TPAs), recordkeepers and other service providers about how SECURE compliance changes to their systems will impact their services, as well as whether any new documents need to be executed to implement SECURE Act changes.
What Should Employers Be Doing Right Now?
The SECURE Act requires employers to take action with respect to certain plan administrative changes, employee notices and plan amendments. Right now, employers should educate themselves about the SECURE Act provisions, prioritize those which have an immediate impact, evaluate the new features and consider plan design changes.
Opportunities To Expand Workplace Savings
The SECURE Act encourages workplace retirement plan access and participation in several new ways, which are discussed below.
Increasing QACA Auto Enrollment Safe Harbor Cap
An annual nondiscrimination test called the actual deferral percentage (ADP) test applies to elective deferrals under a 401(k) plan. The ADP test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or qualified non-elective contributions (QNEC) safe harbors. Automatic enrollment can be part of a safe harbor plan design called a “qualified automatic contribution arrangement” (QACA). For plan years beginning after December 31, 2019, the SECURE Act increases the maximum default contribution rate under a QACA from 10 percent to 15 percent for years after the participant’s first deemed election year.
Covering Long-Term Part-Time Employees In 401(K) Plans
Generally, tax-qualified retirement plans must cover all employees who work at least 1,000 hours per year unless they are not yet age 21. Starting for plan years beginning after December 31, 2020, the SECURE Act will require 401(k) plans (other than collectively bargained plans) to also cover employees who have worked at least 500 hours for three consecutive years starting after December 31, 2020. No employer contributions (not even top-heavy minimum contributions) are required until the employee satisfies the plan’s normal eligibility requirements. A special vesting rule that also applies to these individuals seems to provide vesting credit at 500 hours of service (but guidance is needed on how this provision works).
Relaxed QNEC Safe Harbor Rules
QNEC safe harbor plans generally are deemed to pass certain nondiscrimination tests that would otherwise apply.
Starting in 2020, employers can amend their 401(k) plan into being a QNEC safe harbor plan “mid-year,” so long as the amendment is adopted (1) no later than 30 days before the end of the plan year; or (2) after that date but before the last day for distributing excess contributions for the plan year (i.e., by the close of the following plan year), but only if the QNEC is at least 4 percent (instead of 3 percent) of participants’ compensation. In other words, instead of amending before the end of the current plan year, employers can amend their plan up until the end of the following plan year-end if they make a 4-percent contribution to all eligible employees rather than a 3-percent contribution.
Also, starting in 2020, plans that use the QNEC safe harbor are no longer required to give employees a written safe harbor notice before the start of each plan year.
Delay Of Required Minimum Distributions (RMDs)
Before the SECURE Act, RMDs generally had to start by April 1 of the calendar year following the calendar year in which an employee reached age 70 ½. The SECURE Act increases the age at which RMDs must begin from age 70 ½ to age 72. This change applies to individuals who attain age 70 ½ after December 31, 2019. The exception that allows active employees who are not 5-percent owners to delay RMDs until the separation of employment is unchanged.
Elimination Of Extended Payouts To Young Beneficiaries
For distributions made with respect to DC plan participants who die after December 31, 2019 (December 31, 2021 for collectively bargained and governmental plans), the SECURE Act changes the RMD rules to generally require that all distributions (except for payments to certain beneficiaries) must be made by the end of the 10th calendar year following the year the participant died. “Eligible designated beneficiaries” are not subject to the new 10-year rule. Eligible designated beneficiaries include the surviving spouse, minor children, certain chronically ill or disabled beneficiaries, and individual beneficiaries who are not more than 10 years younger than the deceased participant. Eligible designated beneficiaries may continue to receive RMDs over their life expectancy, provided however, that the account balance must be distributed within 10 years after the death of the eligible designated beneficiary or, in the case of an eligible beneficiary who was a minor child, within 10 years after such child reaches the age of majority (determined under applicable state law).
This change in the law eliminates what is often referred to as a “stretch payment.” Such payments typically were structured so that, upon the participant’s death, RMDs would be paid over the life expectancy of a much younger designated beneficiary (such as the participant’s grandchild). Smaller annual RMDs resulted, which allowed for continued tax deferral on the retirement account assets while they continue to appreciate.
Employers Can Adopt A Retirement Plan Up Until Their Tax Return Due Date, Plus Extensions
One of the most welcome SECURE Act changes for employers is that, for tax years beginning in 2020, employers can retroactively adopt a new qualified retirement plan as late as the employer’s extended federal income tax filing deadline. Except for salary deferral plans (because salary deferrals can only be made prospectively), the new plan can be retroactively effective as of the beginning of the tax year for which the tax return is being filed.
Increased Tax Credits For Having A Retirement Plan
Effective for tax years beginning after December 31, 2019, small employers (i.e., employers with 100 or fewer employees) may be entitled to a new non-tax credit of up to $500 per year for the first three years that they put in place an automatic enrollment feature in a DC plan (like a 401(k) plan or SIMPLE IRA). Automatic enrollment has been shown to increase employee participation and result in higher retirement savings.
The automatic enrollment tax credit is in addition to an existing tax credit for small employers that start a retirement plan, such as a tax-qualified retirement plan, Simplified Employee Pension (SEP) or SIMPLE. Effective for tax years beginning after December 31, 2019, the SECURE Act increases the small employer tax credit to encourage small businesses to set up retirement plans. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit on the credit to the greater of (1) $500, or (2) the lesser of: (a) $250 multiplied by the number of non-highly compensated employees (NHCEs) who are eligible to participate in the plan, or (b) $5,000. The credit applies for up to three years.
Lifetime Income (Annuity) Options In DC Plans
As workplace retirement benefits have shifted over the years from being mostly provided by traditional DB plans to being primarily offered through DC plans, and as the workforce lives and works longer, the retirement industry has emphasized the need to educate DC plan participants about the importance of lifetime distribution options, so they do not outlive their retirement savings. The SECURE Act made three changes in the law to address lifetime income issues.
- The SECURE Act encourages DC plan sponsors to offer lifetime income during retirement by creating a new ERISA fiduciary safe harbor for employers that include such options in their plans. The new safe harbor became effective on December 20, 2019.
- The SECURE Act allows DC plan participants to make in-service, direct trustee-to-trustee transfers of lifetime income investments (or annuity transfers) to an IRA or other retirement plan or to receive a distribution of that investment option if the plan discontinues offering that particular investment option. The transfer or distribution must be made within 90 days after the date when the lifetime income product is no longer authorized to be held as an investment option under the plan. This change is effective for plan years beginning after December 31, 2019; before this change in the law, with certain exceptions, participants generally could not make in-service transfers or take a distribution of just one investment option.
Increased IRS Retirement Plan Penalties
To pay for some of the SECURE Act provisions, some of the more common potential IRS maximum penalties related to retirement plans have increased significantly (i.e., by 10 times). These changes are generally effective for returns, statements and notices required to be filed or provided beginning after December 31, 2019, for the following failures:
- The IRS penalty for failure to timely file a Form 5500 or a Form 5310-A (to report certain transfers, mergers or spin-offs) has increased from $25 per day (capped at $15,000 per year) to $250 per day (capped at $150,000).
- The IRS penalty for failure to file a Form 8955-SSA has increased from $1 per participant multiplied by the number of days the failure occurred (up to a maximum of $5,000) to $10 per participant multiplied the number of days the failure occurred (up to a maximum of $50,000).
- The IRS penalty for failure to file a required notification of changes in a plan’s Form 8955-SSA has increased from $1 per day to $10 per day (up to $10,000).
- The IRS penalty for failure to provide participants with a required notice regarding withholding on periodic and nonperiodic pension plan payments has increased from $10 to $100 per failure.
- The IRS penalty for failure to file a Form 8822-B (to register a change in plan name or plan administrator name/address) will increase from $1 per day (up to $1,000) to $10 per day (up to $10,000).
- The IRS penalty for failure to timely file and pay the prohibited transaction excise tax reported on Form 5330 (used to report and pay the prohibited transaction excise tax related to employee benefit plans) was increased from the lesser of $330 or 100 percent of the amount due to $400 or 100 percent of the amount due.
These increases affect IRS penalties only and have no effect on the much higher DOL penalties. For example, the maximum DOL penalty for failure to timely file a Form 5500 is currently $2,233 (with no maximum). The IRS and DOL have amnesty programs that can reduce late filing penalties significantly. Our Retirement Plan Advisory Team can help employers obtain relief through those programs and with mitigating potential penalty risks. Because correction through an amnesty program generally cannot be started once the employer has been notified of an examination, submitting a filing under those programs is advisable as soon as possible if errors occurred.
Penalty-Free (Not Tax-Free) Withdrawals For Child Birth Or Adoption
Usually, in-service withdrawals from a DC plan before age 59 ½ are subject to a 10-percent early withdrawal penalty, unless an exception applies. Withdrawals that are “eligible rollover distributions” are also subject to mandatory 20-percent federal income tax withholding. But for distributions made after December 31, 2019, the SECURE Act creates a new exception to the early withdrawal penalty and mandatory withholding rule for participants who take withdrawals from DC plans of up to $5,000 within one year after the birth of the participant’s child (or after the adoption is finalized) that is used for expenses related to the birth or adoption. Plans may allow such distributions to be repaid with after-tax dollars at any time — essentially allowing retirement plan participants to restore the full amount of the distribution to their plan accounts. So, if a participant withdrew $5,000 as a qualified birth or adoption expense, he or she could recontribute the full $5,000 back into the plan (even years later), even though the participant paid income tax on the distribution.
The $5,000 limit is per individual. So, a married couple may each separately receive a $5,000 qualified birth or adoption distribution from an eligible retirement plan. Employers should consider whether to offer these special distributions. Plan amendments and updates to forms and communications may be needed if the distributions are allowed.
Retirement Plan Disaster Relief
Congress finally provided special retirement plan disaster relief for the 2018 California wildfires and other major disasters that occurred between January 1, 2018, and February 18, 2020. This relief is similar to relief provided for 2016 and 2017 hurricanes and California wildfires, but is not an extension of (or additional relief) for those earlier disasters.
Pooled Employer DC Plans
For plan years after December 31, 2020, the SECURE Act provides new rules that will allow unrelated employers with no common interest to participate in a “pooled employer plan” (PEP). PEPs would be limited to DC plans that satisfy certain ERISA fiduciary and registration requirements. A PEP must be sponsored by a “pooled plan provider” (PPP), like a financial services company, TPA, insurance company, record keeper, or similar entity (and PPPs will be subject to a $1 million bond). The PPP must serve as the plan’s ERISA plan administrator and named fiduciary and will have other duties, such as ensuring that all parties are properly licensed and bonded (beyond just “handling funds,” which is required for ERISA bonds). The SECURE Act clarifies that an employer who adopts a PEP will be acting as an ERISA fiduciary in deciding to join the PEP and will remain responsible for monitoring the PPP and other plan fiduciaries. The adopting employer will remain the PEP’s investment fiduciary unless the PEP delegates investment management duties to someone else.
PEPs will be treated as a single ERISA plan, which means the plans will have a single plan document, one Form 5500 filing and a single independent plan audit. However, PEPs are not required to be audited until they either cover 1,000 participants or any adopting employer has more than 100 participants. SECURE continues the multiple employer plan (MEP) requirement that the Form 5500 must include a list of adopting employers and show the percentage of current year contributions and plan accounts for adopting employer’s participants.
A MEP is a plan (that is not a collectively bargained plan) maintained by two or more unrelated employers. Historically, DOL rules permitted only “closed” MEPs, where the participating employers shared a common interest. In 2019, the DOL expanded that rule to allow “association retirement plans” (ARPs), allowing looser affiliations to satisfy the common interest requirement. But ARPs were not true “open” MEPs. Similarly, the IRS recently proposed regulations that would provide some relief from the “one bad apple” rule. Under that rule, if just one participating employer failed to satisfy any of the many tax-qualified plan rules, the entire MEP could be disqualified. The SECURE Act goes further than both the DOL and IRS relief, since it will allow unrelated small employers with no common interest to participate in PEPs and will not disqualify the entire PEP if one participating employer fails a qualification requirement.
Combined Form 5500s for DC Plans
Effective for plan years beginning after December 31, 2021, DC plans can file a consolidated Form 5500 if all the plans have the same trustee, named fiduciary, plan administrator, plan year and investment options.
Small employers should watch this development, which may streamline their Form 5500 filing requirements. An employer does not need to participate in a PEP to be able to file a single Form 5500 for multiple plans. But the DOL and IRS will need to issue guidance and a consolidated Form 5500 no later than January 1, 2022, since the SECURE Act merely says that members of a “group of plans” can file a consolidated Form 5500. It appears that the consolidated reporting is not meant to apply only to controlled groups or affiliated service groups. Rather, it appears intended to cover unrelated employers or even PEOs, as a form of MEP/PEP (for reporting purposes only, not for plan document or operation purposes).
Nondiscrimination Testing Relief For Closed DB Plans
The SECURE Act included long-awaited, permanent nondiscrimination testing relief for DB plans that are closed to new participants. The relief applies to plans that were closed as of April 5, 2017, or that have been in operation but have not made any increases to the coverage or value of benefits for the closed class for five years before the freeze can now meet nondiscrimination, minimum coverage, and minimum participation rules by cross-testing the benefits with the employer’s DC plans.
Lower In-Service Withdrawal Ages For Certain Plans
The SECURE Act provides that defined benefit plans (including hybrids like cash balance plans) and 457(b) plans can now allow in-service withdrawals at age 59 ½.
403(b) Plan Terminations
The SECURE Act directs the IRS to issue guidance by June 20, 2020 (within six months after enactment), providing that individual 403(b) custodial accounts may be distributed in-kind to a participant or beneficiary when the 403(b) plan terminates. The guidance will be retroactively effective for tax years beginning after December 31, 2008.
This change in the law means that terminated 403(b) custodial accounts will be treated the same as terminated 403(b) annuities (in other words, a 403(b) plan is allowed to distribute individual custodial accounts to participants and those accounts can continue to be tax-free until amounts are withdrawn from those accounts).
Many of the SECURE Act retirement plan changes in the law apply to both large and small employers, including for-profit and non-profit employers. Some of the changes are especially helpful to small employers. Almost all tax-qualified retirement plans will need to be reviewed for possible amendments and operational changes to reflect the SECURE Act. While further guidance on many of the SECURE Act provisions is needed, employers should review their plan documents and systems in the meantime to determine what, if any, amendments will need to be made, what operations need to be changed, and what systems or processes should be updated.
If you have questions about how to take advantage of new opportunities and how to best minimize the impact of unfavorable changes due to the SECURE Act, contact a member of our Retirement Plan Advisory Team.
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