The SECURE Act: What Plan Sponsors Need to Know

ERISA and Employee Benefits Update

The SECURE Act: What Plan Sponsors Need to Know

The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) was signed into law on December 20, 2019, and is the most significant legislation affecting employer-sponsored qualified retirement plans since 2006. While it grants some time to make required plan amendments¹, plan sponsors need to become familiar with the various required and discretionary changes made by the Act to ensure their plans maintain their qualified status and to take advantage of some of this new law’s more favorable aspects. 

The more relevant changes the Act makes to the law governing employer-sponsored qualified retirement plans are described below. Look for additional Alerts that provide more detail regarding the various provisions of the Act. Plan sponsors should consult with their legal counsel and advisors to determine how these changes affect their plans and prepare to make the operational adjustments and amendments necessary to comply with the Act.

Long-term part-time employees will be able to participate in 401(k) plans

Employers have generally been allowed to exclude part-time employees (for example, employees who work less than 1,000 hours per year) from plans such as 401(k) retirement plans. However, starting in 2021, employers maintaining a 401(k) plan must have eligibility requirements under which long-term part-time employees may become eligible to make pre-tax deferrals. Specifically, an employee who does not complete a one-year-of-service requirement (with the 1,000-hour rule), but does complete three consecutive years with at least 500 hours of service per year may make section 401(k) contributions, but is not required to receive a match or other employer contributions. This new rule will apply to plan years that begin after December 31, 2020, and 12-month periods of service beginning before January 1, 2021 are not considered for eligibility purposes. Thus, part-time employees who have at least 500 hours of service in 2021, 2022, and 2023 will be able to participate as early as January 1, 2024 (for a calendar year plan). This will have significant implications for testing and vesting rules and more guidance is expected from the Department of Labor and the IRS, but the law is clear that employers will be allowed to exclude those eligible part-time employees from any employer contributions, from testing under the nondiscrimination and coverage rules, and from the application of the top-heavy rules.

Required minimum distribution age raised from 70½ to 72

For decades, retirement plan participants and IRA owners were generally required to begin taking required minimum distributions (“RMDs”) by April 1 of the year following the later of the year they (1) reached age 70½ or (2) terminated employment. Under the SECURE Act, for individuals who attain age 70½ on or after January 1, 2020, the required beginning date will be based on the attainment of age 72, rather than age 70½. Thus, for example, an individual born on July 1, 1949, who turned 70½ on January 1, 2020, and who has terminated employment will not be subject to RMDs until turning 72 in 2021, with the initial RMD due by April 1, 2022. In contrast, an individual born on June 30, 1949,  who turned 70½ on December 30, 2019, and has also terminated employment would still be subject to RMDs in 2019, due from their retirement account by April 1, 2020. As under prior law, RMDs for most retirement plan participants (except those who are 5% owners) need not begin until the April 1 after the year in which they terminate employment. Particularly during the transition over the next few years, plan administrators will need to carefully track which participants are subject to the prior age 70½ rule and which are subject to the new age 72 rule.

Many “stretch” RMDs for beneficiaries will be eliminated

For plan participants or IRA owners who pass away before 2020, beneficiaries (both spousal and non-spousal) were generally allowed to “stretch out” the tax-deferral advantages of the plan or IRA by taking distributions over the beneficiary’s life expectancy (in the IRA context, this is sometimes referred to as a “stretch IRA”). However, the SECURE Act significantly reduces this distribution period for deaths of plan participants or IRA owners beginning in 2020² by eliminating the “stretch” strategy for distributions to most non-spouse designated beneficiaries, which are generally required to be distributed within ten years following the plan participant’s or IRA owner’s death.

Exceptions to this new 10-year rule are allowed for distributions to a defined class of “eligible designated beneficiaries” including (1) the surviving spouse of the plan participant or IRA owner, (2) a child of the plan participant or IRA owner who has not reached majority, (3) a chronically ill or disabled individual, and (4) any other individual who is not more than ten years younger than the plan participant or IRA owner. Beneficiaries who qualify under this exception may generally still take their distributions over their own life expectancy (as allowed under the rules in effect for deaths occurring before 2020). Once a minor child reaches the age of majority, the distributions must be made within the following 10-year period.

Certain non-individual beneficiaries (for example, charities or estates) remain subject to the pre-SECURE Act law, which provides that they are required to receive the account in full by December 31 of the year including the fifth anniversary of death if the participant died prior to commencing RMDs, or to continue the RMDs based on the participant’s life expectancy if the participant had already commenced RMDs. 

Penalty-free withdrawals are allowed for expenses related to the birth or adoption of a child

Generally, a distribution from a retirement plan must be included in income, and unless an exception applies, distributions before age 59½  are also subject to a 10% early withdrawal penalty. Starting in 2020, plan distributions (up to $5,000) that are used to pay for expenses related to the birth or adoption of a child are free of the early 10% early withdrawal penalty³. That $5,000 amount applies on an individual basis, so for a married couple, each spouse may receive a penalty-free distribution up to $5,000 for a qualified birth or adoption. Such distributions are also eligible for later recontribution to the plan or an IRA. Section 401(k), 403(b), and 457 plans are permitted to allow such withdrawals while the participant is still employed. 

Optional extended relief for federally declared disasters

Although not part of the SECURE Act, the bill containing the SECURE Act also allows an extension of disaster relief for federally declared disasters occurring between January 1, 2018, and February 19, 2020, similar to relief provided for previous hurricanes. Participants must take advantage of this relief by June 17, 2020. Plan sponsors can offer participants the ability to take a distribution of up to $100,000 that is exempt from the 10% early distribution tax penalty. Further, such a distribution can be recontributed within 3 years, or ratably included in income over a 3-year period. A plan sponsor could also increase the maximum participant loan amount to $100,000 and 100% of the participant’s vested account balance, with some possible extensions of the loan term for up to one additional year. Finally, plan sponsors can permit participants to repay hardship distributions taken for purposes of purchasing a home within the disaster area. Plan sponsors wanting to offer this relief must amend their plans by December 31, 2020 (for calendar year plans), and will also need to review their processes for distributions, loans, rollovers, participant communications, and Form 1099-R reporting.

Increased tax credits for small employer pension plan start-up costs

The Act increases the tax credit small businesses can take for retirement plan start-up costs. 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 of the eligible employer who are eligible to participate in the plan, or (b) $5,000. The credit applies for up to three years. In addition, the Act includes a small employer tax credit of $500 per year for up to three years if a plan adds an auto enrollment feature or if it is included in a new plan.

Plans adopted by tax filing due date may be treated as in effect as of close of prior year

Starting in 2020, employers can elect to treat qualified retirement plans adopted after the close of a tax year, but before the due date (including extensions) of the tax return, as having been adopted as of the last day of the tax year. The additional time to establish a plan provides flexibility for employers who are considering adopting a plan. It also provides an opportunity for employees to receive employer contributions for the prior year. This does not extend the deadline for adopting a section 401(k) feature of a plan, which must be adopted before any section 401(k) contributions are made.

Increase to auto enrollment safe harbor cap

Each year, 401(k) plans must conduct a nondiscrimination test called the actual deferral percentage (ADP) test to elective deferrals. The ADP test is deemed satisfied if a 401(k) plan includes certain minimum matching or non-elective contributions under either of two safe harbor plan designs and meets certain notice and other requirements. For a safe harbor plan that uses non-elective contributions, the prior notice requirement has been eliminated. In addition, an employer may adopt the non-elective contribution safe harbor as late as the end of the following plan year. However, if the non-elective contribution safe harbor is adopted 30 days or less before the end of the plan year in which it is effective, the non-elective safe harbor contribution requirement is increased from 3% to 4% of pay. 

Another type of safe harbor design is an automatic enrollment safe harbor plan that meets certain requirements. Starting in 2020, the new rules increase the cap on the default rate under an automatic enrollment safe harbor plan from 10% to 15%, but only for years after the participant’s first deemed election year.

Modified nondiscrimination rules to protect older, longer service participants in closed plans

Starting in 2020, the nondiscrimination rules as they pertain to closed pension plans (plans closed to new entrants) are being changed to permit existing participants to continue to accrue benefits. The modification will protect the benefits for older, longer-service employees as they near retirement.

New annual disclosures required for estimated lifetime income streams

The Act will require that participants’ benefit statements include a lifetime income disclosure at least once during any 12-month period. The required disclosure will need to illustrate the monthly payments the participant would receive if the total account balance were used to provide lifetime income streams, including a qualified joint and survivor annuity for the participant and the participant’s surviving spouse and a single life annuity. This will be required after DOL issues model disclosures. Plan sponsors should be watching for additional guidance. 

Expanded portability of lifetime income options

Starting in 2020, certain retirement plans can make direct trustee-to-trustee transfers to another employer-sponsored retirement plan, or an IRA, of a lifetime income investment or distributions of a lifetime income investment in the form of a qualified plan distribution annuity. This is allowed if a lifetime income investment is no longer authorized to be held as an investment option under the plan. This change permits participants to preserve their lifetime income investments and avoid surrender charges and fees.

New fiduciary safe harbor for selecting annuity providers

The selection of an annuity provider for a plan is considered a fiduciary act, subject to the fiduciary requirements of ERISA, including a duty of prudence in selecting the provider. Effective upon enactment (December 20, 2019), the SECURE Act sets forth for fiduciaries an optional safe harbor to satisfy the prudence requirement in their selection of an insurer for a guaranteed retirement income contract, and are protected from liability for any losses that may result to participants or beneficiaries due to an insurer’s future inability to satisfy its financial obligations under the terms of the contract.

MEPs and PEPs: Unrelated employers can more easily join to create a single retirement plan

A multiple employer plan (MEP) is a single plan maintained by two or more unrelated employers—not including union multiemployer plans. Starting in 2021, new rules reduce the barriers to creating and maintaining MEPs, which will help increase opportunities for small employers to band together to obtain more favorable investment results, while allowing for more efficient and less expensive management services. For example, prior to the SECURE Act, employers participating in a MEP had to have a “commonality of interest” and meet other requirements. The Act would allow so-called “Open MEPs”—multiple employer defined contribution plans where there is no commonality of interest—referred to in the SECURE Act as pooled employer plans (“PEPs”), which, unlike the prior law, may be maintained by financial service firms, recordkeepers, and third-party administrators. In addition, the Government is directed to permit the filing of aggregated Form 5500s for defined contribution plans that have the same plan administrator, trustee, plan year, named fiduciary, and investment options.

Increased penalties for failure-to-file retirement plan returns

For Forms 5500 due after 2019, the new penalty for failing to file will be increased to $250 per day not to exceed $150,000 (the prior penalty was $25 per day not to exceed $15,000).

A taxpayer’s failure to file a registration statement incurs a penalty of $10 per participant per day, not to exceed $50,000, increasing from a $1 penalty per participant per day not to exceed $5,000. The failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for all failures during any calendar year.

Conclusion

Most of the changes included in the SECURE Act are welcomed by plan sponsors and the retirement industry generally, and as they are implemented will hopefully increase employers’ ability to help their employees save for retirement.  More detailed issue-specific Alerts will follow in the coming weeks and as regulatory agencies provide additional guidance for these changes.

Should you have questions regarding this Alert or the SECURE Act, please contact a member of Fennemore Craig, P.C.’s ERISA and Employee Benefits Practice Group:

Ryan Curtis, Chair
rcurtis@fclaw.com | 602.916.5426

David N. Heap
dheap@fclaw.com | 602.916.5326

Kristi L. Hill
khill@fclaw.com | 602.916.5353

For more information regarding the SECURE Act’s effects on how individuals plan for their retirement, please see an alert from James Lee in Fennemore Craig, P.C.’s Trusts and Estates practice group. See Recent Tax Developments – 2020 January – The SECURE Act (Individual)

 

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[1] Generally, qualified plans have until December 31, 2022 to make required amendments. Governmental plans and collectively-bargained plans must adopt amendments by December 31, 2024.

[2] This will be later for some participants in collectively-bargained plans and governmental plans.

[3] These distributions are still subject to ordinary income taxes.