On December 20, 2019, President Trump signed into law H.R. 1865, the Further Consolidated Appropriations Act, 2020 (now Pub. L. 116-94) (the “Appropriations Act”), which, among other things, contains the Setting Every Community Up for Retirement Enhancement (SECURE) Act (the “Act”). The Act is a significant piece of retirement legislation which seeks to expand access to retirement savings for small businesses and part-time workers, promote the availability of annuities as a source of lifetime retirement income, and simplify defined contribution plan formation and administration. It funds its expansion of retirement savings in large part by eliminating the popular use of the “Stretch IRA” as a means of tax-efficient intergenerational wealth transfer. Absent some limited changes (discussed below), the bulk of the Act is identical to the heavily-publicized bill of the same name passed by the U.S. House of Representatives as H.R. 1994 on May 23, 2019.
The Act amends a broad assortment of retirement plan provisions in the Code and ERISA and ushers in certain operational changes that stakeholders of retirement plans of all types—particularly sponsors and administrators of defined contribution plans—should begin thinking about and processing now. However, plan amendments incorporating these operational changes are in general not required until the end of the 2022 plan year (2024 for governmental plans).
Below is a summary of the provisions of the Act that we believe are most immediately relevant to our clients and friends. Given the broad scope of the Act, we anticipate issuing future alerts on provisions not discussed here.
Changes to 401(k) Participation and Safe Harbor Plan Design Rules
- Elective Deferrals for
Certain Part-Time Employees (Generally effective for plan years
beginning after December 31, 2020). The Code’s
current participation rules permit a 401(k) plan to prevent
employees who have not yet completed a year of service, defined as
a year in which at least 1,000 hours are worked, from making
elective deferrals under the plan. Once an employee completes a
year of service, the plan may not exclude that employee from making
elective deferrals on the basis of hours of service, even if he or
she works less than 1,000 hours in subsequent years (but the plan
may condition eligibility for nonelective or matching contributions
in later years on such a service requirement). The effect of these
rules has been to deny many long service, part-time employees (who
never complete a “year of service” as defined above)
the benefits of tax-deferred retirement savings under their
employer’s 401(k) plan. In response, effective for part-time
employee service years beginning on or after January 1, 2021, the
Act amends Code section 401(k) to require a plan to permit an
employee who has worked at least 500 hours per year for at least
three consecutive years (and has attained the age of 21 by the end
of such third consecutive year) to make elective deferrals under
the plan. No employer contributions are required, and the Act
provides nondiscrimination and top-heavy testing relief for this
group. Each year in which the part-time employee works at least 500
hours (regardless of whether that occurs over three consecutive
years) will be treated as one service year for purposes of
crediting vesting service under the plan for employer
contributions, if provided. Service years that begin prior to
January 1, 2021 will not count for determining eligibility, which
means that part-time employees will not become eligible to
participate in plans under this new rule until the 2024 plan
year.
- Permitted Increase in Default
Contribution Rate for Qualified Automatic Contribution Arrangements
(QACAs) (Effective for plan years beginning after December 31,
2019). Under pre-Act law, to achieve exemption from
nondiscrimination testing, a QACA safe harbor section 401(k) plan
design must provide for automatic enrollment for eligible
participants (subject to participant opt-out) at a rate of no less
than 3% of compensation in the first year of eligibility, with
gradually increasing annual minimum contribution rates thereafter,
but subject in all years to a 10% maximum default contribution. To
encourage greater rates of deferral and more retirement savings in
such QACA plans, the Act permits sponsors of QACAs to increase
default contribution rates for automatically enrolled participants
to 15% of compensation for the second year of eligibility and
thereafter. This QACA change is permissive and if adopted by the
plan sponsor, can take effect for the 2020 plan year.
- Removal of Barriers to Adopting Nonelective Contribution-Type Safe Harbor Plans (Effective for plan years beginning after December 31, 2019). Currently, a 3% nonelective employer contribution safe harbor plan design may not be implemented in the middle of a plan year, because certain safe harbor notices must be sent out to participants prior to the first day of the plan year. The Act simplifies the formation of nonelective safe harbor 401(k) plans by eliminating this notice requirement. Traditional 401(k) plans may now be amended mid-year to become a nonelective contribution safe harbor plan. If the mid-year amendment is adopted fewer than 31 days before the end of the plan year, the nonelective contribution for the plan year must be at least 4% of compensation (rather than 3%), and the written amendment to the plan must be adopted no later than the end of the next plan year. This change is effective for plan years beginning after December 31, 2019.
Changes to Rules Regarding Distributions and Withdrawals from Plans
- Increase in Age for Required
Minimum Distributions (RMDs) (Effective for individuals turning 70
½ after December 31, 2019). Under pre-Act law, RMDs
must generally begin to be taken by April 1 of the calendar year
following the year in which the retired employee or IRA owner
attains age 70 ½. Responding to the fact that many Americans
are now working past the traditional retirement ages of the past,
and also to increased life expectancies since the introduction of
the Code’s RMD rules in 1962, the Act increases the age at
which RMDs (from plans and IRAs) are triggered from 70 ½ to
72. This new rule applies to individuals who attain age 70 ½
after December 31, 2019. In practice, the change will first apply
to retirees born after June 30, 1949. The Act also permits
individuals to contribute to a traditional IRA after attaining age
70 ½, effective for taxable years after December 31,
2019.
- Elimination of Stretch IRA
for Most Child Beneficiaries (e.g., 10-Year Distribution Rule for
“Ineligible” Designated Beneficiaries) (Effective for
post-death distributions after December 31, 2019). Under
pre-Act law, if a participant/IRA owner dies prior to receiving a
distribution of their full account balances, the designated
beneficiary may receive the account balance over the
beneficiary’s life (i.e., the designated beneficiary may
“stretch” RMDs therefrom over their lifetimes, allowing
for the possibility of decades of additional tax-free growth). The
Act largely eliminates this estate-planning strategy by requiring
that savings in retirement accounts inherited by individuals other
than eligible designated beneficiaries— defined by the Act as
spouses, minor children (until reaching majority), disabled and
“chronically ill” beneficiaries, and other
beneficiaries less than 10 years younger than the employee—be
distributed in full within 10 years of the employee’s death.
The rules apply separately to each beneficiary in a
multi-beneficiary trust which itself has been designated as a
beneficiary. This change applies in general to distributions from
plans other than qualified defined benefit, section 403(b),
governmental 457(b) plans, and annuity contracts, and takes effect
for plan years beginning after December 31, 2019 (after December
31, 2021 for collectively-bargained plans and governmental
plans).
- Reduced Age for In-Service
Distributions (Effective for plan years beginning After December
31, 2019). A provision in Division M of the Appropriations
Act (separate and apart from the SECURE Act) reduces the minimum
age for allowable in-service distributions from (a) qualified
retirement plans subject to Code section 401(a)(36), from age 62 to
age 59 ½, and (b) governmental section 457(b) plans, from
age 70 ½ to age 59 ½. This will eliminate some plan
design complexity for plans wishing to allow in-service
distributions at an age that is younger than the plan’s
definition of normal retirement age. This change will be available
for plan years beginning after December 31, 2019.
- Treatment of Section 403(b)
Plan Terminations (Guidance to be issued by Treasury Department
within 6 months). Because section 403(b) plans often hold
assets in the form of annuity contracts and mutual funds in
custodial accounts in the names of the participants, rather than in
a trust, it can be difficult for sponsors to terminate the plan and
distribute its assets. The Act directs the Treasury Department to
issue rules in 2020 regarding terminations of section 403(b) plans,
which will permit distributions of the custodial accounts in-kind
to participants, and require custodians of those assets to continue
treating them for tax purposes as if the contracts or accounts
remained in a section 403(b) plan. These rules will have
retroactive effect.
- Penalty-Free Withdrawals up
to $5,000 for Childbirth or Adoption (Effective for distributions
after December 31, 2019). The Act amends Code section
72(t) and provides that the early-distribution penalty thereunder
will not apply to distributions from all plans (other than
qualified defined benefit plans) up to a maximum of $5,000 (per
parent) on an aggregated controlled group basis for a
“qualified birth or adoption distribution,” which is
defined as any distribution up to $5,000 occurring within a year of
the child’s birth or the date the legal adoption of a minor
or adult-disabled child is finalized. The provision allows the
distributed amount to be later recontributed to the plan in the
same manner as a rollover from another plan or IRA. The amendment
to section 72(t) provides that a plan that allows these withdrawals
will be treated as satisfying the Code’s in-service
distribution rules. The change takes effect for plan years
beginning after December 31, 2019.
- Elimination of Participant Loans by Credit Card (Effective for loans made as of December 20, 2019). The Act amends Code section 72(p) to eliminate the loan treatment for plan loans taken in the form of a “credit card or any other similar arrangement,” presumably due to concerns that these arrangements would raise compliance challenges for qualified plans offering them. The change is effective as of December 20, 2019.
Expanded Access to Annuities as a Source of Lifetime Retirement Income
- ERISA Fiduciary Safe Harbor
for Selection of Annuity Provider (Immediately effective).
The decline of defined benefit pension plans, with their lifetime
annuity payments, has largely left retirees responsible for
ensuring that their defined contribution account balances will last
them throughout retirement. Because it is difficult for individuals
to predict how long they will live, and what expenses they will
incur through their retirement years, some retirees (who have
otherwise saved adequately throughout their working years)
experience a funding shortfall in later years, and this has been
perceived as a problem in the current system of retirement
security. Although there has never been a rule preventing annuity
contracts from being offered as an investment option within defined
contribution plans, the fiduciary decision to offer them has been,
under existing guidance, a complicated and risky one in light of
the possibility that a selected annuity provider may later default
on its obligations to participants. The existing ERISA safe harbor
for selection of an annuity provider for distributions from
individual account plans, 29 C.F.R. § 2550.404a-4, requires
the plan fiduciary to engage in a thorough evaluation of the
annuity provider, and many employers find it too complicated to
provide meaningful guidance. The Act now simplifies the
fiduciary’s decision-making process by providing an express,
statutory safe harbor for the selection of an annuity provider that
largely defers to state insurance commissioners’ current and
ongoing evaluations of the providers’ financial health.
However, the safe harbor still requires a fiduciary to prudently
evaluate the costs and features of the offered annuity products,
and makes clear that a prudent decision in this respect will not
require selection of the lowest cost annuity option. This safe
harbor amends ERISA as of December 20, 2019.
- Lifetime Income Disclosure
(Effective date delayed until after DOL guidance).
Employers that sponsor defined contribution plans subject to ERISA
will be required to provide participants an annual statement
detailing the estimated monthly income stream at retirement that
would result from the purchase of a qualified joint and survivor
and single life annuity with the participant’s account
balance. (This type of information is often already made available
by recordkeepers online, but participants have to locate it, which
can be difficult.) The Act directs the U.S. Department of Labor
(DOL) to issue a model disclosure and the assumptions required to
be used. These requirements will take effect for affected plans
twelve months after the DOL publishes its guidance.
- Portability of Annuity Products in Event of Certain Contingencies (Effective for plan years after December 31, 2019). The Act provides that, beginning with the 2020 plan year, participants may make direct trustee-to-trustee transfers of “lifetime income investments,” or transfer the actual annuity contracts, from one eligible retirement plan to another, or between a plan and an individual retirement account (IRA), without regard to plan restrictions on in-service distributions, to help avoid surrender charges or penalties if the lifetime income investment is removed from the plan lineup.
Changes to Nondiscrimination Rules for Certain Closed Defined Benefit Plans (Generally effective as of December 20, 2019)
The Act provides relief in special circumstances from the Code’s nondiscrimination, minimum coverage and minimum participation rules for certain participants in some closed and soft frozen plans, to permit greater flexibility in providing continued accruals to certain groups of participants (generally older and longer service employees) without a full freeze of accruals under the plan. These rules are highly technical. The rules are generally effective on December 20, 2019, but retroactive application may be available in certain cases.
Administrative Changes and Increased Penalties
- Plan Adopted by Filing Due
Date (Effective for plans adopted for years beginning after
December 31, 2019). In general, a qualified retirement
plan must be adopted by the end of a given taxable year to be
treated as in effect for that year. The Act now permits plans to be
treated as adopted by employers by the end of Year 1, provided the
Plan is adopted by the time the employer’s tax return for
Year 1 is due to be filed (including extensions) in Year 2. This
change is designed to make it easier for employers to start plans
by giving them the benefit of reviewing the company’s
financial performance for Year 1 before making plan design
decisions applicable to formation of a plan effective that year.
This change applies to plans adopted for taxable years beginning
after December 31, 2019.
- Increased Penalties for Failure to File Certain Returns (Effective for filings required after December 31, 2019). The Act substantially increases penalties, and penalty caps, for failure to file certain retirement-related information returns, including the Form 5500 (from $25/day up to $15,000 total, to $250/day up to $150,000 total), the annual retirement plan registration statement and notification of changes (from $1/per participant per day of the failure up to $5,000 and $1,000 respectively, to $10/per participant per day of the failure up to $50,000 and $10,000 respectively), and annual withholding notice (from $10/failure up to $5,000 total, to $100/failure up to $50,000 total). The Act also increases the penalty for failure to file individual information returns unrelated to retirement plans. Note that some of these increases are significantly greater than provided for in earlier versions of the Act. The increases affect returns, statements, and notifications required to be filed, and notices required to be provided, after December 31, 2019.
Repeal of “Cadillac Tax” (Effective for tax years beginning after 2019)
A provision in Division N of the Appropriations Act (separate and apart from the SECURE Act) repeals the much-maligned “Cadillac Tax”—the Affordable Care Act’s excise tax on high-cost employer sponsored medical plans. The Cadillac Tax was originally scheduled to go into effect in 2018, but was delayed by Congress twice, and had most recently been set to apply in 2022.
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The Act requires some near-term operational changes for many plans, particularly with respect to the changes to the RMD rules, which plan sponsors and recordkeepers should begin jointly processing. The Act also presents several opportunities for plan design enhancements as the new decade gets underway.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.