SECURE ACT: Key Provisions in Brief
And the it finally happened: Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law on December 20, 2019. SECURE is the largest piece of retirement regulation since the passage of the Pension Protection Act in 2006 and a culmination of various retirement reform proposals introduced in Congress. Its provisions, mostly effective for plan and tax years beginning after December 31, 2019. SECURE seeks to address the three main contributors to the US retirement crisis – the retirement plan coverage gap, the retirement savings gap, and the access to guaranteed income gap.
While the Internal Revenue Service and Department of Labor are busy working on updating guidance and issuing new regulations (much clarification is necessary), employers and service providers are expected to operate based on good faith interpretation of how the new rules apply. Retroactive amendments will be required for all plans by the last day of plan year beginning on or after January 1, 2022, i.e. December 31, 2022 for calendar-year plans, but IRS may grant a later deadline at some point. Many of the provisions of SECURE Act will require technical clarification and detailed guidance and many provisions deserve their own article; the summary below focuses on some of the key provisions of the Act. We will provide detailed analysis and application in the coming months.
401(k) plans – No More Safe Harbor Non-Elective Notice
SECURE Act eliminated the notice requirement for 401(k) plans that use a non-elective contribution – commonly three percent of pay – to automatically satisfy the non-discrimination test for deferral amounts. Plans that use a safe harbor match option will need to continue providing the annual notice to participants to retain their safe harbor status (This provision is effective for plan years beginning after December 31, 2019). This provision will reduce administration time for preparation of notices, will save a lot of paper, will cut some of the disclosure-related headaches and costs, and – importantly- will take off failure to provide a non-elective safe harbor notice from the list of retirement plan-related offences. It’s one less thing to worry about; we’ll take it!
401(k) plans – More Time to Elect a Safe Harbor Non-Elective Status
Safe harbor nonelective provision may now be adopted retroactively to start of the year so long as the amendment is signed 30 days before the plan year-end. Those who miss the 30-day deadline, or wait for the outcome of non-discrimination testing generally performed at or near close of the year, have an additional grace period: they may now elect the safe harbor nonelective status up until the following plan-year end so long as the amount of safe harbor contribution is increased from the 3% of compensation to 4% (This provision is effective for plan years beginning after December 31, 2019). A gift of perfect hindsight for some and a savior for procrastinators, this provision will be another solution for fixing failed non-discrimination tests (mostly for smaller plans due to its cost) and a safety valve for employers seeking maximum flexibility .
401(k) plans – Automatic Enrollment Rate Cap Up to 15% After First Year of Participation
Under old law, auto-enroll 401(k) plans that use the qualified automatic contribution arrangement (QACA) safe harbor to avoid deferral amounts testing were required to cap the default rates at 10%. The SECURE Act retained the 10% limit for the first year of participation but allowed it to be increased up to 15% thereafter (This provision is effective for plan years beginning after December 31, 2019). Better late than never, the increase aligns with research-backed recommendations on savings rates, allowing employers to nudge employees toward better savings outcomes one deferral percent at a time. With some employers cautious around defaults and escalating deferral provisions, it’ll be interesting to see how long it will take for the 10%+ auto-deferral rate to be a new normal.
401(k) plans – Plans to Open to Long-term Part-time Employees
Pre-SECURE Act, employers were generally allowed to exclude part-time employees (those who work less than 1,000 hours per year) from participation in their retirement savings programs. SECURE Act, in essence, created a dual eligibility requirement for 401(k) plans: completion of either (1) a one year of service requirement (with the 1,000-hour rule) or (2) three consecutive 12-month periods with at least 500 hours of service (3-12-500 rule). The age 21 requirement may continue to apply if desired. Part-time employees who become plan participants under the new 3-12-500 rule are not required to receive any employer contributions, even when a plan is top heavy; and they are dropped from coverage and non-discrimination testing, including the salary deferral nondiscrimination test. The effective date of this provision is for plan years beginning after December 31, 2020, and since service before January 1, 2021 may be disregarded for purposes of this rule, first part-time employees will not become eligible for 401(k) enrollment until some point in 2024. This is an example of a SECURE provision where much guidance will be required from the IRS and DOL; implementation should not be rushed and careful document revisions will be needed to avoid unexpected consequences. Some owner-only plans, that currently meet this requirement because of use of part-time workforce, may lose their relaxed government reporting and participant disclosure regime. When employers use a seasonal or part-time workforce, plans that currently enjoy a small plan status may find themselves quickly graduating to large plan status, resulting in more complex Form 5500 and plan audit requirements. Employers will have to be diligent about tracking of their seasonal and part-time workforce. Questions arise: how will participants who go in and out of part-time status be treated? How would plans using elapsed time for service crediting implement this rule? Hopefully, guidance will be available soon.
New Plans & New Auto-features – Plan Set-up Tax Credit Increased to $5,000 + New $500 Credit for Auto-401(k)
Small employers (defined as those with up to 100 employees receiving at least $5,000 in compensation) received a much-anticipated increase in Plan Start-up Credit cap. Under SECURE, the new dollar amount is the greater of (1) $500, or (2) the lesser of: (a) $250 for each eligible non-highly compensated employee, or (b) $5,000. As before, the credit applies for up to three years and may not exceed 50% of certain costs paid or incurred in connection with starting a retirement plan (e.g. set-up, administration, and retirement education).
Additionally, SECURE created a new small employer tax credit to encourage adoption of automatic enrollment features for 401(k) and SIMPLE IRA plans. The $500 per year tax credit is available for three years to employers who start retirement savings plans and those with existing plans who add an auto-enrollment feature. Both tax credit provisions are effective for tax years after December 31, 2019. The enhanced tax credits will help small employers to defray some of the plan costs associated with new plans, especially more costly complex designs. It does address one of the barriers to plan setup among small businesses – the cost to establish and administer a plan. When combined with state mandates and other provisions of SECURE, such as delayed adoption and coverage for long-term part-time employees, it may move the needle in expanding coverage.
New Plans – Adoption Deadline Extended to Due Date of Employer’s Tax Return, Including Extensions
SECURE extended the new plan adoption deadline from the last day of plan year up to the tax return due date of the employer, including extensions (similar to the current rule for SEP IRAs). This rule applies only to employer contributions; salary deferral provisions will have to be in place before a plan can accept salary deferral contributions. From practical point of view, it’s likely that plans will have to be established at some point before the un-extended Form 5500 deadline (so it can be timely extended by filing Form 5558) and before the minimum funding deadline applicable to pension plans. IRS guidance will shed more light on the many issues this new rule creates. (This provision is effective for plan years beginning after December 31, 2019). This might be a provision most liked by CPAs and least liked by TPAs (who now will have additional complexities and rush requests during already busy compliance season), but the gift of a retroactive adoption of qualified plans for business owners pining for a last-minute deduction is likely to help increase new plan numbers, cover more employees, and give savings a boost. It might also make December a little less stressful for advisors, retirement plan consultants, and employers who waited until the last minute or recognized a substantially higher income than originally anticipated.
IRAs – Maximum Contribution Age for Traditional IRA Contribution is Gone, but with Some Strings Attached
SECURE lifted the ban which prohibited individuals age 70.5 or older from making traditional IRA contributions so long as they have eligible earnings. The Act, however, also reduced the IRA qualified charitable distribution (QCD) allowance to coordinate with the age-related update. The $100,000 QCD limit for the year is now reduced, but not below zero, by the combined amount of deductions allowed for prior tax years with respect to contributions made after age 70.5. Stated plainly, deductible IRA contributions made for the year in which an individual reached age 70.5 and in later years will reduce the annual QCD allowance (This provision is effective for tax years beginning after December 31, 2019. This is welcome news to those who continue working past age 70.5 and want to continue saving for retirement on a tax-deferred basis; that said, due to reduction in QCD allowance, the overall impact of the additional retirement savings may be muted for those who also wish to use their IRA disbursement for charitable deduction purposes.
IRAs – New Compensation Types Added for Contribution Eligibility
Home health care workers: prior to the passage of SECURE, home health care workers were not eligible to make IRA contributions if their earnings consisted only of the tax-exempt difficulty of care payments. SECURE modified the definition of eligible compensation for IRA and defined contribution plan purposes to count these amounts for purposes of contribution calculation (This provision is effective upon enactment).
Graduate students: Similarly, SECURE Act amended the definition of compensation for IRA contribution purposes to include taxable stipend and graduate or post-doctoral non-tuition fellowship payments (This modification is effective for tax years beginning after December 31, 2019). This modification is a welcome development for those seeking to and able to maximize their savings, but the extent of its impact is not likely to be consequential for overall retirement security for most – it targets populations known to be among most economically vulnerable. The difficulty of care modification is effective as of the date of enactment, making it potentially possible to implement for the 2019 IRA contributions (due by the 2019 tax filing deadline); this is another example where timely IRS guidance will be key.
IRAs & Qualified Plans – Requirement Minimum Distribution Age Increased to 72 for Post-2019 RMDs
The age 70.5 requirement was applied in the retirement plan context in the early 1960s and hasn’t since been adjusted to consider increases in life expectancy. SECURE finally increased the required minimum distribution age from 70.5 to 72. The updated Required Beginning Date is now April 1 following the year in which a plan participant attains age 72. This provision, however, applies only to individuals who reach age 70.5 after December 31, 2019. Since those who reached their RMD age under the old rules prior to December 31, 2019 have to start or continue taking their RMDs based on old rules, this provision is good tidings to those who turn 70.5 in 2020. The new IRS mortality for RMD purposes will help figure out the true impact of this delay on both groups. Employers and retirement service providers will now have to be even more vigilant to assure that RMDs are processed timely.
IRAs & Qualified Plans – Beneficiary Distribution Options Changed, aka Elimination of the “Stretch”
This isone of the most controversial provisions of SECURE that helped balance out the provisions which are projected to reduce tax revenues. The SECURE Act (1) eliminated the lifetime distribution option for beneficiaries who are not in the group of eligible designated beneficiaries and (2) placed a 10-years cap on the maximum time allowed to deplete the inherited IRA or qualified retirement plan accounts. Eligible designated beneficiaries are defined as a surviving spouse, a minor child, a disabled or chronically ill person, or a person who is not more than 10 years younger than the original account owner. This group can continue to stretch their RMDs over their expected lifetime. Minor children, however, must begin using the 10-year rule on the date they reach the age of majority. Similarly, the 10-year rule also kicks in upon death of any eligible designated beneficiary. The old rules continue to be in effect for non-individual beneficiaries, such as estates and charities, which are subject to a five-year distribution rule and can’t spread the payouts over a longer period. The new rules apply with respect to individuals who die after December 31, 2019. NOTE: Delayed effective dates apply for governmental plans and collectively bargained plans. The new rules do not apply to binding annuity contracts in effect as of the date of enactment of SECURE. Elimination of stretch option is unwelcome news to many whose wealth transfer planning involved relied on old rules. Experts say that certain estate planning tools may help soften some of the impact of the new rules along with greater utilization of Roth IRAs and conversion of pre-tax balances to Roth. Plan participants, IRA account holders and professionals who serve them may be well served by urgently reexamining and strategically updating beneficiary designations, savings approaches, and estate plans.
IRAs & Qualified Plans – New Exception to 10% Premature Withdrawal Penalty for Birth or Adoption Costs
SECURE added a new 10% premature distribution penalty waiver for distributions used to cover childbirth or adoption expenses up to $5,000 (this is an individual limit, meaning each spouse can request a withdrawal of up to $5,000 per qualifying event). The 20% mandatory withholding for qualified retirement plan distributions is also waived. The adopted child must be either under age 18 or physically or mentally incapable of self‑support; the distribution must be made during the one‑year period following the birth or legal adoption of the child. These special distributions may be repaid to a qualified retirement plan or IRA at a later date (This provision is effective for tax years beginning after December 31, 2019). The provision comes with a proverbial double-edged sword: it allows penalty-free access to funds to cover the high expenses of adoption and child birth but also contributes to leakage by diverting retirement-designated costs for other expenses. We are rooting for the silver-lining provision of ability to repay the funds at a later date; one can hope.
Lifetime Income – Annuity Investments Get Better Portability
Lifetime income investments, such as annuities, are frequently subject to termination penalties, surrender charges, and other liquidation fees. In addition, the Internal Revenue Code imposes various withdrawal restrictions on retirement plan accounts. As a result, plan fiduciaries often shied away from offering annuities and participants were not eager to use them even when available as a plan investment. The SECURE Act seeks to address some of these concerns by permitting retirement plan participants to roll over an annuity to an IRA or another employer-sponsored retirement plan or take a distribution in the form of a qualified plan distribution annuity contract without a traditional distribution triggering event if this option is discontinued. Such distribution is now permitted starting 90 days before the date the investment is removed from the plan’s investment options list (This change is effective for plan years beginning after December 31, 2019). Employers will need to carefully consider impact of this provision on their plan. Will it accept annuity rollovers from other plans from past-employer plans of current employees or as a result of plan merger? If annuity options are already or will become a feature of their plan menu, sponsors will need to timely amend the plan to allow in-kind transfers to other plans and IRA accounts of participants.
Lifetime Income – A Fiduciary Safe Harbor for Annuity Selection
The Act gave a new safe harbor for selection of lifetime income investment providers to plan fiduciaries. The new rule largely draws on DOL’s 2008 regulations. Fiduciaries are required to make a prudent selection but may rely on specific written representations from annuity providers regarding their financial standing under state insurance laws. While plan fiduciaries are expected to assure that the costs are reasonable, the new rule does not mandate selection of the lowest-cost contract; fiduciaries are encouraged to take into account the value of features, benefits and characteristics of the offering. The new rule clarifies that fiduciaries are not required to review the appropriateness of a selection after the purchase of a contract and that they are deemed to conduct a periodic review if they receive written representations from the provider annually. Fiduciaries that satisfy the safe harbor requirements will be protected from liability with respect to participant losses in the event the annuity provider is unable to pay the full benefits when due (This change is effective on the date of enactment). SECURE provides generous safe harbor for plan fiduciaries, but the due diligence process still requires a solid deep dive into products notoriously and inherently complex and difficult to compare. Determining whether or not a specific annuity is in the best interest of participants remains a high bar. As to participants, it will be interesting to see the change in uptake of annuity options; loss of access flexibility and wealth transfer aspirations remain as potential barriers to adoption. Thoughtful retirement income planning with assistance of a financial advisor may help assuage some of these concerns.
Plan Reporting – A Single Consolidated Form 5500 for Groups of ‘Similar Plans’
With the SECURE Act, defined contribution that have the same trustees, named fiduciaries, plan administrator, plan year, and investment options will be permitted to file a single consolidated Form 5500. The SECURE Act directed the IRS and the DOL to modify the annual retirement plan reporting rules for plan years beginning in 2022. The modified reporting rule may help reduce some of the costs of 5500 preparation for employers who sponsor multiple plans, related employers who sponsor separate plans and use a master trust approach, and opens a possibility for unrelated employers to use this approach provided they have identical feature as required by the rule. The new rules doesn’t do away with a requirement for each plan to obtain its own separate audit, when applicable. A single 5500 will be available outside of the MEP and PEP constructs.
Plan Reporting – Penalties for Missing or Late Plan Reports Increase 10x
The SECURE Act sharply raised the late filing penalties for several required tax returns and filings:
– Form 5500: $250 per day up to a total of $150,000
– Annual Registration Statement: a daily penalty of $10 per participant up to $50,000
– Notification of Change of Status: $10 per day up to $10,000.
– Withholding Notice: $100 for each failure up to $50,000 per calendar year
(This change is effective for plan years beginning after December 31, 2019). Delinquent filer programs, both DOL and IRS, have now become even more valuable and relatively inexpensive. Employers and service providers will need to become more diligent in assuring proper controls for timely extensions and confirmed filing of required governmental reports.
Open MEPs – Pooled Employer Plans Are Now a Reality
With the employer commonality requirement dispensed under SECURE, unrelated employers can now participate in an open Multiple Employer Plan (MEP), now called a pooled employer plan’ or PEP, treated as a single plan for ERISA purposes. A PEP must be a qualified defined contribution plan established by a Pooled Plan Provider (PPP). The PPP is subject to registration requirement, audit, examination, and investigation by the IRS and DOL. The PPP is required to take on the responsibilities of a named fiduciary/ plan administrator, and is responsible for performing all administrative duties necessary to ensure that the plan complies with the Tax Code and ERISA. Except with respect to the administrative duties of the PPP, each employer in a PEP is treated as the plan sponsor with respect to the portion of the plan attributable to its employees.
The Act eliminates the ‘one bad apple’ rule, so noncompliance of one employer will not hurt the rest of the PEP. As a condition for PEP relief, assets attributable to the bad apple employer would need to be spun off from the PEP to a separate plan or IRA. The bad apple employer will be held liable for any plan qualification issues that impact its employees.
A PEP will need to include specific terms that: (1) name and designate the PPP as a named fiduciary; (2) appoint trustees responsible for collection of contributions under written collection procedures and for holding plan assets; (3) spell out that each participating employer retains fiduciary responsibility for selection and monitoring of the PPP and any other named fiduciary, and, unless delegated to a third party, the investment and management of plan assets that belong to their employee accounts; (4) require that each participating employer ensure that unreasonable restrictions, fees, or penalties are not levied on employers or employees for ceasing participation, taking distributions, or transferring assets; (5) require the PPP to provide to participating employers any disclosures or other information required by the DOL, including items that help participating employers in selection or monitoring of the PPP; (6) require that each participating employer take actions determined by the PPP or the DOL as necessary to operate the plan in line with the tax code and ERISA, including any disclosures; and (7) that any such disclosures may be provided electronically and designed to be provided only at a reasonable expense to PPPs and participating employers.
The Act increases the PEP audited requirement until the point in time when they either cover 1,000 participants or any adopting employer has more than 100 participants. The new law does require that Form 5500 include a list of participating employers along with an estimate of percentage of current year contributions and plan accounts for each employer’s participants. Until the DOL and IRS issue PEP regulations and guidance, employers and PPPs are given a good faith relief for reasonable interpretation of the new law (The PEP provision is effective for plan years beginning after December 31, 2020). Note: The new PEP rules do not apply to association MEPs and MEPs historically sponsored by professional employer organizations (PEOs). They continue to operate under the rules separately authorized by the DOL before enactment of SECURE. We hope that MEPs will help employers lower the barriers to entry and alleviate at least some the challenges of cost, complexity, and administrative hurdles of retirement plans thus improving availability of plans to employees. It will be curious to see how the PEP provision will impact current employers and the retirement plan industry. While many predict another accelerated provider consolidation and greater fee compression, others remain skeptical pointing to unfulfilled doomsday predictions of the fee disclosure regulations. One thing is certain, availability of PEP will spur innovation, new technology, service models, products and offerings. While the DOL and the IRS work out the guidance, employers should consider whether joining a PEP may be the right move. Will it nudge participants to better outcomes? Will it help simplify plan operations? Will is reduce fiduciary risks? Will the savings be worth the new complexities? Advisors and other professionals serving retirement plans will be well-served to examine whether joining other PEP(s?) or building their own solution(?s) fit best with their vision of the future, improves their agility, service philosophy and competitive positioning.
As customary for any major piece of legislation, more questions will arise during as provisions are analyzed for application. We anticipate that much will be clarified in the guidance expected from IRS and Department of Labor in the coming months. Cetera Retirement Plan Solutions continues to review the impact of the SECURE Act and will assess the specific regulatory guidance as it becomes available.
For discussion purposes only and in no way represents legal or tax advice. For advice regarding specific circumstances, the services of an appropriate legal or tax advisor should be sought.