Passed by Congress and signed into law at the midnight hour as part of the 2019 comprehensive budget appropriation package, the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act is now the law of the land. In our previous blog, we listed and discussed in a very general way many of the SECURE Act’s most important provisions affecting 401(k) plans.
In this blog, which is Part One of a series of two, we are going to zero in on a few of the main SECURE Act 401(k) plan provisions and provide a little more detail. Specifically, Part One will cover the following topics:
- Increases In 401(k) Retirement Plan Access for Unrelated Employers Through Open MEPs
- Increases in Business Tax Credit for Small Employer Retirement Plan Startup Costs
- Increases in Annuity Options Available Within 401(k) Retirement Plans
- Increase in the Age at Which Required Minimum Distributions (“RMDs”) Must Commence
- Establishment of Penalty-Free 401(k) Withdrawals for Childbirth or Adoption
- Simplification of Non-Elective Contribution 401(k) Safe Harbor Arrangement
Part Two, which we plan to publish in a couple of weeks, will cover the following additional topics:
- Tax Credit Available for Certain Auto Enrollment Plans
- Requirement for 401(k) Plans to Allow Long-Term, Part-Time Employees to Participate
- Modification of Closed Plan Nondiscrimination Rules to Protect Older, Longer Service Participants
- Provision of Lifetime Income Disclosures for 401(k) Plans
- No More 401(k) Plan Loans by Means of Credit Cards
- Increases in Internal Revenue Code Penalties for Failure to File Certain Retirement Plan Returns
IMPORTANT NOTE: By concentrating on the provisions discussed in Part One and Part Two of this series, we will not be attempting to exhaust every SECURE Act provision that could conceivably have an effect on 401(k) plans. Furthermore, not all of the Act’s provisions apply to 401(k) plans. For example, individual retirement accounts (“IRAs”), defined benefit retirement plans, and Internal Revenue Code Section 529 qualified tuition programs are all affected by various provisions in the new legislation. THESE NON-401(K) PLAN PROVISIONS WILL NOT BE ADDRESSED IN THIS SERIES.
As future developments occur – for example, if official guidance in the form or regulations or other pronouncements are released covering any SECURE Act provisions discussed in these blogs – we will be sure to keep you up-to-date.
Background. As we reported in the previous blog referenced above, the SECURE Act incorporates 29 separate retirement-related provisions, many of which were proposed in one form or another over the course of several years. The product of broad bipartisan effort and support, the SECURE Act has been rightfully called the most sweeping change to the retirement plan system (which includes 401(k) plans) since the last comprehensive legislative package — the Pension Protection Act (“PPA”) of 2006.
The text of the budget appropriations act can be found here, with the SECURE Act provisions grouped under the section entitled “Expanding and Preserving Retirement Savings.”
Keeping in mind that many of these provisions are already effective (or soon will become effective), here is a breakdown of six of the key provisions that we believe will be sure to have a major effect on 401(k) plans (six others will be addressed in Part Two of this series):
- Increases In 401(k) Retirement Plan Access for Unrelated Employers Through Open MEPs.One of the SECURE Act’s major stated goals was to increase retirement plan coverage across the board by making it easier for unrelated employers to offer retirement plans. The SECURE Act accomplishes this in large part by making it easier for unrelated, often smaller employers lacking the resources to offer retirement plans on their own, to band together to provide “pooled” 401(k) retirement plans for their employees.
Legally, this is accomplished by expanding and modifying the present-day multiple employer plan (“MEP”) rules. After SECURE, employers generally may now band together to offer 401(k) plans through a “pooled plan provider.” This is now true even if the employers are not related to each other – meaning they no longer have to share “a common characteristic,” such as being in the same industry – as was the case under previous multiple employer plan rules.
Generally stated, the new MEP provisions (sometimes called “open MEPs”) apply to unrelated employers who jointly sponsor a retirement plan (such as a 401(k) plan) through a “pooled plan provider,” which must acknowledge in writing that it is the “named fiduciary” for the combined plan. The pooled plan provider, which must serve as the entity providing most of the plan administrative functions (including nondiscrimination testing), must be registered with the DOL, be properly bonded, and meet a number of other specific legal requirements.
OBSERVATION: The practical effect of the new open MEP provisions on employers who band together to offer open MEPs is that these employers can offer plans with a reduced amount of fiduciary liability concern, and less administrative cost, than was previously possible for them. This is true because most of the fiduciary burden shifts to the pooled plan provider, while the administrative costs can be spread out among the various employers sponsoring the pooled plan.
Interestingly, the legislation requires the DOL to publish model plan language which meets the specific SECURE Act requirements for open MEPs. This will be sure to be helpful to entities wishing to become pooled plan providers, thereby taking advantage of the opportunities afforded by the new legislation.
Effective Date — The provisions permitting open MEPs through pooled plan providers are effective for plan years beginning on and after December 31, 2020.
- Increases in Business Tax Credit for Small Employer Retirement Plan Startup Costs. In a further effort to help make setting up retirement plans more affordable for small businesses; a separate SECURE Act provision increases the business tax credit for plan startup costs. Under the new law, the tax credit increases from the current cap of $500 to:
For the first credit year and for each of the two taxable years immediately following the first credit year, the greater of —
- $500, or
- the lesser of —
- $250 for each employee who is not a “highly compensated employee” and who is eligible to participate in the sponsoring employer’s retirement plan; or
Accordingly, under the new law, the credit may be as high as $5,000 for up to three years.
Effective Date – The increase in the business tax credit for small employer retirement plan startup costs is effective for taxable years beginning after December 31, 2019.
- Increases in Annuity Options Available Within 401(k) Retirement Plans. In one of the more significant and controversial changes from previous law, the SECURE Act meaningfully changes the existing fiduciary rules to help ease the path for 401(k) plan sponsors to select providers of distribution options in the form of annuities. Annuities offer a guaranteed income over the course of a retiree’s lifetime – which can be especially beneficial, considering many Americans these days are living longer lives and spending more years in retirement. Up until now, most 401(k) plans have distributed participant’s account balances in the form of lump-sums or installment payments. Relatively few 401(k) plans these days distribute benefits in the form of annuities.
All of that is about to change. Previously, retirement plan sponsors had the sole fiduciary responsibility to prudently choose and monitor annuity providers. However, the burden and potential risk of loss that accompany choosing and monitoring annuity providers often has been a deterrent, particularly to smaller plan providers. Should an annuity provider go out of business, for example, the plan sponsor faced the potential for liability, including possible litigation.
The new SECURE Act rules generally shift the fiduciary liability onto the annuity providers themselves, which are often large insurance companies, by imposing on these providers the duty to provide plan sponsors with products appropriate for their customers. These providers are generally more than willing to take on the fiduciary responsibility in exchange for the opportunity to earn large profits by selling their products to a wide new sector of 401(k) retirement plan sponsors.
Although there are numerous specific requirements listed in the new law, generally stated, employers sponsoring plans are insulated from risk if the insurer they pick is in good standing with the state insurance department in which the insurer is based. The employer is specifically not required to select the lowest cost provider when making a determination.
OBSERVATION: This SECURE Act provision seeks to expand the use of annuities in 401(k) plans with the stated goal of providing increased retirement income security to retirees. But critics have charged that the provision encourages insurance companies to sell annuity products that may be overly complex, inadequately communicated, or simply inappropriate for a particular 401(k) plan’s general demographic. Annuitization could also result in heftier fees and penalties, should insurance companies choose to take unfair advantage. Now that this provision is the law, we are optimistic that the goal of increased retirement security will be realized, in part because the marketplace should help ensure that quality products will ultimately prove their attractiveness and value, and help keep fees competitive.
Effective Date – The expanded annuity option provisions are effective immediately.
- Increase in the Age at Which Required Minimum Distributions (“RMDs”) Must Commence. The law requires participants in 401(k) plans to begin taking their money out of their plans at a specified age, known as the “required beginning date.” Starting at this date, participants generally must begin taking what are known as “required minimum distributions” from their 401(k) plans. Prior to the SECURE Act, the required beginning date was the later of age 70 ½, or, if a 401(k) plan permits, the date on which the participant retires.
Under the SECURE Act, the age at which RMDs from 401(k) plans generally must now commence increases to age 72, up from the previous, long-standing RMD required age of 70 ½. Once a participant reaches his or her required beginning date for RMDs (now age 72 if no longer working), he or she generally must take the first RMD by the April 1 of the year after reaching age 72. The RMD for any year is typically the account balance as of the end of previous year (Dec. 31) divided by a distribution period taken from the “Uniform Lifetime Table” published by the IRS.
Effective Date – Notably, this provision is effective for distributions made after December 31, 2019, for individuals who attain age 70 ½ after this date.
OBSERVATION: Generally stated, if you did not reach age 70 1/2 by the end of 2019, your new required beginning date for RMDs will be age 72. However, if you reach were age 70 1/2 at the end of 2019, your required beginning date is already set, and the SECURE Act does not change the requirement for you to begin taking RMDs at age 70 1/2.
RECOMMENDATION: We highly encourage individuals who are affected by the change in age to promptly confer with their individual tax advisors for advice in planning the timing of any RMDs that may need to be taken (or not taken) in 2020 – along with discussing the related impact on their overall financial planning picture.
- Establishment of Penalty-Free 401(k) Withdrawals for Childbirth or Adoption. Because 401(k) plans are meant to be retirement vehicles, there are penalties in place for withdrawals or distributions that are made from such plans for purposes other than retirement or other legally sanctioned purposes. One of these is a ten percent (10%) penalty tax for early withdrawals made from 401(k) plans, which generally applies to withdrawals that are made prior to age 59 ½, unless an exception applies. Previous exceptions included death, disability, and distributions made pursuant to a “qualified domestic relations order.”
The SECURE Act adds a new exemption from the 10% percent penalty tax for early withdrawals made from 401(k) plans in the event of a “qualified birth or adoption.” Basically, any distribution to an individual if made during the one-year period beginning on the date on which either (i) a child of the individual is born; or (ii) on which the legal adoption of an eligible adoptee is finalized.
The aggregate amount which may be treated as a “qualified birth or adoption” withdrawal by any individual for any birth or adoption cannot exceed $5,000.
The withdrawal is not considered to be a plan loan, and so it is not subject to the regular plan loan repayment rules. However, a special rule permits recipients to repay the amount of the withdrawal in one or more contributions to the plan, in what is effectively one or more rollover contributions (assuming that the plan allows rollover contributions).
OBSERVATION: This is a unique provision and is no doubt intended to encourage participants to replenish their retirement savings, once they have reached a point where it is possible for them to do so. It does not appear that there is a time limit for making the repayments. Notably, qualified birth or adoption withdrawals, although exempt from the ten percent penalty tax, are still subject to regular income taxation.
Effective Date – The new exemption is effective with respect to withdrawals made after December 31, 2019.
- Simplification of Non-Elective Contribution 401(k) Safe Harbor Arrangement. Many 401(k) plans these days are “safe harbor plans,” meaning that they are designed to meet specific legal requirements in order to gain exemption from some of the nondiscrimination testing rules that would otherwise apply. Safe harbor plan requirements include the making of mandatory employer matching or nondiscretionary contributions, accelerated vesting provisions, and special participant notice obligations.
The SECURE Act simplifies the safe harbor plan rules for plans that use the non-elective arrangement, which is one of the permissible options. The arrangement requires employers to contribute annually an amount equal to three percent (3%) of a participant’s eligible compensation to the plan. Generally stated, the new law accomplishes two things designed to help employers who choose to use this safe harbor arrangement:
- The annual notice requirement is eliminated.
- Plan sponsors using a three-percent of compensation nonelective contribution arrangement generally may now switch to a safe harbor 401(k) plan by formally amending the plan at any time prior to the 30th day before the close of the plan year.
- Alternatively, if a plan sponsor wishes to adopt a safe harbor nonelective contribution arrangement of four percent (4%) of compensation, then it has until the end of the following plan year in which to formally amend the plan to accomplish this change.
OBSERVATION: Eliminating the annual participant notice requirement is a major “plus” for employers sponsoring these types of safe harbor 401(k) plans – partly because there has never been a foolproof way of correcting failures to timely provide the notices to eligible participants before the beginning of each plan year. Technically, failure to provide the notices can mean that the plan is not a “safe harbor plan” and must, therefore, pass the otherwise applicable nondiscrimination tests.
Importantly, the existing annual notice and plan amendment requirements for other types of safe harbor plan arrangements (for example, those using a safe harbor matching contribution instead of a safe harbor nonelective contribution) have not been changed by the new law.
A Word on Plan Amendments. The SECURE Act specifically provides for a special remedial plan amendment period. Generally stated, the Act states that plan sponsors have until the last day of the 2022 plan year — or a later date, should the U.S. Department of Treasury so provide – in which to make any plan amendment required under the SECURE Act.
OBSERVATION: If the past is any guide, the 2022 amendment deadline is likely to be eventually extended – probably in order to reflect guidance in the form of regulations and other official governmental pronouncements that is certain to be issued in the coming months and years in response to SECURE.
Part Two is Coming Up! Be sure to be on the look-out for Part Two in this series, which we plan to publish in a couple of weeks, for details on the additional SECURE Act provisions listed at the beginning of this blog.
The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning the potential effects of the SECURE Act upon your 401(k) retirement plan, please consult your own ERISA attorney or advisor.