On December 20, 2019, President Trump signed into law the Further Consolidated Appropriations Act, 2020 (the “Appropriations Act”), a comprehensive government funding bill that includes substantial employee benefits-related provisions. The legislation affects both retirement and health plans, has some immediate and January 1, 2020 effective dates, and will have a significant impact on the way that many plans are operated.
Most of the retirement provisions of the Appropriations Act come from the SECURE Act, which was passed by the House of Representatives earlier this year and is included in its entirety in the Appropriations Act. Many of the SECURE Act provisions are intended to encourage the use of lifetime income products (such as annuities) in 401(k) plans and other defined contribution plans, while others are designed to encourage small-to-midsized employers that do not currently offer retirement plans to employees to adopt a plan. Other provisions are intended to increase retirement savings in existing plans, and some are simply intended to increase revenue.
This legal alert summarizes the most important provisions of the Appropriations Act affecting retirement plans, including IRAs. We will issue a separate alert addressing the provisions that affect health plans.
Section 401(k) Plan Changes
Participation by longer service part-time workers
Under current law, qualified requirement plans can generally exclude employees until they have completed 1,000 hours of service during the 12-month period beginning on the date of hire (or, if applicable, a subsequent anniversary year or plan year). Many 401(k) plans use these rules to exclude employees working less than 1,000 hours annually because these employees are less likely to make elective deferrals, often contribute at lower rates and are more likely to terminate employment after a relatively short period, all of which can result in nondiscrimination and administration difficulties for the plan.
The SECURE Act provides that a 401(k) plan must allow employees to make elective deferrals upon the earlier of completing (1) at least 1,000 hours of service during a 12-month period (that is, the current rule) or (2) at least 500 hours of service per year over three consecutive 12-month periods. Plans can exclude from nondiscrimination testing and the top-heavy requirements those employees who are eligible solely because of the new rules. The new rules do not apply to employees who are under age 21 and collectively bargained employees.
This change generally applies for plan years beginning in 2021.
Increased limit for automatic enrollment safe harbor
Section 401(k) plans that automatically enroll eligible employees, automatically increase their default contributions annually, and satisfy other requirements, are exempt from certain nondiscrimination rules. This “qualified automatic contribution arrangement” is known as a QACA. Currently, the maximum automatic default contribution under a QACA is 10% of compensation.
The SECURE Act increases the 10% limit to 15%, although the limit remains at 10% for the first year in which an employee participates in the QACA.
This change is effective for plan years beginning in 2020.
Mid-year election of safe harbor 401(k) status
In addition to the safe harbor for plans using automatic enrollment, 401(k) plans that provide a specified level of employer matching or nonelective contributions and satisfy other requirements are also exempt from certain nondiscrimination rules. Among these requirements is a notice that must be provided before the beginning of the plan year, informing participants about employer contributions and other relevant plan features. As a practical matter, the notice requirement means that a plan generally must elect safe harbor status before the beginning of a plan year.
The SECURE Act provides greater flexibility for employers that want to satisfy the safe harbor using nonelective contributions. For nonelective contribution safe harbor 401(k) plans, the legislation (1) eliminates the notice requirement, (2) allows a plan to become a safe harbor plan at any date before the 30th day before the end of the plan year, and (3) allows a plan to become a safe harbor plan even later (generally the close of the following plan year) if the nonelective contribution is equal to at least 4% and certain other conditions are met.
These provisions are effective for plan years beginning in 2020.
Changes to Promote Lifetime Income Options in Defined Contribution Plans
Portability of lifetime income products
Some plan sponsors may have found it challenging to add a lifetime income product as an investment option under a defined contribution plan out of a concern that participants might lose some or all of the lifetime guarantee that they have accumulated if the product is discontinued from the plan’s investment menu. Income guarantees are product specific and usually cannot easily be transferred between providers in the way that non-guaranteed investments such as mutual funds can be. In the event that the option is removed from the plan, participants who are not distribution eligible (e.g., for a 401(k) plan, active employees under age 59½) have been unable to preserve the guarantee by rollover to an IRA offered by the same annuity issuer.
The SECURE Act adds new provisions to the tax code that permit a defined contribution plan to transfer or distribute a lifetime income investment under certain circumstances, even if the participant is not otherwise eligible to take a distribution. Under the new provisions, if a lifetime income investment that meets certain requirements is no longer authorized to be held as an investment option under a tax-qualified defined contribution plan (including a 401(k) plan), 403(b) plan or governmental 457(b) plan, the plan will generally be able to allow (1) a distribution of the investment in a trustee-to-trustee transfer to another employer-sponsored retirement plan or IRA, or (2) a distribution of the investment in the form of an annuity contract purchased for the participant, even if the participant is actively employed and not yet age 59½. The distribution must be made within 90 days of the date when the lifetime income product is no longer authorized to be held as an investment option under the plan.
These provisions are effective for plan years beginning in 2020.
Lifetime income disclosure
Defined contribution plans subject to ERISA are generally required to provide a benefits statement to each plan participant once every 12 months, identifying the participant’s accrued benefit and vested benefit.
The SECURE Act requires defined contributions plans to include a lifetime income disclosure in the annual benefits statement. The lifetime income disclosure is an estimate of the monthly payments that the participant would receive if his or her account balance were converted to a lifetime income stream under a single life annuity or a qualified joint and survivor annuity with the participant’s spouse, based on assumptions to be specified by the Department of Labor. The legislation directs the Department of Labor to issue a model lifetime income disclosure within one year of enactment.
The legislation provides that no plan fiduciary, plan sponsor or other person will have any liability under ERISA solely by reason of providing a lifetime income disclosure statement in accordance with the rules established by the Department of Labor.
This requirement applies with respect to benefit statements provided more than 12 months after the latest of the issuance by the Department of Labor of (1) interim final rules, (2) the model disclosure, and (3) prescribed assumptions.
Fiduciary safe harbor for evaluating annuity issuers
The choice of an annuity as an investment or distribution option in a defined contribution plan subject to ERISA is a fiduciary decision, and the Department of Labor has previously issued guidance that plan fiduciaries can use to demonstrate prudence in selecting an annuity for a defined contribution plan under certain circumstances. One of the factors that a fiduciary must consider when deciding whether to include an annuity option in a defined contribution plan is the financial capability of the insurance company issuing the annuity. Evaluating the financial strength of an insurance company is a task that few plan sponsors feel qualified to do, and many plan sponsors have cited fiduciary concerns as a significant reason for not including annuity options in defined contribution plans.
To address this concern, the SECURE Act introduces a new safe harbor that a plan fiduciary may use to demonstrate that it acted prudently in determining the financial capability of an insurer backing a guaranteed retirement income contract. Under the safe harbor, a plan sponsor generally can rely on representations of the insurance company with respect to its financial capabilities in purchasing an annuity. As explained in the legislative history to the SECURE Act, the safe harbor would be an optional means of establishing prudence and not the exclusive means.
It is important to note that the safe harbor does not extend to the terms of the underlying insurance contract. Accordingly, a fiduciary still must conduct an analysis of the prudence of the terms and conditions of the annuity contract based on present law and guidance.
This provision is effective immediately.
Other Defined Contribution Plan and IRA Changes
Credit card loans
Tax-qualified defined contribution plans can generally permit participants to borrow from their accounts under the plan. Under current law, there is no prohibition on plans providing these loans through the use of credit or debit-type cards. The SECURE Act, however, provides that qualified plans are prohibited from making new loans through credit cards and other similar arrangements.
This provision is effective immediately.
Penalty-free withdrawals upon the birth of child or adoption
The tax code imposes an additional 10% tax on early distributions from a qualified retirement plan, including an IRA. There are a number of exceptions to this tax, including exceptions for distributions to pay certain types of medical expenses and to individuals called to active duty. The available exceptions differ depending on whether the distribution is from an employer-sponsored retirement plan or an IRA.
The SECURE Act adds another exception for distributions from qualified retirement plans and IRAs (but excluding defined benefit plans) made in connection with the birth or legal adoption of a child. The distribution amount is limited to $5,000 and can only be made in the first year following the adoption or birth. A participant can repay the amount to the plan or IRA at any time.
This provision is effective for distributions made in plan years beginning in 2020.
Difficulty of care foster care payments
The amount that can be contributed to a defined contribution plan or an IRA for any individual for a taxable year generally cannot exceed the individual’s compensation, which generally includes only an individual’s taxable income.
The SECURE Act provides that certain tax-exempt “difficulty of care” payments for “qualified foster care” (as defined under section 131 of the Internal Revenue Code) are treated as compensation for purposes of these limits. This change is aimed at helping home healthcare workers, who have limited taxable income other than tax-exempt difficulty of care payments, save for retirement.
This change is effective for IRA contributions made after the date the SECURE Act is enacted (December 20, 2019), and is effective for defined contribution plans for plan years beginning in 2020.
Termination of section 403(b) custodial accounts
While existing tax regulations provide for the termination of section 403(b) plans, the mechanics and other details of that termination process have never been articulated. The SECURE Act instructs the Treasury Department to issue guidance within six months, providing that if an employer terminates a 403(b) custodial account, the distribution needed to effectuate the plan termination may be the distribution of an individual custodial account in kind to a participant or beneficiary. Further, the guidance must provide that (1) the section 403(b)(7) status of the distributed custodial amount is generally maintained if the custodial account thereafter adheres to all requirements of section 403(b) that are in effect at the time of distribution of the account, and (2) that a custodial account would not be considered distributed to the participant or beneficiary if the employer has any material retained rights under the account.
This guidance will be retroactive to tax years beginning after December 31, 2008.
Defined Benefit Plan Changes
In-service distributions at age 59½
Defined benefit plans generally cannot make distributions to active employees who are under age 62. Distributions to active employees who are age 62 or older are permissible, and are most common in cash balance defined benefit plans and in money purchase pension plans, although some traditional defined benefit plans permit in-service distributions as part of a phased retirement program.
A provision of the Appropriations Act lowers the minimum age at which defined benefit retirement plans may provide voluntary in-service distributions for active employees to age 59-1/2.
This change is effective for plan years beginning in 2020.
Nondiscrimination relief for frozen plans
For a variety of reasons, many defined benefit plans have been closed to new entrants, but continue to provide accruals for existing participants. These plan closures often occur in connection with a shift to a cash balance plan or defined contribution plan for new hires (or individuals hired after a certain time). Although the defined benefit plans satisfy all applicable nondiscrimination requirements at the time of the closure, they often have difficulty complying with the nondiscrimination rules over time as the existing participants gradually become older and higher-paid. An employer with a plan that cannot pass the nondiscrimination tests may have no choice but to freeze future accruals under the defined benefit plan for all participants.
Although the IRS has issued some limited nondiscrimination testing relief for closed plans, the SECURE Act provides long-awaited, broad-based nondiscrimination relief for defined benefit plans that are closed to new participants. The relief includes the following:
- allows closed defined benefit plans to be aggregated with defined contribution plans for coverage and amounts testing, despite not meeting the otherwise applicable thresholds to do so;
- allows certain defined contribution plans to be cross-tested on a benefits basis when the plans provide make-whole contributions to participants who are no longer participating in a closed defined benefit plan;
- permits closed defined benefit plans to be treated as satisfying benefits, rights, and features nondiscrimination testing; and
- provides relief from the minimum participation rule of section 401(a)(26) of the Internal Revenue Code.
Various conditions must be satisfied to obtain the relief. To qualify for the relief allowing a defined benefit plan to be tested on an aggregated basis with a defined contribution plan and for the relief from benefits, rights and features testing, a plan must generally:
- satisfy applicable nondiscrimination requirements in the year of the participation closure and for the following two plan years (without relying on SECURE Act relief);
- not be amended after participation closure to change the class of participants covered by the plan, the benefits under the plan, or the benefits, rights and features provided to that class in a way that discriminates significantly in favor of highly compensated employees; and
- either (1) be closed to new participants as of April 5, 2017, or (2) be in effect for at least five years as of the date it is closed to new participants and, during the five year period preceding the date of closure, have no substantial increase in the coverage, benefits, or value of the benefits, rights or features provided to the closed class of participants.
These rules are applicable upon enactment, although plan sponsors can elect to apply the rules to plan years beginning in 2014 and later. The legislation also provides some relief for plans that were amended before the enactment of the legislation in a way that would otherwise make them ineligible to use the new rules.
Changes to Required Minimum Distribution Rules
Repeal of “stretch” distribution rules
Under current law, if a beneficiary (other than a spouse) inherits a retirement account under a defined contribution plan or an IRA, distributions to the beneficiary can be made over a period (a “stretch”) as long as the beneficiary’s life expectancy (using the IRS’s life expectancy tables).
The SECURE Act generally shortens the period over which non-spouse beneficiaries may take distributions to ten years. Disabled individuals, chronically ill individuals, individuals who are not more than ten years younger than the employee, children who have not reached the age of majority and certain individuals who are being paid under a “qualified annuity” (generally a binding lifetime annuity contract) as of the date of enactment are all exempted from the ten year period, and can stretch their payments over their own lifetimes. However, once a child reaches the age of majority, the amount remaining in the account must be distributed within ten years. The determination of whether an individual qualifies for one of these exemptions is made as of the date of death of the employee or IRA owner.
This change applies to the accounts of individuals who die on and after January 1, 2020.
Required minimum distribution age extended from 70½ to 72
Individuals generally must begin taking withdrawals from their IRAs and retirement plan accounts when they reach age 70½. The SECURE Act increases that age to 72 for individuals who reach age 70½ after on and after January 1, 2020. Individuals who are already taking required minimum distributions as of January 1, 2020, must continue to do so under the old rules and cannot stop taking them, even if they are under 72.
This change is effective January 1, 2020.
Changes to IRA Rules
Repeal of maximum age for traditional IRA contributions
Currently, individuals over age 70½ cannot make contributions to a traditional IRA. The SECURE Act repeals this prohibition. This change is effective for contributions made for the 2020 taxable year and later taxable years.
Certain stipend and fellowship payments treated as compensation As mentioned previously, contributions to an IRA generally cannot exceed the amount of an individual’s compensation for a year. The SECURE Act provides that certain taxable non-tuition stipend and fellowship payments will be treated as compensation for IRA purposes. Prior to this change, these payments could not be contributed to an IRA because they were not compensatory, even though they were includible in gross income and taxable.
This change is effective for taxable years beginning in 2020.
Changes Affecting Plan Administration
Timing of plan adoption
Currently, plan documents must be adopted by the last day of the employer’s taxable year to be effective for that taxable year. The SECURE Act allows an employer to adopt a retirement plan that is effective for a taxable year after the close of that taxable year, but before the due date (including extensions) for the employer’s tax return for the year. This provision only applies to newly adopted plans and does not extend plan amendment deadlines.
This provision is applicable for plans adopted for taxable years beginning in 2020.
Group filing of Form 5500s
Under current law, an annual information return –Form 5500 – must be filed with the IRS and Department of Labor for each separate retirement plan. The SECURE Act allows a single aggregated Form 5500 to be filed for a group of retirement plans provided that all of the plans (1) are defined contribution or individual account plans; (2) have the same trustee, fiduciaries, administrator and plan years; and (3) provide the same investments or investment options to participants and beneficiaries. The legislation also includes additional guidance as to administrative requirements and electronic filing requirements for the Form 5500s.
This change is effective for Form 5500s due for plan years beginning in 2022.
Increased penalties for failure to file certain tax returns and Form 5500s
The SECURE Act significantly increases – by tenfold – the penalties for failing to timely file the following forms –
- Form 5500 and Form 5310-A (reporting certain retirement plan mergers, transfers and spin-offs): from $25 per day to $250 per day, with a maximum of $150,000 (previously $15,000).
- 8955-SSA (identifying separated participants with deferred vested benefits): from $1 per participant per day to $10 per participant per day, with a maximum of $50,000 (previously $5,000).
- Required notification of change (notifying the IRS of certain changes in plan status, satisfied through Form 5500 reporting): from $1 per day to $10 per day, with a maximum of $10,000 (previously $1,000).
- Required withholding notice (notifying participants of their right to elect different withholding percentages for periodic payments): from $10 per failure to $100 per failure, with a maximum of $50,000 (previously $5,000).
The SECURE Act also increased the penalty for failure to timely file and pay the tax reported on Form 5330 (used to report and pay the prohibited transaction excise tax related to employee benefit plans) a (used to report additional taxes on IRAs and other qualified retirement plans or tax-favored accounts, like HSAs) from the lesser of $330 or 100% of the amount due to $400 or 100% of the amount due.
These increases apply to returns, statements and notifications required to be filed, and notices required to be provided after December 31, 2019.
Enhanced plan start-up incentives
The SECURE Act made several changes to encourage small employers (those that have 100 employees or fewer) to establish retirement plans for their employees. The tax code currently provides that small employers can receive a credit for the costs of establishing a qualified retirement plan up to $500 per year for the first three years. The SECURE Act increases this credit up to $5,000 per year. The legislation also provides a new $500 per year credit for the first three years for employers that add an automatic enrollment feature to their plans.
These credits are available for tax years beginning in 2020.
Multiple Employer Plans and Pooled Plan Providers
Multiple employer plans (MEPs) – that is, plans in which multiple unrelated employers participate – are fairly common, but, under current law, the employers participating in a MEP generally must be related by a “common interest” for the arrangement to be treated as a single plan for ERISA purposes. (By statute, MEPs are treated as a single plan for some tax qualification purposes, and as a series of separate plans for other tax purposes.)
The SECURE Act provides for a new type of “open MEP” (in industry parlance) to be known as a “pooled employer plan.” The employers participating in a pooled employer plan do not need to be related by a common interest or in any other way, and, in fact, employers with a “common interest” cannot form a pooled employer plan. A pooled employer plan is a defined contribution plan that (1) provides that a “pooled plan provider” is the named fiduciary of the plan responsible for the general administration of the plan, (2) designates trustees to be responsible for collecting contributions to the plan, (3) provides that employers and participants are not subject to unreasonable restrictions, fees or penalties in connection with ceasing participation in the plan and (4) meets certain other requirements.
A pooled plan provider can be any person who registers with the IRS and Department of Labor and agrees to perform all of the actions required of it under ERISA, the tax code and applicable guidance. There are no other explicit limitations on who may serve as a pooled plan provider. Employers participating in the plan remain responsible for the selection and monitoring of the pooled plan provider and any other named fiduciary of the plan.
In addition, the SECURE Act eliminates the “one bad apple” rule from existing tax regulations. Under that rule, a tax qualification defect on the part of any employer participating in a MEP results in the disqualification of the entire plan for all employers and participants. Even before the enactment of the SECURE Act, the Treasury Department and IRS had proposed rules to eliminate the one bad apple rule.
These provisions are effective for plan years beginning in 2021.