As part of the 2020 appropriations act, Congress passed the SECURE Act (Setting Every Community Up for Retirement Enhancement Act of 2019), which was signed into law by the President on December 20, 2019. The SECURE Act has a number of implications for 401(k) plans, a summary of which follows.
- Increase in Maximum Automatic Deferral. The maximum “automatic” deferral that can be made to a 401(k) plan that is a qualified automatic contribution arrangement is increased from 10% of compensation to 15% of compensation. This change is effective for plan years beginning after December 31, 2019.
- Notice Requirements for Safe Harbor Plans. A “safe harbor” 401(k) plan that satisfies the safe harbor through non-elective employer contributions at least equal to 3% of the employee’s compensation is no longer required to provide the annual safe harbor notice at least 30 days before the beginning of the plan year. Safe harbor plans that satisfy the safe harbor through matching contributions are still subject to the annual notice requirements. This change is effective for plan years beginning after December 31, 2019.
- Timing of Adoption of Safe Harbor Status. A 401(k) plan can be amended to become a safe harbor plan providing a 3% non-elective contribution by the day before the 30th day before the end of the plan year (December 1 for a calendar year plan.) Alternatively, the plan can be amended to become a safe harbor plan providing a 4% non-elective contribution by the last day of the following plan year. This change gives employers another tool to correct a 401(k) plan that fails the ADP test. For example, if a non-safe harbor plan fails the ADP test for the plan year ending December 31, 2020, in lieu of distributing excess contributions to highly compensated employees, the plan can be amended by December 31, 2021 to add a 4% non-elective contribution for the 2020 plan year. The SECURE Act does not state when the non-elective contribution must be made to the plan for the 2020 plan year. These amendments may not be adopted if the 401(k) plan is a safe harbor plan that satisfies the safe harbor through matching contributions. This change is effective for plan years beginning after December 31, 2019.
- No Loans Through Credit Cards or Similar Arrangements. Some 401(k) plans made plan loans available to participants through what was essentially a credit card. Each use of the card constituted a new loan; the participant received a bill, and made monthly payments to the plan. Effective December 21, 2019, loans from a 401(k) plan through the use of a credit card or similar arrangement are not allowed under Section 72(p) of the Internal Revenue Code (the “Code”). Any such loans would be treated as a taxable distribution from the plan.
- In-Service Distribution of Annuity Contracts. 401(k) plans may offer an annuity or similar contract providing for lifetime income as an investment option. These contracts may have surrender charges if they are liquidated, for example, if the investment is no longer available as an investment option under the plan. Effective for plan years after December 31, 2019, a 401(k) plan may allow participants to take an in-service distribution of such annuity contract within 90 days before the date on which the annuity contract is no longer authorized to be held as an investment option under the plan, even if the participant is not otherwise entitled to a distribution under the plan. The distribution must be in the form of a direct trustee-to-trustee transfer to an IRA or other qualified retirement plan or as a distribution of the annuity contract to the participant.
- Elective Deferrals by Long-Term Part-Time Employees. A “long-term part-time” worker must be allowed to make elective deferrals to a 401(k) plan. A long-term part-time worker is an employee who is at least age 21 and has completed three consecutive years of service with at least 500 hours of service in each such year. Such an employee must enter the plan on the earlier of (a) the first day of the plan year after meeting the age and service requirements; or (b) the date that is six months after the date on which the employee satisfied the age and service requirements.
The employer is not required to make any matching or non-elective contributions to a long-term part-time employee who is making elective deferrals under this special rule. If the employer makes matching or non-elective contributions on behalf of a part-time worker, he or she will earn a year of vesting service for every year in which the worker has at least 500 hours of service.
A long-term part-time worker who becomes a full-time employee will no longer be treated as a long-term part-time worker as of the first day of the plan year following the plan year in which the employee completes 1000 hours of service.
For testing purposes, an employer may elect to exclude long-term part-time employees for the purposes of:
- Non-discrimination testing under Code Section 401(a)(4)
- ADP testing
- Safe harbor contributions
- Automatic contribution arrangements
- ACP testing
- Coverage testing under Code Section 410(b)
Further, such employees may be excluded for purposes of minimum benefits and vesting under the top-heavy rules.
These new rules do not apply to collectively bargained employees.
The new participation rule for long-term part-time workers applies to plan years beginning after December 31, 2020, except that for purposes of determining whether the three consecutive year period has been met, 12-month periods beginning before January 1, 2021 will not be taken into account.
- Qualified Birth or Adoption Distributions. A 401(k) plan may allow an in-service distribution of up to $5,000 for a “qualified birth or adoption distribution.” This is a distribution made within the one year period following the birth or legal adoption of a child. Such a distribution may be repaid to the plan by the participant. A qualified birth or adoption distribution is exempt from the 10% early distribution tax under Code Section 72(t)(2). This provision is effective for distributions made after December 31, 2019.
- Lifetime Income Stream Disclosure. At least once in every 12-month period, the participant’s benefit statement must disclose the “lifetime income stream equivalent” of the participant’s account balance. A lifetime income steam equivalent means the monthly payments the participant would receive if his or her account balance were used to provide a qualified joint and survivor annuity and a single life annuity. The Department of Labor (“DOL”) is directed to issue a model lifetime income disclosure, appropriate assumptions and interim final rules by December 20, 2020. No plan fiduciary or plan sponsor will have any liability under ERISA if it provides the lifetime income equivalents in accordance with the DOL’s assumptions consistent with explanations contained in the model lifetime income disclosure. This disclosure will apply to benefit statements furnished more than 12 months after the latest of the issuance by the DOL of the interim final rules, the model disclosure or the assumptions.
- Fiduciary Safe Harbor for Selection of Lifetime Income Provider. The SECURE Act sets out a safe harbor for a fiduciary who selects a guaranteed annuity contract providing lifetime income to a participant. The fiduciary will be protected from fiduciary liability under ERISA if it evaluates the financial capability of the insurer and the cost of the contract, and receives certain written representations from the insurer. The fiduciary must satisfy these responsibilities at the time of selection of an insurer for a participant or beneficiary. This means if the insurer is unable to meet its payment obligations in the future under the contract, the fiduciary is not liable for any losses that affect the participant.
- Required Beginning Date Increased to Age 72. The required beginning date for purposes of required minimum distributions is increased from age 70½ to age 72. This applies to distributions required to be made after December 31, 2019 with respect to individuals who attain age 70½ after that date. Required minimum distributions based on age 70 ½ due April 1, 2020 must still be made.
- RMD Rules Revised. If an employee dies before receiving his or her entire account balance, the required minimum distribution (RMD) rules are revised to provide that the entire benefit must be distributed within 10 years. A beneficiary (other than certain “eligible designated beneficiaries”) is no longer permitted to receive distributions over his or her lifetime. An eligible designated beneficiary who is permitted to receive distributions over his or her lifetime includes a surviving spouse and a person who is not more than 10 years younger than the employee. This change is generally effective for distributions with respect to employees who die after December 31, 2019.
Plans must be amended to incorporate the changes made by the SECURE Act by the last day of the first plan year beginning on or after January 1, 2022 (or a later date prescribed by the IRS), and must be operated in accordance with the provisions of the SECURE Act as of the applicable effective date. As many of these changes are effective for plan years beginning after December 31, 2019, plan sponsors should evaluate the changes, determine the impact on the operation of their plan and communicate the changes to participants.