On December 20th, before the outbreak of COVID-19 and the resulting pandemic, President Trump signed into law the Setting Every Community Up For Retirement Enhancement Act of 2019 (the “SECURE Act”) and the Bipartisan American Miners Act of 2019 (the “Miners Act”). The SECURE Act and the Miners Act contains a number of amendments to the Internal Revenue Code of 1986, as amended (the “Code”) and the Employee Retirement Income Security Act of 1974, as amended (“ERISA”) that impact employer-sponsored retirement plans, including many significant participant-facing changes. Our prior Legal Update on the SECURE Act, available here, highlights the provisions that are most relevant to employer-sponsored retirement plans.
After the SECURE Act’s enactment in late 2019, a number of open questions remained about some of the more important changes that could potentially have a significant impact on plan administration, such as the participation of “long-term part-time employees”. However, in the wake of the coronavirus pandemic beginning in early 2020, the CARES Act took center stage, as plan sponsors focused on making it easier for participants to access retirement plan money from qualified plans.
We have been eagerly waiting guidance from the IRS on the SECURE Act (at least, since the IRS issued guidance on the CARES Act last month), which arrived in the form of Notice 2020-68 (“Notice”) on September 2, 2020. The Notice addresses many, but not all, of the lingering questions relating to the SECURE Act and one section of the Miners Act, as detailed below.
Distributions For Expenses Related to the Birth or Adoption of a Child (SECURE Act Section 113)
As a reminder, for plan years beginning after December 31, 2019, the SECURE Act permits penalty-free distributions for birth or adoption-related expenses of up to $5,000 from defined contribution plans, including IRAs, without the penalty that normally might apply to an early distribution. These distributions are available to each parent for a period of up to one year following the birth or finalization of the legal adoption of a child. The recipient of such a distribution will be allowed to later re-contribute all or a portion of the distribution to a qualified retirement plan (or IRA) in which the recipient participates (even if not the same plan that made the distribution), provided certain requirements are met.
The Notice provides a number of detailed Q&As related to these distributions, many of which are reminiscent of the recent guidance that was issued by the IRS with respect to “coronavirus-related” distributions under the CARES Act. Notably, the Q&As:
- Clarify that these distributions are not mandatory. Plan sponsors may, but are not required to, permit these distributions. However, if a plan does not permit these distributions, a participant may still treat an otherwise permissible in-service distribution from the plan as a qualified birth or adoption distribution to avoid early distribution penalties (although the participant may not be able to recontribute the distribution to the plan, as described below).
- Provide that an individual is permitted to receive qualified birth or adoption distributions with respect to the birth or adoption of more than one child (e.g., up to $10,000 for twins, $15,000 for triplets, and so on), provided the distributions are made during the applicable one year period.
- Provide that the participant may self-certify that he or she is eligible for a qualified birth or adoption distribution. The plan administrator may rely on reasonable representations from the participant, unless the plan administrator has actual knowledge to the contrary.
- Provide that a defined contribution plan must accept the re-contribution of a qualified birth or adoption distribution if:
1. the plan permits such distributions,
2. the individual received the distribution from that plan, and
3. the individual is otherwise eligible to make a rollover contribution to that plan at the time he or she wishes to re-contribute the distribution.
- Clarify that, similar to a coronavirus-related distribution, qualified birth and adoption distributions are not treated as eligible rollover distributions for purposes of the direct rollover rules, so a Code Section 402(f) notice is not required, nor do the mandatory 20% withholding requirements under Code Section 3405 apply.
Although the majority of the Q&As in the Notice relate to qualified birth and adopted distributions, questions still remain about the mechanics of these distributions and later re-contributions. For example, the Notice does not include guidance regarding the tax reporting of re-contributions of qualified birth or adoption distributions, nor does it address what (if any) type of substantiation is required when a distribution is later re-contributed. Also absent from the Notice is a discussion of any limit on the time period for making a re-contribution, so the period still appears to be indefinite, which will undoubtedly create administrative challenges for plan administrators.
The Notice does provide that the IRS intends to issue regulations addressing the rules for re-contribution of these distributions, including rules related to timing of re-contributions, so additional guidance is forthcoming. We anticipate that the tax reporting and substantiation of re-contributions may track the guidance recently issued by the IRS regarding the reporting of re-contributions of coronavirus-related distributions.
Vesting Considerations for Long-Term Part-Time Workers (SECURE Act Section 112)
As described in more detail in our prior Legal Update under the Code’s eligibility rules, many 401(k) plans exclude part-time employees who work less than 1,000 hours in a year from plan participation. However, the SECURE Act limits a plan sponsor’s ability to exclude “long-term part-time employees” from eligibility to make their own salary deferral contributions. Under the SECURE Act, a plan is required to permit part-time employees who perform work for the plan’s sponsoring employers for at least 500 hours of service each year over three consecutive years to make salary deferrals.
The eligibility rules relating to employer contributions have not changed, so employers will not be required to make employer contributions for these long-term part-time employees. However, if an employer does voluntarily make employer contributions for long-term part-time employees, and such contributions are subject to a vesting schedule, a special vesting rule must be applied with respect to these employees.
Under the new special vesting rule, a long-term part-time employee must be credited with a year of service for purposes of vesting for ALL 12-month periods during which the employee had at least 500 hours of service (as opposed to the 1,000 hours requirement that is used by many plans with a vesting schedule) with respect to employer contributions (i.e., matching or non-elective contributions). Notably, the Notice clarifies that this special vesting rule applies only to those long-term part-time employees who become eligible to participate in a plan solely on account of this new rule (and not all employees or plan participants).
In addition, the Notice provides that while 12-month periods beginning before January 1, 2021 are not taken into account for purposes of determining a long-term part-time employee’s eligibility to participate in a plan, all periods, including those beginning before January 1, 2021, are taken into account for purposes of determining vesting (with certain exceptions, such as those periods before the employee was 18 years old). Employers will need to make necessary modifications to their administrative systems to account for both the future eligibility of these employees, as well as the special vesting provisions applicable to these employees (if the plan provides employer contributions to long-term part-time employees and such contributions are not immediately vested).
Many plans that already permit part-time employees to participate do not provide for employer contributions, so from a systems perspective, these plans will have an easier time implementing the new rules. The new rules may influence some plan sponsors not to make such contributions available to part-time employees for administrative convenience, i.e., to avoid having to maintain separate vesting system requirements, and due to lack of data for hours worked before 2021.
Mechanics of the Automatic Enrollment Tax Credit (SECURE Act Section 105)
To encourage automatic enrollment, the SECURE Act provides employers with fewer than 100 employees who received at least $5,000 of compensation with a special tax credit of $500 per year for up to three years (for a total of $1,500) if they amend their plan to include an eligible automatic contribution arrangement (“EACA”). This new tax credit was effective for taxable years beginning after December 31, 2019.
One lingering question was whether an employer who established an EACA less than three years before the SECURE Act’s enactment could claim this new tax credit. The Notice answers this question in the affirmative, providing an example where an employer first included an EACA in one of its qualified plans during the 2018 tax year. In the example, the employer is eligible to receive a $500 credit for the 2020 taxable year, but no credit for any subsequent tax years because the three year credit period expired after 2020. Thus, employers who established an EACA prior to 2018 are not eligible for any of this tax credit.
The Notice further clarifies that an employer may receive a credit only during a single three-year credit period that begins when the employer first includes an EACA in any qualified retirement plan. Expanding upon the prior example, if the employer included an EACA in a second qualified retirement plan for the 2020, 2021 and 2022 taxable years, the employer is still not eligible for a credit for tax years after 2020. When determining eligibility for the credit, the Notice makes it clear that you look to when the employer first included an EACA in one of its qualified retirement plans (i.e., 2018 in this example). The employer must continue to maintain the same EACA in the same plan for all three taxable years in order to be eligible for the full $1,500 credit (although, the Notice makes it clear that special rules apply in the event of a plan spin-off).
Elimination of Age Limit on Traditional IRA Contributions (SECURE Act Section 107(d))
Historically, an individual who reached 70½ before the end of the year could no longer make annual contributions to a traditional IRA. The SECURE Act eliminated this restriction with respect to contributions made for taxable years beginning after December 31, 2019. Because individuals 70½ and older may now continue to make deductible contributions to an IRA, the SECURE Act also reduced the amount of qualified charitable distributions (but not below zero) that those 70½ and older can exclude from tax (historically, up to $100,000 could be excluded).
The Notice includes some helpful guidance relating to these changes. First, it provides an illustration of how the qualified charitable distribution exclusion is calculated. (The formula is a bit complex, so the examples shed some helpful light on how to perform this calculation). Second, the Notice clarifies that a financial institution that serves as a custodian, trustee or issuer of an IRA is not required to accept post-70½ IRA contributions. If a financial institution accepts such contributions, however, it must amend its IRA contracts to provide for these contributions by December 31, 2022, and must also distribute a copy of the amendment to the IRA contract and a new disclosure statement to each “benefited individual” no later than 30 days after the date on which the amendment is adopted or, if later, the date it becomes effective.
The IRS stated it intends to issue revised model IRAs and prototype language addressing the changes under the SECURE Act, although it is not clear when these revised documents will be provided.
Difficulty of Care Payments Included in 415 Compensation (SECURE Act Section 116)
The SECURE Act amends the Code to provide that “difficulty of care” payments that are excluded from taxable compensation are now included in compensation for purposes of calculating the contribution limits to defined contribution plans and IRAs. A “difficulty of care” payment is a payment received by an individual under a foster care program of a state or political subdivision thereof. The Notice clarifies that if an employer makes difficulty of care payments to its employees, such payments are includible in the definition of compensation for purposes of the contribution limits (difficulty of care payments NOT paid by the employer are still excluded, however).
Reduction in Minimum Age For In-Service Distributions (Miners Act Section 104)
Under Section 401(a)(36) of the Code, a defined benefit pension plan may permit in-service distributions if an employee has reached a certain age. The Miners Act lowered the age at which these in-service distributions may be made from age 62 to age 59-1/2. Interestingly, the Miners Act did not amend the mirror section of ERISA (ERISA §(3)(2)(A)(ii)), which still requires a participant to have attained age 62 in order to receive an in-service distribution, but a change to the language of ERISA could be picked up in subsequent technical correction amendments. The Miners Act also amended the Code to allow a governmental 457(b) plan to make amounts under the plan available to a participant at age 59-1/2. Previously, amounts under a governmental 457(b) were permitted to be available no earlier than age 70-1/2 or the participant’s termination from employment.
The Notice clarifies that no plan is required to allow for in-service distributions and that if a plan allows an in-service distribution at age 62, the plan is not required to be amended to allow such distribution at age 59-1/2. The Notice also states that the change to age 59-1/2 in the Code for in-service distributions does not affect the rules related to the choice of “normal retirement age” under the plan. For example, a plan must still comply with the requirement that a normal retirement age under the plan must be an age that is not earlier than the earliest age that is reasonably representative of the typical retirement age for the industry in which the covered workforce is employed.
Plan Amendment Deadlines
The deadline for amendments reflecting SECURE Act revisions and Section 104 of the Miners Act is generally the last day of the plan year beginning on or after January 1, 2022. For calendar year plans, that means December 31, 2022. However, later deadlines may apply to governmental plans or collectively bargained plans.
Many employers have already adopted SECURE Act provisions (e.g., the increase in required minimum distribution date and the birth/adoption distribution). Other employers have not and were waiting for guidance which has now arrived. In particular, for those who do not already cover part-time employees (e.g., working less than 1,000 hours a year generally), the long-term part-time employee eligibility rules are significant, and will require careful planning and administrative system changes. This IRS Notice gives those employers some time to evaluate their next steps and begin the process of modifying their plan administrative practices.