As part of the year-end government funding legislation, on December 20th, President Trump signed into law the Setting Every Community Up For Retirement Enhancement Act of 2019 (the “SECURE Act” or the “Act”). The 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. The SECURE Act is probably the most significant single piece of employer retirement plan legislation since the Pension Protection Act of 2006.
As a result, it’s important for plan sponsors to be aware of the different provisions of the SECURE Act, some of which became effective on January 1, 2020. While many provisions of the Act are already in effect, the Act does provide some relief for employers to adopt any necessary amendments to their plans. Generally, the Act includes a remedial plan amendment period until the last day of the 2022 plan year (or the 2024 plan year for certain governmental plans), or a later date if the Treasury Department so provides. So while employers have plenty of time to adopt any necessary plan amendments, the SECURE Act will have an impact on the manner in which a retirement plan is administered far sooner, which will require discussions with third party administrators and the issuance of participant communications to explain the changes.
In that regard, the following highlights the provisions of the SECURE Act that are most relevant to employer-sponsored retirement plans. We first address the SECURE Act provisions that are participant-facing, and then the provisions which affect plan administration, but do not necessarily impact participants directly.
Increasing RMD Age from 70½ to 72
One of the most “participant-facing” changes affects the age at which participants are required to commence distribution of their retirement plan benefit. Under current law, a participant is generally required to begin taking annual “required minimum distributions” (“RMDs”) from their retirement plan beginning no later than April 1 of the year following the year that they attain age 70½ or, if still working, the year in which they retire. The Act delays the RMD age from age 70½ to age 72, and applies equally to individual retirement accounts (IRAs). The existing RMD age found its way into pension law in 1962, and had not been updated since to reflect other changes in retirement plan law or increases in life expectancy over the past 57 years.
Effective Date: The increased age applies to individuals who attain age 70½ after December 31, 2019, and there is no relief for those who have already commenced receipt of their RMDs, or those required to do so under existing law by April 1, 2020.
Required Coverage of Long-Term, Part-Time Workers
Generally, qualified retirement plans may not exclude part-time employees. However, as permitted under the Code’s eligibility rules, many 401(k) plans exclude employees who work less than 1,000 hours in a year from all plan participation, including the ability to make their own salary deferral contributions. The Act restricts the ability of plan sponsors to exclude this type of part-time employee by requiring the inclusion of “long-term part-time employees” in 401(k) plans if certain conditions are satisfied. Under the provision, 401(k) plans will be required to permit part-time employees who perform work for at least 500 hours of service over three consecutive years to contribute to a 401(k) Plan. The rules relating to employer contributions are not changing, so employers will not be required to make employer contributions for these long-term part-time employees (although they will be free to do so). The Act does not change the eligibility rules with respect to collectively bargained employees or the use of a minimum age (no more than age 21) for plan eligibility. Fortunately, the Act also permits plan sponsors to disregard these long-term part-time participants for purposes of application of the Code’s nondiscrimination testing and top-heavy rules.
Effective Date: This new rule goes into effect beginning in 2021; however, because the counting of hours and years of service will first start in 2021, the mandated participation of long-term part-time employees under this provision will be delayed until 2024. Nevertheless, employers will need to make necessary modifications to their administrative systems by no later than January 1, 2021, to account for the potential future eligibility of these employees.
Distributions For Expenses Related to the Birth or Adoption of a Child
The Act permits penalty-free distributions for birth or adoption-related expenses of up to $5,000. Under the provision, the withdrawal is available for up to one year following the birth or finalization of the legal adoption of a child. Generally the adoption must be of a child under age 18, but adoption of older children also is permitted if the child is physically or mentally incapable of self-support. Although a qualifying distribution will be penalty-free it will still be subject to then current taxes. This new distribution is not mandatory; plan sponsors will have the option whether or not to permit it. If permitted, the recipient of such a distribution will be allowed to later repay all or a portion of the distribution to a qualified retirement plan in which the recipient participates (even if not the same plan that made the distribution), provided that the recipient plan will accept such repayment under its rollover provisions.
Effective Date: Plans may adopt this new distribution provision for plan years beginning after December 31, 2019.
Lifetime Income Disclosure Requirements
As employer-provided retirement benefits have transitioned over the years from defined benefit pension plans to defined contribution individual account plans, much has been said about the need to educate plan participants to the importance of lifetime annuity distribution options. The Act contains two provisions designed to encourage plan sponsors and plan participants to consider lifetime annuity investment and distribution options under defined contribution plans.
The first of these provisions require plan sponsors to include a “lifetime income disclosure” on a participant benefit statement at least annually, even if the plan does not offer annuity distribution options. Accordingly, this new disclosure requirement will impact all employers that sponsor a defined contribution retirement plan. The lifetime income disclosure will be an estimation of the monthly payments a plan participant and their beneficiaries would receive if benefits were paid in the form of a qualified joint and survivor annuity or single life annuity.
The Secretary of Labor is directed to issue a model disclosure and to prescribe assumptions that plan sponsors can use in preparing these lifetime annuity estimates by December 2020.
Effective Date: Employers must provide the lifetime income disclosure in benefits statements no more than one year after the later of the date the Department of Labor issues final rules, the model disclosure, or the assumptions relating to the new disclosure requirement.
Annuity Selection Safe Harbor
The second SECURE Act provision relating to the provision of annuities in defined contribution plans creates a new fiduciary safe harbor to encourage the plan sponsors to make available an annuity option. Once a plan sponsor determines to add an annuity option, the selection of the annuity provider is an inherently fiduciary act, and in 2008, the Department of Labor adopted a safe harbor to protect fiduciaries from losses that may result due to an insurer’s inability to meet its financial obligations under the terms of the annuity contract. However, the old safe harbor still required fiduciaries to conduct substantial due diligence in order to identify the safest available annuity provider. The new safe harbor is intended to replace the historic “safest available annuity” standard with a minimum set of standards that an annuity provider must satisfy in order for a fiduciary to be able to select the provider.
To qualify for the safe harbor relief, the plan fiduciary needs to ensure that the selected annuity provider represents that, for the prior seven years and on an ongoing basis, it: (1) operates under a license or authority of a state insurance commissioner to offer guaranteed retirement income contracts; (2) files audited financial statements in accordance with state laws; and (3) maintains financial reserves that satisfy all the statutory requirements of all states where the annuity provider conducts business.
While some will support the inclusion of this provision as a much needed step to help solve the problem of lifetime income for employees, it is too soon to know if this new safe harbor will have any significant impact on the availability of lifetime annuity options under defined contribution plans. The decision to offer such investment and distribution options is not itself a fiduciary act, but nevertheless will require plan sponsors to consider the appropriateness of making annuity products available to defined contribution plan participants due to, among other things, the administrative complexities that would be added. So only time will tell whether or not this new fiduciary safe harbor will incentivize plan sponsors to open their defined contribution plans to annuity investment and distribution options.
Effective date: The annuity provider safe harbor is available as of the effective date of the Act—January 1, 2020.
Reduction of Earliest Age for Pension Plan In-Service Distributions
Defined benefit pension plans typically have permitted distributions upon termination of employment (and in certain cases, only then after attainment of an early retirement age) or in-service upon attainment of normal retirement age, typically age 65. Recognizing that such strict distribution rules did not reflect the reality that many employees phase into retirement over time, the Pension Protection Act of 2006 authorized in-service distributions from pension plans as early as age 62. The Act takes that one step further and reduces the in-service distribution age to as low as 59½.
Effective Date: This is a permissive provision that employers can adopt for plan years beginning after December 31, 2019.
Modifications Applicable to 401(k) Safe Harbor Plans
The Act also includes the following two significant changes to the 401(k) safe harbor plan rules.
We are all familiar with the requirement that a “traditional” safe harbor plan design (matching or non-elective contribution safe harbor) must be adopted before the beginning of the plan year and that participants must be notified in advance of the plan year for which such plan design is being adopted. This rule made sense with respect to matching contribution safe harbor designs (participants need to know their match in advance so they have the opportunity to take full advantage of that match). However, since non-elective contributions are not dependent on a participant’s salary deferral contributions, the same logic didn’t apply to the 3% non-elective contribution safe harbor design. The Act addresses this disparity and eliminates the requirement that a non-elective safe harbor plan notify participants of such safe harbor status prior to the beginning of the plan year. Further the Act establishes new rules that permit the adoption of a non-elective safe harbor plan design at any time during a plan year. The minimum safe harbor non-elective percentage remains at 3% of compensation, provided that if adopted within the last 30 days of the plan year, the safe harbor non-elective contribution jumps to a minimum of 4%. In any event, the ability to adopt the non-elective safe harbor mid-year is not available in any year when a matching safe harbor applies.
The second safe harbor modification made by the Act relates to the use of the qualified automatic contribution arrangement (or “QACA”) safe harbor design. Up to now, the auto-contribution percentage that a plan could apply was capped at 10% of compensation. The Act increases this cap to 15% of compensation, provided that the maximum remains at 10% in the first year of a participant’s automatic deferrals. Of course plans can continue to require automatic contributions at lower levels than the maximums (no less than 3%).
Effective Date: Both of these safe harbor modifications are applicable to plan years beginning after December 31, 2019.
Employer Adoption of Tax-Qualified Retirement Plan After the Close of the Plan Year
Normally, pension and profit sharing plans can be adopted with respect to a particular year by the last day of that year. The Act changes this and provides that such a plan may be adopted as late as the due date, including extensions, of the sponsor’s tax return for the year and still be considered to have been adopted timely for that prior year. Note: 401(k) plans must be adopted prior to any participants being able to make salary deferral contributions, and this change does not modify this 401(k) plan rule.
Effective Date: This provision applies for tax years beginning after December 31, 2019.
Nondiscrimination Testing Relief for Frozen Defined Benefit Plans
In defined benefit (“DB”) plans that are closed to new employees (a so-called “soft freeze”), existing employees continue to accrue benefits. Typically, as the participant population ages and becomes more highly paid, frozen plans can experience difficulty in satisfying the Code’s nondiscrimination requirements. In fact, some plan sponsors opt to or are forced to completely freeze their DB plans (i.e., cease all further benefit accruals) to avoid running afoul of the testing requirements. The Act addresses this issue by adding a new Code rule modifying the existing nondiscrimination rules to give certain “closed-class” plans a testing pass. This new Code rule applies to DB plans that were “soft-frozen” before April 5, 2017 or DB plans that are frozen after April 5, 2017, were in effect for at least five years, and did not substantially increase benefit in the last five years prior to being frozen. We can expect the details of this provision to be addressed in the coming months in new Treasury guidance.
Effective Date: These provisions are generally effective January 1, 2020, but employers have the option to adopt these rules retroactively to plan years beginning after December 1, 2013.
Termination and Distribution of 403(b) Custodial Accounts
The termination of 403(b) plans has always sent shivers down sponsoring employers’ spines. While the termination of a 401(k) involves the relatively simple task of liquidating and distributing each plan account to the owner/participant, the funding vehicle for 403(b) plans include annuity contracts and custodial agreements which may not be liquidated and distributed at any given time. In 2011, the IRS issued Revenue Ruling 2011-17 that clarified that a terminating 403(b) plan may consider an annuity contract to be distributed (in-kind) upon the establishment of a fully paid individual annuity contract to the plan participant. These individual annuity contracts would hold the benefit until properly distributed in accordance with the Section 403(b) distribution requirements. However, the Revenue Ruling did not afford the same treatment to 403(b)(7) custodial accounts.
The Act now provides that custodial accounts also may be distributed in kind by the establishment of an individual custodial account.
Effective Date: The Department of the Treasury is required to issue guidance within six months of the effective date of the Act. Once issued, such guidance will be effective retroactive to plan years beginning after December 31, 2008.
Multiple Employer Plans (“MEPs”)/Pooled Employer Plans (“PEPs”)
There has been much discussion from the present Administration about the ability of unrelated employers to pool together under one “plan” to be able to take advantage of the economies of scale normally reserved to large employers. Historically, ERISA has required some commonality of employment or the plan would be considered a “multiple employer plan”, with each participating employer treated as sponsoring its own separate plan. That meant each employer was required to file its own annual Form 5500, and if the employer covered more than 100 participants, obtain its own independent audit report.
The Act changes this and allows unrelated employers to participate in a “pooled employer plan” and treat that plan in the aggregate as a single plan for ERISA purposes. Provided that the plan has the same trustee, named fiduciary, administrator plan year, and investment options applicable to all plan participants (regardless of which employer they work for), such a PEP will be permitted to file one consolidated Form 5500 for the entire PEP; each participating employer will no longer need to file its own Form 5500. The Department of Labor is expected to issue guidance implementing this new rule.
Effective Date: This provision of the Act will be effective for plan years beginning after December 31, 2021.
In addition to the provisions discussed above, the SECURE Act includes several other miscellaneous provisions, including:
- An increase to the penalties for failure to timely file the annual Form 5500 (from $15.00 a day up to a maximum of $15,000, to $250 a day up capped at $150,000), applicable to any Form 5500 required to be filed after December 31, 2019.
- Elimination of so-called “Stretch IRAs”, which now will need to be distributed within 10 years (and not over the lifetime of the beneficiary).
- Ability to make tax deductible contributions to an IRA up to age 72.
While the SECURE Act includes several provisions that plan sponsors, plan fiduciaries, and plan participants would welcome, the Act also creates some additional administrative burdens for plan administrators. Although actual plan amendments will not be required for some time, modifications will need to be made to administrative systems starting in 2020, and any SECURE Act changes adopted will need to be communicated to plan participants, either by distributing a summary of material modifications or preparing a new summary plan description. In considering the various changes made by the SECURE Act, plan sponsors should consult with their legal counsel and third party plan administrators to determine which changes are desirable, as well as to ensure that any changes that are adopted are done correctly. There will be guidance issued by both the Department of Labor and the IRS to assist with implementation of the new rules, so we will continue to monitor developments.