Employee benefit specialists have come to expect inaction on the part of the Congress as it relates to policy reforms despite the presence of bipartisan support for certain areas of change over the last few years. Accordingly, the inclusion of mostly positive reforms by Congress in the government’s omnibus budget bill is both welcome and somewhat surprising news. These new provisions, contained in a bill aptly named the Setting Every Community Up for Retirement Enhancement Act or the “SECURE Act” (there apparently is no truth to the rumors that there are people who work in the basement of the Capitol whose jobs are to make up these catchy acronyms), will affect employee benefit planning and to some extent estate planning and have the potential to lead to some needed systemic changes as to how employee benefits are delivered to employees-particularly employees who work for smaller employers.
Following below is a list of some of the more significant provisions contained within the SECURE Act:
Multiple Employer Plans. For the last several years, industry specialists have advocated for a broadening of the rules related to multiple employer plans. The intent has been to provide a meaningful option for small employers, historically cautious about both the costs and the related risks associated with plan sponsorship, to offer benefit plan coverage to their employees. In recent years this effort generally enjoyed bipartisan support in Congress but lacked a legislative vehicle for passage. That wait is now over.
The basic concept of a multiple employer plan (a “MEP”) is to allow otherwise unrelated employers to participate in a single employer benefit plan. Such a single plan concept should afford adopting employers certain economies of scale on costs and, through a common administrator, lessen or eliminate risks of legal liability for those employers. The concept, although legislatively elusive, actually is quite simple -and quite needed. However, certain restrictions based on statutory language or regulatory guidance formed roadblocks and effectively limited the growth of MEPs. These roadblocks have been eliminated.
Prior to the passage of the SECURE Act, and as a result of a presidential directive, the United States Department of Labor took some limited steps to revise the regulatory authority referenced above. That action generally dealt with the adoption of MEPs by associations and, while positive, was not itself sufficient to break the logjam. The Internal Revenue Service also issued some proposed guidance aimed at lessening other roadblocks.
The SECURE Act attempts to resolve the problems confronting the use of MEPs by creating a new type of MEP called a pooled employer plan. The provisions dealing with the new type of plan are scheduled to become effective for plan years beginning on or after January 1, 2021 and they apply only to defined contributions plans (which in the current marketplace are the plan of choice anyway). These new plans would be administered by an entity called a pooled plan provider (“PPP”), which will be charged with performing an array of administrative and fiduciary duties regarding the operation of a pooled employer plan. The ranks of PPP’s will be made up of various types of financial institutions (e.g., banks, insurance companies and mutual fund companies), so this new vehicle also opens up significant new business opportunities.
The new provisions eliminate the commonality of interest requirement for the establishment of MEP’s opening the doors for the adoption of MEP’s by unrelated employers-thus broadening the class of employers that can consider this type of structure. In addition, the statute eliminates the “one bad apple” rule that had plagued MEPS, and which had provided that a failure by one employer in a MEP could result in disqualification of the entire plan. These changes should be significant in making these plans both more attractive and easier to maintain, although time will tell if smaller employers actually embrace the opportunity.
Change in Minimum Distribution Requirements. Prior to the enactment of the SECURE Act, an heir designated as a beneficiary of an IRA could stretch out the distribution of the balance held within the IRA over the applicable beneficiary’s life expectancy. Since the balance held in the IRA would continue to grow in a tax-deferred manner, such an arrangement could result in considerable tax savings. These arrangements came to be known as “stretch IRAs”. The SECURE Act changes the rules related to this planning option by requiring all beneficiaries, other than certain “eligible designated beneficiaries”, to receive the full balance of the inherited IRA within 10 years following the date of the death of the IRA owner. For this purpose, the term eligible designated beneficiaries includes any beneficiary who is: (a) the surviving spouse, (b) disabled, (c) chronically ill, (d) an individual not more than 10 years younger than the participant or IRA owner, or (e) a child who has not attained the age of majority (until that child reaches age 18, at which time the child would be required to receive the IRA within 10 years). This new rule generally is effective for deaths after December 31, 2019. This new rule curtailing the use of stretch IRAs certainly will prompt estate planning practitioners to review existing estate plans. IRA documents also will need to be revised.
Required Beginning Date. The SECURE Act has changed the required beginning date to commence required minimum distributions for plans and IRA’s from the April 1 following the year in which the owner attains age 70-1/2 until the April 1 following the year in which the owner attains age 72. While generally positive, it is a bit unclear (at least to this author) how significant this change will be in the long term, which generally is effective with respect to persons attaining 70-1/2 after December 31, 2019, but it does seem likely that employee benefit plans will have to be amended to incorporate the change. The deadline for making those amendments has been postponed until 2022.
Part-Time Employee Eligibility for 401(k) Plans. In another idea that has been kicking around for a while, 401(k) plans will be required to allow employees who work at least 500 hours during each of three consecutive 12-month periods to make deferral contributions in the plan. This change does not require that these part-time employees receive employer contributions. This change applies for plan years beginning after December 31, 2020, and for the purpose of determining plan eligibility service worked before 2021 will not be taken into account. Once again, plan amendments will be required.
Non-discrimination Testing Rules for Frozen Defined Benefit Plans. The SECURE Act extends discrimination testing relief to employers who froze entry to their defined benefit plan for new employees while allowing existing participants to continue to accrue benefits. This is another positive change even if the numbers of plans affected might be dwindling in number. The provisions are immediately effective without regard to the date the plans were frozen.
Safe Harbor 401(k) Plan Enhancements. Employers will have more flexibility to adopt a 3% non-elective safe harbor plan mid-year. Additionally, the SECURE Act eliminates the notice requirement for 3% non-elective safe harbor plans. The automatic deferral cap for plans that rely on the automatic enrollment safe harbor model is increased from 10% to 15%, effective for plan years beginning after December 31, 2019.
Extended Period for Adopting Qualified Retirement Plans. While perhaps of limited application on a practical basis, employers who adopt a tax-qualified plan after the end of a calendar year but before the due date for filing tax returns, including extensions, for that year may treat the plan as adopted during that calendar year for purposes of deducting employer contributions to the plan. This rule is effective for new plans adopted with respect to taxable years beginning after 2019.
Reduced Minimum Age for In-Service Distributions. The SECURE ACT allows but does not require in-service distributions under a pension plan or a 457(b) plan be permitted at age 59-1/2, which moves up the permissible distribution timeline. This change, which as noted is voluntary, is effective for plan years beginning after December 31, 2019.
Withdrawals for Adoption. The SECURE Act permits penalty-free retirement plan and IRA withdrawals for a birth or adoption for up to one year following the birth or the legal adoption of up to $5,000, although these withdrawals would be subject to income tax. This rule is effective for distributions made after December 31, 2019.
Adding Life-time Income Options for Defined Contribution Plans. Many industry observers have argued for years that defined contribution plans should offer life-time income benefit distribution options. While the SECURE Act does not compel the addition of these life-time income options, it does create a new fiduciary safe harbor for the selection of a life-time income provider so as to encourage employers to offer this option. As a further inducement, the legislation also establishes a tax-advantaged portability of annuities from one plan to another or between plans and IRAs so as to avoid surrender charges and/or penalties that otherwise might be applicable. Under these changes, defined contribution plans must disclose to plan participants estimates of the monthly income that the participants would receive if they invested their account balances in the plan in annuities. The estimates must be based on assumptions to be prescribed by the United States Department of Labor, and this new disclosure requirement will not become effective until 12 months after the Department of Labor offers definitive guidance.
While intentions may be good, it is difficult to say how many sponsors of defined contribution plans actually will avail themselves of this option as anecdotal evidence does not suggest a large demand for this option among plan participants.
Contributions to Individual Retirement Accounts After Age 70-1/2. The rule that generally prohibited individuals who had attained age 70-1/2 from making contributions to IRAs had been repealed, effective with respect to contributions for calendar year 2020 and thereafter.