On December 20, 2019 President Trump signed the Setting Every Community Up for Retirement Enhancement Act (Act) into law as part of the 2020 appropriations bill. The Act is the most significant reform to the nation’s retirement system in a decade.
The Act has 30 different provisions, which generally aim to make it easier for smaller employers to offer access to and incentivize employees to participate in retirement plans and encourage plan sponsors to offer annuities to retiring participants.
We highlight below the more significant provisions of the Act.
401(k) Plans Will Have to Allow Long-term, Part-time Employees to Contribute
Under existing law, 401(k) plans can exclude employees who work under 1,000 hours in a 12-month period from participating in the plan. Consequently, many part-time employees are effectively excluded from participating in their employer’s 401(k) plans. Beginning January 1, 2021, 401(k) plans will not be to exclude employees who work 500 hours per year over three consecutive years. On the plus side, these employees will only have to be offered the opportunity to contribute – employers need not make employer nonelective or matching contributions for them. Part-time employees also may be excluded from the plan’s top-heavy minimum contribution and vesting requirements and may be excluded from nondiscrimination testing. Service before 2021 will not need to be counted. This will effectively delay implementation of this new rule until 2024.
Changes to Required Minimum Distribution Rules
1. Increase in Mandatory Commencement Age
Under existing law, minimum distributions from retirement plans and IRAs must begin no later than the year following the year in which the individual reaches age 70½. Failure to comply with this requirement results in a 50% excise tax on the required minimum distribution. The Act increases the age after which required minimum distributions must begin to age 72. The change is effective for distributions required to be made for employees and IRA owners who attain 70½ after December 31, 2019.
2. Post-Death Distribution Timing for Designated Beneficiaries - Stretch IRAs
Under existing law, the timing of required minimum distributions after the death of the employee or IRA owner depends on whether the death occurs before or after the required beginning date and whether there is a designated beneficiary. Required minimum distributions may be paid over a non-spouse designated beneficiary’s lifetime, which can be particularly beneficial when the designated beneficiary is much younger than the employee or IRA owner. Inherited IRAs of this nature are commonly called “stretch IRAs.” Under the Act, the required minimum distribution period for certain non-spouse designated beneficiaries would be limited to 10 years following the employee’s or IRA owner’s death, rather than the beneficiary’s lifetime. This 10-year limit would not apply when the beneficiary is the employee’s or IRA owner’s spouse or disabled or chronically ill. In addition, if the beneficiary is a minor age at the time of the employee’s or IRA owner’s death, the 10-year distribution period does not begin until the child reaches majority. This change is generally effective with respect to employees or IRA owners who die after December 31, 2019.
Millions of plan participants and IRA account holders will be adversely affected by this new rule and should consider the benefits/drawbacks of annual installment drawdowns versus a lump sum payment just before 10 years have elapsed. In particular, affected account holders should consider the tax consequences if, for example, the account doubles in value with market returns during the 10-year period following the death of the account holder. It may be that taking the lump sum after 10 years of investment appreciation is more advantageous than spreading portions of the distributions into lower income tax brackets by taking annual withdrawals.
Simplification of 401(k) Safe Harbor Rules
The 401(k) safe harbor rules allow plans to avoid annual nondiscrimination testing in certain circumstances.
1. Nonelective Contributions and Notice Requirements
Under existing law, to qualify for safe harbor status, employers must (1) issue a safe harbor notice to plan participants before the beginning of each plan year, and (2) make either a minimum nonelective contribution equal to 3% of compensation or one of two types of matching contributions:
Basic match - 100% match on the first 3% of deferrals plus a 50% match on deferrals between 3% and 5% (4% total).
Enhanced match – at least as much as the basic match at each tier of the match formula (e.g., 100% match on the first 4% of deferrals).
For plan years beginning after December 31, 2019, the Act eliminates the notice requirement, but maintains the requirement to allow employees to make or change an election at least once per year and changes the timing to adopt a safe harbor feature:
to add a 3% safe harbor nonelective contribution feature to its 401(k) plan during and up to 30 days before the end of the plan year; or
to add a 4% safe harbor nonelective contribution feature to its 401(k) plan if the plan is amended after 30 days before the end of the plan year and no later than the close of the following plan year.
This rule effectively allows a plan sponsor to first run its ADP/ACP test after the end of a plan year and remediate any failures with a 4% vested nonelective contribution. Safe harbor matching contributions remain unchanged.
2. Automatic Enrollment Default Rate Cap Increase
Under existing law, 401(k) plans that automatically enroll employees at default contribution rates (e.g., QACAs and EACAs) are exempt from nondiscrimination testing. The maximum default contribution rate for these plans cannot exceed 10% of compensation. For plan years beginning after December 31, 2019, the Act raises the automatic enrollment default rate cap to 15%.
Qualified Plans Prohibited from Making Loans through Credit Cards
The Act prohibits the distribution of plan loans through credit cards or similar arrangements. The intent is to ban plan loans for routine or small purchases.
Benefit Statement Disclosures
Defined contribution plans often do not offer benefits in the form of annuities or other lifetime-income payment options, and plan participants may not understand how to evaluate the lifetime income stream that could be provided by their account balance. The Act requires plan administrators to disclose the monthly lifetime equivalent benefit of a participant’s account balance in the form of a single or qualified joint and survivor annuity. The disclosure must be provided in at least one of the benefit statements required under ERISA Section 105 during any 12-month period. The Department of Labor is required to issue a model lifetime disclosure.
Portability of Lifetime Income Options
The Act permits qualified defined contribution plans, section 403(b) plans, and governmental section 457(b) plans to make a direct trustee-to-trustee transfer to another employer-sponsored retirement plan or IRA of lifetime income investments or distributions of a lifetime income investment in the form of a qualified plan distribution annuity if a lifetime income investment is no longer authorized to be held as an investment option under the plan. The change will permit participants to preserve their lifetime income investments and avoid surrender charges and fees.
Repeal of Maximum Age for Traditional IRA Contributions
The Act repeals the ban on contributions to a traditional IRA by an individual who has attained age 701/2. Under the Act, individuals can continue contributing out of their wages at any age.
Withdrawals for Birth or Adoption No Longer Subject to 10% Additional Income Tax
Withdrawals from retirement plans for any qualified birth or adoption distributions will only be subject to ordinary income tax.
Fiduciary Safe Harbor for Selection of Lifetime Income Provider
Under existing Department of Labor (DOL) regulations plan fiduciaries are afforded a safe harbor in satisfying the prudence rule in selecting annuity providers and contracts for benefit distributions from a defined contribution plan. Building on the DOL regulation, the Act would provide specific measures plan fiduciaries may take to satisfy the prudence rule when selecting an annuity provider, including determining whether the provider is financially capable of satisfying its obligations under the contract. This provision is effective on the date of enactment.
Increased Penalties for Failure to File Retirement Plan Returns
The Act modifies the failure to file penalties for retirement plan returns. The Form 5500 penalty would be increased from $25 per day up to $15,000 to $105 per day up to $50,000. The penalty for failing to file a registration statement would increase from $1 per participant per day up to $5,000 to $2 per participant per day up to $10,000. The penalty for failure to file a required notification of change is increasing from $1 per day up to $1,000 to $2 per day up to $5,000. This penalty applies to the failure to file a notification of a change in the status of the plan, such as a change in the plan name, a termination of the plan, or a change in the name or address of the plan administrator. Failure to provide a required withholding notice results in a penalty of $100 for each failure up to $50,000 for all failures during any calendar year.
Relief for Qualified Disasters
In addition to the Act’s provisions summarized above, the 2020 Appropriations Bill includes temporary tax relief for areas affected by qualified disasters occurring in 2018, 2019, and up to 60 days after enactment of the bill. The bill provides that the 10% early withdrawal tax will not apply for qualified disaster relief distributions up to $100,000 from an IRA, a qualified retirement plan, a 403(b) plan. First-time homebuyers who took a hardship distribution for the purchase of a home in a qualified disaster area and were ultimately unable to complete the purchase because of the qualified disaster will be able to recontribute those amounts back into the applicable plan without penalty.
What Plan Sponsors Should Do Now
The Act reflects Congress’ desire to makes it easier for Americans to use employer-sponsored retirement plan accounts and IRAs to save for retirement and for employers to offer retirement plans to their employees. Plan sponsors should stay tuned, as the passage of the Act is bound to result in significant amendments to all 401(k) and other retirement plans.