Second In A Series
On December 20, 2019, President Trump signed into law the Further Consolidated Appropriations Act, 2020, which includes the Setting Every Community Up for Retirement Enhancement Act (the “SECURE” Act). The SECURE Act amounts to the most significant retirement legislation in more than a decade.
This is the second in a series of articles describing key provisions of the SECURE Act. Our focus in this article is on the legislation’s effect on retirement plans generally, including provisions broadly applicable to defined contribution, defined benefit, 401(k), 403(b), and certain 457(b) plans. Note that some of the Act’s provisions apply only to 401(k) plans, 403(b) plans, or IRAs. We will provide a more detailed discussion of those provisions in subsequent articles.
REQUIRED MINIMUM DISTRIBUTIONS
Some of the SECURE Act’s most significant changes are to the Tax Code’s required minimum distribution rules.
Required Beginning Date Increased to Age 72
Prior to the passage of the SECURE Act, the age at which minimum distributions were required to begin was 70 ½. The Act amended Section 401(a)(9) of the Tax Code to increase the age to 72.
- Plans Affected: Defined benefit plans and defined contribution plans (including 401(k),403(b), and 457(b) plans)
- Optional or Required: Required
- Effective Date: Applies to individuals who attain age 70 ½ after December 31, 2019.
- Comments and Recommendations: Plan amendments will be required. Plan sponsors may still choose to require distributions at an earlier age (e.g., at normal retirement age). Coordination with plan record keepers and changes to the special tax notice under Code Section 402(f) will be required in order to ensure that distributions for participants who turn 70 ½ in 2020 are treated appropriately for rollover purposes.
Reduced Payout Period for Distributions to Some Beneficiaries
Current law allows designated beneficiaries of deceased participants or IRA owners to “stretch” distributions over the beneficiary’s remaining life expectancy. The SECURE Act generally requires that all distributions after the participant’s or IRA owner’s death be made within 10 years. The 10-year rule generally does not apply to an “eligible designated beneficiary,” which is defined as the participant’s or owner’s surviving spouse or minor child, a disabled or chronically ill person, or anyone not more than 10 years younger than the participant or IRA owner. Those individuals can spread payments beyond 10 years, except that the 10-year rule applies to minor children beginning on the date they reach the age of majority. Special rules apply to collectively bargained employees.
- Plans Affected: Defined contribution plans (including 401(k), 403(b), and governmental 457(b) plans)
- Optional or Required: Required
- Effective Date: Applies with respect to participants or IRA owners who die after December 31, 2019, with potential delayed applicability for collectively bargained plans; December 31, 2021, for governmental plans
- Comments and Recommendations: Plan amendments may be required, depending on current provisions for the payout of post-death distributions.
LIFETIME INCOME OPTIONS
One of the centerpieces of the SECURE Act is its attempt to encourage plan sponsors to offer lifetime income investment and distribution options in defined contribution plans. Consistent with Department of Labor rule making over the past few years, Congress hopes to give plan participants a more realistic picture of their retirement readiness and an ability to choose annuity forms of payment that they will not outlive.
Fiduciary Safe Harbor for Annuity Provider Selection
The Act amends Section 404 of ERISA to create a new fiduciary safe harbor on which defined contribution plan fiduciaries may rely when selecting lifetime income providers. The safe harbor is similar to the one described in DOL regulations that were issued in 2008, but the new rule sets forth specific measures that fiduciaries may take when selecting a lifetime income provider (typically an insurance company). By obtaining certain representations from the provider about its status under, and satisfaction of, state insurance laws, plan fiduciaries are deemed to have satisfied the prudence requirement under ERISA applicable to the selection. Fiduciaries who qualify for the safe harbor would be protected from liability for participant losses in the event the lifetime income provider is unable to pay the full benefits when due.
- Plans Affected: Defined contribution plans that are subject to ERISA (including 401(k) and ERISA 403(b) plans)
- Optional or Required: Optional
- Effective Date: Effective upon enactment (i.e., immediately)
- Comments and Recommendations: The safe harbor will provide protection for fiduciaries who decide to offer a lifetime income option. However, fiduciaries still should engage in a robust process when deciding whether to offer such an option, giving careful consideration to costs.
New Participant Disclosures
The SECURE Act requires plan sponsors to include in defined contribution plan benefit statements an estimate of the monthly income a participant’s account balance could produce in retirement if a qualified joint and survivor annuity or a single life annuity were purchased with the account. Sponsors must provide these estimates at least annually, regardless of whether a lifetime income option is offered under the plan. The Act directs the Department of Labor to issue safe harbor model disclosures and specific assumptions that plans may use when preparing the estimates by the end of 2020.
- Plans Affected: Defined contribution plans that are subject to ERISA (including 401(k) and ERISA 403(b) plans)
- Optional or Required: Required (but only after model notices are issued)
- Effective Date: Effective for benefit statements furnished more than 12 months after the DOL issues guidance
- Comments and Recommendations: Plan sponsors should ask their record keepers how they intend to provide the required disclosures. Some record keepers already provide similar information on their statements or websites; plan sponsors should understand how that information may change under the new rules, particularly how current lifetime income projections might be affected.
Lifetime Income Option Portability
Many lifetime income products are subject to fees and penalties (such as surrender and early-termination charges) if they are liquidated. These fees can dissuade plan fiduciaries from offering such options under a plan. The SECURE Act addresses these concerns by making lifetime income options portable. The Act permits participants to make direct trustee-to-trustee transfers of lifetime income investments (or to transfer annuity contracts) to an eligible employer plan or IRA if fiduciaries make a plan-level decision to eliminate the lifetime income option. Participants may take a distribution of the option without regard to other plan-level restrictions on in-service distributions.
- Plans Affected: Defined contribution plans (including 401(k), 403(b), and governmental 457(b) plans)
- Optional or Required: Optional
- Effective Date: Plan years beginning on and after January 1, 2020
- Comments and Recommendations: Plans that intend to offer a lifetime income option must include language permitting these kinds of distributions. Similarly, plan sponsors should consider whether to amend their plans to accept in-kind transfers of lifetime income investments.
CHANGES TO DISTRIBUTION AND WITHDRAWAL RULES
The SECURE Act makes it easier for participants to access their defined contribution plan accounts in certain circumstances, while making it somewhat harder in others.
Prohibition of Credit Card Loans
The SECURE Act prohibits plan loans made through a credit card or “other similar arrangement.”
- Plans Affected: Defined contribution plans (including 401(k) and 403(b) plans)
- Optional or Required: Required
- Effective Date: Effective upon enactment (i.e., immediately)
- Comments and Recommendations: Few plans currently allow participants to take loans in this manner, but those that do should immediately suspend that practice.
Penalty-Free Child Birth or Adoption Distributions
Sponsors of 401(k), 403(b), and governmental 457(b) plans may now permit their participants to obtain penalty-free distributions of up to $5,000 for expenses related to the birth or adoption of a child. The adopted child must be either under age 18 or physically or mentally incapable of self-support. Distributions are available during the one-year period following the birth or adoption and are subject to ordinary income tax. Subject to certain restrictions, these special distributions may be repaid to an applicable eligible retirement plan to which a rollover can be made.
- Plans Affected: Defined contribution plans (including 401(k), 403(b), and governmental 457(b) plans)
- Optional or Required: Optional
- Effective Date: Effective for distributions made on or after January 1, 2020
- Comments and Recommendations: This is an optional change that, if adopted, will require updates to participant communications and forms, and ultimately will require a plan amendment.
Qualified Disaster Distributions
A separate portion of the legislation that included the SECURE Act provides temporary relief from the 10% additional tax on early distributions under Code Section 72(t) for “qualified disaster distributions.” The relief applies to distributions of up to $100,000, but is limited to distributions made within 180 days after the legislation’s enactment. The legislation authorizes the repayment of such distributions within three years to an eligible retirement plan to which a rollover contribution could be made. The maximum plan loan amount for individuals whose principal residence is in a qualified disaster area also may be increased from $50,000 to $100,000, and the repayment period for such loans may be extended.
- Plans Affected: Defined contribution plans (including 401(k) and 403(b) plans) and governmental 457(b) plans
- Optional or Required: Optional
- Effective Date: Effective upon enactment (i.e., immediately), but only for 180 days after the date of enactment (i.e., until June 17, 2020)
- Comments and Recommendations: Employers that elect to add one or both of these distribution options must act quickly. They generally must amend their plans before the end of the 2020 plan year (for governmental plans, the deadline for plan amendments is the end of the 2022 plan year), but because of the limited time within which these additional distributions are permitted, such employers should prepare and distribute participant notices as soon as possible.
DEFINED BENEFIT PLAN CHANGES
A few of the SECURE Act’s changes apply only to defined benefit plans.
Relaxed Nondiscrimination Testing for Frozen Plans
The Act provides nondiscrimination testing, minimum coverage, and related relief for certain closed or “soft-frozen” defined benefit plans. The relief permits existing participants in such plans to continue accruing benefits without violating these testing requirements.
- Plans Affected: Defined benefit plans that were closed or frozen before April 5, 2017, and those that satisfy other detailed requirements.
- Optional or Required: Optional
- Effective Date: Effective upon enactment (i.e., immediately)
- Comments and Recommendations: This change may be particularly helpful for “soft-frozen” plans with older, more highly compensated participant demographics.
In-Service Distributions Permitted at Age 59 ½
Another portion of the legislation that included the SECURE Act reduces the age at which in-service distributions may be taken from defined benefit, money purchase pension, and governmental 457(b) plans. Such distributions now may be taken at age 59 ½ (rather than 62 for pension plans and 70 ½ for governmental 457(b) plans).
- Plans Affected: Defined benefit plans, money purchase pension plans, and governmental 457(b) plans
- Optional or Required: Optional
- Effective Date: Plan years beginning on or after January 1, 2020
- Comments and Recommendations: This change was designed as a revenue generator in order to offset the cost of other changes made by the legislation. Although plan amendments are not immediately required, employers choosing to offer the earlier distribution option should modify participant notices and distribution request forms appropriately.
INCENTIVES FOR SMALL EMPLOYERS
A key objective of the SECURE Act is to encourage small employers to make retirement plans available to their employees.
Tax Credit for New Small-Employer Plans
The Act increases the nonrefundable tax credit that is available to eligible small businesses (those with 100 or fewer employees) that adopt a new qualified retirement plan. The credit is intended to offset the start-up costs incurred to adopt the new plan. Under the SECURE Act, the amount of the credit is increased from $500 to as much as $5,000 for three years.
- Plans Affected: Newly adopted qualified (i.e., 401(a) and 401(k)) and 403(b) plans of employers with 100 or fewer employees
- Optional or Required: Optional
- Effective Date: Taxable years beginning on and after January 1, 2020
- Comments and Recommendations: The maximum amount of the credit depends on the number of nonhighly compensated employees eligible to participate in the plan.
Automatic Enrollment Credit
Small employers may receive an additional nonrefundable tax credit of up to $500 for three years if they establish a plan that includes an eligible automatic contribution arrangement, or if they add such an arrangement to an existing plan.
- Plans Affected: Qualified (i.e., 401(a) and 401(k)) and 403(b) plans to which an eligible automatic contribution arrangement is added
- Optional or Required: Optional
- Effective Date: Taxable years beginning on and after January 1, 2020
- Comments and Recommendations: This change reflects the general consensus that automatic enrollment harnesses the power of behavioral economics to improve savings.
Pooled Employer Plans
The SECURE Act sanctions a new form of multiple employer plan (or “MEP”). The new “pooled employer plans” (or “PEPs”) permit unrelated employers to pool their resources in order to create a single plan for purposes of ERISA. The Act supersedes prior Department of Labor guidance that generally prevents unrelated employers from participating in a MEP. It also amends the Tax Code to eliminate the unified plan (or “one bad apple”) rule, so that one employer’s qualification failure does not lead to the disqualification of the entire PEP. PEPs are subject to a number of requirements, including that they (i) must be sponsored by a new ERISA entity known as a “pooled plan provider,” which serves as the plan’s named fiduciary and plan administrator; (ii) reserve certain fiduciary responsibilities for the participating employers (including the selection and monitoring of the pooled plan provider); and (iii) protect participants from unreasonable fees, restrictions, and penalties.
- Plans Affected: Qualified defined contribution individual account plans (i.e., 401(k) plans); changes do not apply to 403(b) plans or 457(b) plans
- Optional or Required: Optional
- Effective Date: Plan years beginning on and after January 1, 2021
- Comments and Recommendations: Additional guidance and a model PEP plan document are expected. In the interim, the Act affords limited relief for good faith compliance with the statutory changes. PEPs are likely to appeal primarily to smaller employers.
PLAN AMENDMENTS
Generally, plans must be amended to include all mandatory changes – and any optional changes a plan sponsor chooses to add – by the end of the first plan year beginning on or after January 1, 2022. Thus, for calendar year plans amendments must be adopted by December 31, 2022. For collectively bargained and governmental plans, the amendment deadline is the end of the first plan year beginning on or after January 1, 2024.
Most of the SECURE Act’s changes are effective long before the deadline for formal amendments. In the meantime, plans that are administered as if the amendments were already in effect will not be treated as violating the Tax Code’s anti-cutback rule when the amendments are retroactively adopted. In order to ensure that administrative practices are consistent with plan terms, however, we encourage employers to consider the merits of amending plan documents prior to the amendment deadline. Alternatively, employers may want to adopt formal administrative guidelines for SECURE Act changes now (on which plan amendments may be prepared later). Spencer Fane’s employee benefits attorneys are prepared to help you with these considerations.
This blog post was drafted by Greg Ash, an attorney in the Spencer Fane LLP Overland Park, KS office. For more information, visit spencerfane.com.
