Introducing the SECURE Act

On December 20, 2019 President Trump signed the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) into law.  This new law ushers in some of the most sweeping retirement plan changes in decades. While many of the specific provisions of the act had been included in legislative proposals over the last few years, their eleventh-hour inclusion in the year-end spending bill presented just the opening needed for them to finally become law.

The SECURE Act’s provisions are wide-ranging, covering everything from new tax credits to increased penalties. While we’ll cover the specific changes in greater detail in this issue, there are quite a few details that we still don’t know. For the majority of those details, we are eagerly awaiting promised guidance from the Internal Revenue Service and Department of Labor.

Many of the SECURE Act’s provisions are already effective this year. However, some have delayed effective dates, specifically the date by which Plans must be amended to reflect the new changes until the end of the 2022 plan year.

Expanded Tax Credits

One of the primary goals of the SECURE Act was to increase the number of American workers covered by employer-sponsored retirement plans. To encourage employers to adopt plans that would cover a greater number of employees, the SECURE Act expanded the tax credits available to employers. Specifically, the SECURE Act increased the tax credits available for startup plans and created a new tax credit for implementing automatic enrollment provisions in new and existing plans.

Here are some highlights of the increased tax credits for startup plans:

  • Was previously limited to $500 per year for three years, but now will be limited to $5,000 per year for three years. Here’s how it is calculated:
    • 50% of qualified startup costs limited to:
      • Greater of $500, or;
      • The lesser of $250 multiplied by the number of non-highly compensated employees or $5,000
  • Still limited to employers that previously did not sponsor another plan covering the same employees within the last three years (including SIMPLE and SEP plans)
  • Still limited to small employers (no more than 100 employees)
  • Must have at least one covered non-highly compensated employee

Let’s look at an example:

ABC Company 401(k) Plan has 12 total employees, 10 of whom are non-highly compensated employees.  -Let’s suppose the out-of-pocket cost paid by ABC Company amounts to $2,500 per year.  In previous years, the credit would be limited to $500.  Now, due to the SECURE Act, the credit in this example would be $1,250, resulting in significant savings to the plan sponsor.

It’s important to reiterate that this credit is available for the first three years of the plan’s existence.  So, if you’ve established a plan within the last couple of years, please talk to your tax advisor to make sure you are taking full advantage of this credit.

Here are the highlights of the new automatic enrollment tax credit:

  • It applies to existing plans that do not already have this provision as well as start up plans
  • The credit applies for the first three years in which the feature is implemented

If you would like to discuss adding automatic enrollment provisions to your plan, please contact your TSC consultant.

Nonelective Safe Harbor Changes

The annual notice requirement for plans using the safe harbor nonelective formula has been eliminated. However, safe harbor plans utilizing a matching formula, including nonelective safe harbor plans making an additional matching contribution, are still required to provide the notice. Therefore, we recommend continuing to provide the safe harbor notice until additional IRS guidance is provided.

Removal of the annual notice requirement permits delayed adoption of nonelective safe harbor plans. Mid-year addition of the nonelective contribution is permitted if adopted 30 days before the end of the plan year. For example, plans with a December 31st year end have until December 2, 2020 to execute the amended adoption agreement for the 2020 plan year. The nonelective contribution must be at least 3%.

For plan years starting in 2020 or thereafter, the plan may elect to be safe harbor for a prior plan year. This amendment must be made no later than the end of the following plan year. For example, a plan that receives failing test results in 2021 may adopt the safe harbor provision by December 31, 2021. However, a 4% nonelective contribution would be required.

Additional guidance is needed. Without the notice requirement, questions remain about reducing or terminating a safe harbor nonelective contribution. Other testing correction methods could be more beneficial than adding a safe harbor 3% nonelective contribution. Also, depending on the timing of the contribution, the deduction and annual additions may not relate to the year tested.

Increased QACA Limit

A Qualified Automatic Contributions Arrangement (QACA) is a type of automatic enrollment plan that contains safe harbor features and might include an automatic increase provision.

Previously, the maximum automatic deferral percentage permitted was 10%. The SECURE Act changed this. Now, the initial year’s maximum is 10% and subsequent years may increase up to 15%. The following chart illustrates the auto enroll deferral rates that are available each period after 2020:

Period QACA Deferral Rate
1 No less than 3% and no greater than 10%
2 No less than 4% and no greater than 15%
3 No less than 5% and no greater than 15%
4 No less than 6% and no greater than 15%

This plan provision requires the document be amended before these limits are applied. In addition, the necessary disclosure forms and participant communications must be updated.

Extended Deadline to Adopt Retirement Plan

For tax years beginning after December 31, 2019, an employer can now adopt a plan until the tax filing due date (including extension) for the year the plan is made effective. Generally, the latest deadlines will be either September 15 or October 15 (for entities taxed as sole proprietorships). Since calendar-year plans still need to file a Form 5500 by October 15 (if extended), the practical deadline will be earlier.

Importantly, the 401(k) deferral portion of the plan still needs to be executed before the first deferrals are made to the plan. Meanwhile, the profit sharing portion of the plan can be implemented earlier.

New Eligibility Requirement for Part-Time Employees

There are new eligibility requirements for part-time employees. Retirement plans may impose a service requirement for employees to become eligible to participate in the plan.  For example, one of the more commonly used service requirements of one year and 1,000 hours can make some part-time employees ineligible for the retirement plan.

Under the new rules of the SECURE Act, part-time employees who work 500 hours a year for three consecutive years must be permitted to make 401(k) contributions to the plan.  These employees do not have to receive the employer contributions such as safe harbor, matching or profit share contributions.

Including these participants would normally have an effect on the non-discrimination testing, which can make passing these tests difficult; however, with the SECURE Act, these employees do not need to be included in the plan’s nondiscrimination testing, nor do they need to receive a top-heavy minimum contribution.

Tracking starts following the December 31, 2020 plan year.  The earliest entry dates for employees under this rule would be January 1, 2024.

New Required Minimum Distribution (RMD) Age

Qualified plans have long required participants to start taking Required Minimum Distributions (RMD) in the calendar year in which they turn age 70½.  However, under the SECURE Act employees who turn 70½ in 2020 or later are not required to withdraw RMD’s until the calendar year in which they turn 72. Their first RMD can be delayed until no later than April 1 of the following year which would require two distributions that year. But like most rules, there is an exception. Unlike IRAs, employees who are not 5% owners and are still working may delay their RMD until the year in which they terminate their employment.

RMDs are still required for nonworking participants and 5% owners who turned 70½ prior to 2020. Anyone who has already started taking RMDs must continue taking them.

IRA Contributions Past Age 70-1/2

Previously, contributions to Traditional Individual Retirement Accounts (IRAs) after a participant has reached the age of 70 ½ were prohibited. This has changed with the SECURE Act. Participants who are age 70 ½ or older are now able to make contributions to Traditional IRAs. Roth IRAs continue to disregard age for eligibility purposes.

Increased 5500 / 8955-SSA Penalties

Most plan sponsors are required to file an annual Form 5500 as well as an annual Form 8955-SSA (report terminated participants with a vested balance).  The due date for filing these returns is the last day of the seventh month after the plan year ends, with an optional two and one half month extension.  For calendar year plans, the due date is July 31 and the extended due date is October 15.

Effective immediately, the IRS penalty for failure to file a Form 5500 increases substantially to $250 per day, not to exceed $50,000.  The penalty for failure to report a terminated participant on the Form 8955-SSA increases to $10 per participant per day, not to exceed $50,000.

These penalties are in addition to penalties that the Department of Labor (DOL) can impose.

Plan sponsors may still take advantage of the IRS/DOL’s delinquent filer programs to mitigate these potential costly penalties.  In order to qualify for the delinquent filer programs, the employer must apply prior to being selected for audit or examination.

Terminating Custodial 403(b) Plans

The SECURE Act also addresses a somewhat obscure issue known mostly to 403(b) sponsors and their service providers. Under prior law, it was nearly impossible to terminate 403(b) plans with individual custodial accounts. Since individual custodial accounts are structured as an investment contract between the participant and the custodian, the employer didn’t actually have the authority to force participants to take a distribution. Under the SECURE Act, the employer now has the authority to unilaterally direct the distribution of the individual custodial account to the participant, thereby clearing the way for plan terminations. Importantly, the distribution will be treated as an in-kind distribution of the custodial account which will be maintained on a tax-deferred basis for the benefit of the participant until it is paid out. To cover prior terminations that may have followed this methodology, this provision is retroactively effective back to December 31, 2008. To address technical issues and questions, the IRS will issue further guidance on this topic by June 20th of this year.

Lifetime Income Provisions

Among the hallmark features of the SECURE Act are its provisions designed to help ensure that retirement plan participants do not run out of money during their retirement. In an attempt to achieve that goal, the SECURE Act includes several provisions related to lifetime income products and lifetime income disclosures.

Lifetime Income Product Provider Selection Protection

Plan sponsors that may have been hesitant to offer lifetime income products as a plan investment can now take some comfort in the new safe harbor created by the SECURE Act. Specifically, the safe harbor provides protection for plan fiduciaries related to litigation based on their selection of a lifetime income product provider as long as certain requirements are met. To receive this protection, plan fiduciaries must obtain specific written representations from the lifetime income provider. The representations must state that the provider is in compliance with state licensure, certification, and examination requirements. Importantly, to rely on the safe harbor, fiduciaries must not have received information that would cause them to question the lifetime income provider’s representations.

Portability of Lifetime Income Products

Another barrier to offering lifetime income products was the issue of what to do with those products should they cease to be an investment option in the plan. Under the SECURE Act, plan sponsors have the ability to distribute guaranteed income investments even if the participant is not otherwise eligible for a distribution from the plan. Any distributions made under this provision must be: (1) “qualified distributions” of the specific lifetime income investment, or (2) distributions in the form of a “qualified plan distribution annuity contract.”

Lifetime Income Disclosure

Under the SECURE Act, annual participant statements must soon include an illustration of the annuity equivalent of the participant’s account. To assist plan sponsors and service providers with this requirement, the Department of Labor has been tasked with issuing a model disclosure and assumptions within the next year. Once this is issued, plans will have a year to start providing lifetime income illustrations. While many participants already have access to some type of lifetime income illustrations or models, those may need to be changed or supplemented to satisfy this new requirement.

Beneficiary Options and Elimination of Stretch IRAs

A notable change with the SECURE Act includes the elimination of lifetime payouts for non-spouse beneficiaries. Previously, individuals could take payouts of inherited retirement plans or Individual Retirement Accounts (IRAs) based on their age or the deceased participant’s age (depending on the relationship of the beneficiary). Many times these inherited dollars would be rolled into an IRA where the payments would stretch over the life of the beneficiary, earning these accounts the nickname of “stretch IRAs.”

Dollars that are newly inherited in 2020 or thereafter now must be depleted within 10 years of the date of death. However if the dollars are inherited by a spouse, minor child (until age of majority is reached), disabled or chronically ill individual, or any other individual who is no more than 10 years younger, an exception will apply. Unlike some other features under the SECURE Act, this is not an optional provision and all Defined Contribution plans must apply these new rules.

At this time, the age of majority has not been defined. Future guidance from the IRS is anticipated. Once guidance is received, additional plan amendments may apply.

Distributions for Births/Adoptions

One of the new provisions provided for in the SECURE Act is a withdrawal option for births and adoptions.  Plans may now allow a participant to take a withdrawal (after December 31, 2019) of up to $5,000 per birth or adoption of the participant’s child within the one-year period following the birth or adoption. If the parents each have a retirement plan account or IRA, they can each separately receive a $5,000 penalty-free distribution.

The adopted child must be less than 18 years old, or physically or mentally incapable of self-support. This withdrawal provision does not extend to the adoption of a spouse’s child. The withdrawal would not be subject to the IRS 10% premature penalty tax, federal 20% mandatory withholding and direct roll over rules applicable to retirement plans, but it is still subject to ordinary income tax if it is withdrawn from pretax sources.

The participant would have the option of repaying the withdrawal. Guidance is needed from the IRS regarding the repayment timing.

This new provision is optional and must be incorporated into the plan document if allowed.

In-Service Distributions of Pension Accounts at 59-1/2

Previously, a participant who has an account balance of Money Purchase Pension assets needed to reach age 62 in order to receive an In-Service distribution from that source. With the SECURE Act, the age for In-Service Distributions for Pension accounts (also including Defined Benefit plans and governmental 457(b) plans) has been lowered to age 59 ½. This is applicable to plans with a year-end that begins after December 31, 2019.

This is a discretionary change and therefore must be adopted by the last day of the plan year in which distributions are taken at the earlier age. There are administrative questions to this provision at this time which await IRS guidance. Additional communications will be sent when the option to implement this change is available.

Pooled Employer Plans (PEPs)

Beginning in 2021, the SECURE Act created a new type of Multiple Employer Plan called a Pooled Employer Plan or PEP.  This is a type of plan that allows employers that are not related to one another to join together in the same retirement plan.  Policymakers included PEPs in the SECURE Act  in an effort to help alleviate perceived fiduciary and administrative concerns by small businesses that they believed prevented employers from establishing retirement plans for their employees.

Here are some of the highlights of the new Pooled Employer Plans under the SECURE Act:

  • Effective for plan years starting January 1, 2021 or later
  • The plan will have a single plan document, Form 5500, and independent accountant audit (when necessary)
  • Eliminated the “one bad apple rule” which means actions of one participating employer no longer will jeopardize the compliance status of the entire plan
  • The plan must be sponsored by a Pooled Plan Provider (PPP)
    • A PPP is a new type of entity for which additional guidance is needed
    • The PPP must serve as the ERISA section 3(16) plan administrator and the named plan fiduciary
    • The PPP must register with the IRS / DOL (parameters and application not yet available)

While many aspects related to Pooled Employer Plans are still unresolved, TSC is diligently preparing solutions to help small employers provide retirement plan coverage to their employees while minimizing their administrative and fiduciary burdens.  We understand the challenges these companies face and are committed to helping employers and their advisors address those challenges.

Adoption and Application of the SECURE Act Provisions

TSC plans to provide a sponsor level amendment to all of its clients’ plans to include the provisions of the SECURE Act so that there is nothing its clients need to do at this point.  However, the actual amendment won’t be adopted until we receive additional guidance from the Internal Revenue Service and Department of Labor. Importantly, the SECURE Act specifically delayed the date by which Plans must be amended to reflect the new changes until the end of the 2022 plan year.