Sweeping Retirement Plan Changes Enacted with Secure Act

On December 20, 2019 the “Setting Every Community Up for Retirement Enhancement” (SECURE) Act of 2019 was signed into law. The SECURE Act provides the most sweeping changes to retirement plan law for over a decade. The law’s provisions are intended to improve the ability of small business owners and employees to save for retirement. Most of the provisions are effective with tax years starting after December 31, 2019, with some provisions delayed until 2021.

Required Minimum Distribution (RMD) Age 

• Current rules require that minimum distributions commence from tax-deferred retirement accounts following the attainment of age 70-1/2. This is now delayed to age 72 for people who turn 70-1/2 in 2020.

No Maximum Age Limit for IRA Contributions

• The maximum age limit for making individual IRA contributions is repealed for 2020 and future years. This change recognizes that people are working longer and still need to make IRA contributions. 401(k) plans have always allowed older employees to continue to participate.

Childbirth or Adoption Expense Withdrawals

• Penalty-free withdrawals from retirement plans for expenses for childbirth or adoption of up to $5,000 are allowed. In addition, these withdrawals can be “paid back” to the retirement plan and treated as a rollover account to keep them exempt from taxation.

Safe Harbor 401(k) Plan Changes

• Safe Harbor 401(k) plans that use the “3% non-elective” method will no longer be required to provide Safe Harbor notices to their eligible employees. Plans that use Safe Harbor matching contributions will still be required to provide the Safe Harbor notice.
• A change that will add greater flexibility for plan sponsors is that an employer can now add the 3% non-elective Safe Harbor contribution provisions to their 401(k) plan mid-year (this is not available for plans that use the Safe Harbor matching contribution which generally must be in place before the year begins). The use of the Safe Harbor contribution provides for an automatic pass for the required 401(k) test (“the actual deferral percentage” or ADP test).
• In addition, if an employer adopts the non-elective Safe Harbor fewer than 31 days before the end of the year, the Safe Harbor contribution amount must be at least 4% of compensation (instead of 3%), and the amendment must be adopted no later than the last day for distributing excess contributions for the plan year. This change will allow the employer to decide upon whether or not to use the non-elective Safe Harbor after the year is over and the results of the ADP test are known.

Retroactive Plan Adoption

• Another important change that allows for retroactive flexibility is the ability to adopt a new retirement plan by the due date of the company’s tax return instead of the end of the tax year. This makes the timing rule for adopting a qualified retirement plan the same as for an IRA or a SEP IRA and is a welcome change that should increase the adoption of qualified plans.

Increased Tax Credit for New Plans

• The tax credit for small employers who establish a new plan will be increased to 50% of the plan’s start-up costs to the greater of $500, or $250 multiplied by the number of “non-highly compensated employees” eligible to participate up to a maximum of $5,000. An additional tax credit of $500 per year for three years is available to small businesses that add automatic enrollment to an existing plan or if it is included in a new plan.

Increased Auto Enrollment Default

• Plans that use qualified automatic contribution arrangements (QACA) can now increase an employee’s automatic 401(k) contributions up to 15% of compensation (the maximum was previously 10% of compensation). The 10% cap still applies for an employee’s first year of automatic enrollment. QACA’s provide for automatic enrollment and a safe harbor employer contribution and are exempt from the ADP test.

In-Service Withdrawals from Pension Plans

• The Act also changes the minimum age for an in-service withdrawal from a pension plan to age 59-1/2 from age 62. This was included as a revenue raiser in the anticipation of additional taxable withdrawals. However, it provides an interesting opportunity for plan sponsors who sponsor defined benefit and cash balance plans to provide for in-service withdrawals that could be “rolled over” to an IRA or 401(k) plan and then have self-directed investments.

Lifetime Income Illustration

• Retirement plans will be required to show how a participant’s account balance converts to “lifetime income” to help participants understand how much their account can provide in retirement. This provision is effective 12 months after the release of guidance from the Department of Labor.

Credit Cards Loans Prohibited

• Retirement plans will no longer be able to make participant loans with a credit card. Some retirement plans allowed for this feature, which allowed a participant to use a credit card to create a participant loan, and then add to the loan amount with new purchases. This raised concerns about reducing retirement security for plan participants as well as increasing their debt.

Encouraging Lifetime Income Options

• The Act provides for a stronger safe harbor for plan fiduciaries with regard to selecting an insurance company to provide for participant annuities. It also provides for the portability of annuity or lifetime income options if a participant terminates employment, or if the lifetime income investment is no longer held as an investment option under the plan. These changes are part of an increasing focus on providing for lifetime income options for plan participants.

403(b) Plan Changes

• The SECURE Act also provides 403(b) plans with mutual fund investments (“403(b)(7)” plans) a way to terminate and allow participants to transfer their accounts “in-kind” to IRA accounts. The Act also clarifies that ministers and employees of non-profits can participate in certain “Church” plans that have their own nondiscrimination and reporting requirements.

New Compensation Permitted for IRA and Retirement Plans

• Certain types of compensation will now be eligible for IRA and/or retirement plan purposes. Stipends paid to graduate students will be eligible for compensation for IRA contributions. “Difficulty of care” payments to foster parents will also be eligible compensation for contributions to IRAs and qualified plan contributions (for after-tax contributions).

Withdrawals for Major Disasters

• The Act also provides that retirement plans can allow for penalty-free withdrawals from retirement accounts of up to $100,000 in the event of a major disaster as declared by the President under federal law. The tax impact of the withdrawal can be treated ratably over a three-year period, or the withdrawal can be repaid to avoid taxation. In addition, the participant loan limit is increased for individuals in the declared disaster area from $50,000 to $100,000.

Pooled Employer Plans

• A new type of retirement plan called a “Pooled Employer Plan” (PEP) will allow financial services companies to provide “multiple employer plans” to unrelated small businesses. The goal is to allow small businesses that do not have sufficient plan assets the ability to access competitive investment pricing, plan features and options and fiduciary protections that large employer plans currently enjoy. Additional regulations and guidance are expected from the Department of Labor and the Internal Revenue Service. It is expected that many third party administrators, record keepers, insurance companies and similar businesses will offer these plans to small businesses, increasing the options and quality of plans available to these employers which should increase the number of employees who have company-sponsored plans to save in.

Part-Time Employees

• Part-time employees who work at least 500 hours a year for three consecutive years must be offered the opportunity to participate in a company’s 401(k) plan. The rule also specifies that these employees are not required to receive company contributions (even if the plan is top-heavy and must satisfy the top-heavy requirements). This change is effective for years beginning after December 31, 2020, and employee service prior to January 1, 2021, can be disregarded.

Group 5500 Filings

• The Act directs the Internal Revenue Service and Department of Labor to work together to allow members of a “group” of plans to file a consolidated Form 5500. Plans may be considered a “group” for this purpose if all of the plans are defined contribution plans, have the same trustee, the same fiduciaries, the same administrator, the same plan year and provide the same investment options to participants.

On the downside, there are also some negative provisions with the ACT that are meant to “pay for” the lost tax deductions that come with the beneficial provisions.

Increased Penalties

• The SECURE Act increases late filing penalties for Form 5500 to $250 per day not to exceed $150,000, and for Form 8955-SSA to $10 per participant per day, not to exceed $50,000. These penalties go into effect for forms to be filed after December 31, 2019. However, late filers need to know that these penalties can often be avoided by using existing late filing correction programs.

Elimination of Stretch IRAs

• Another “pay for” is the elimination of “stretch IRAs” (these rules also apply to qualified plans) that allow a non-spousal beneficiary to stretch the required death benefit distributions (and taxable income) over the beneficiary’s lifetime. The new rules apply to participants or IRA owners who die after December 31, 2019, and will require that with some limited exceptions amounts held by a plan or IRA be distributed to the beneficiary within 10 years of death.

529 Plan Changes

• Although not a retirement plan provision, it is worth noting that the SECURE Act allows for 529 plans to pay for up to $10,000 of student loan debt. 529 plans can now also be used to pay for the expenses of apprenticeships and training programs. Please note however that these changes are effective for Federal tax law, and State tax laws may not conform right away or at all.

Most of these changes are welcome news for small business owners and employees who are saving for retirement. Additional guidance from the Department of Labor and the Internal Revenue Service will be needed to help plan sponsors to administer these changes correctly.  The law requires that retirement plans be amended for these changes by the end of the 2022 plan year.

If you have questions about these changes, please contact your Aldrich Advisors consultant or email David Strom.

This article is a broad overview of the SECURE Act and is provided as a service to our clients and friends. It should not be relied upon for tax advice.