After dragging their feet for most of 2019, the U.S. Senate finally, on December 19th, passed the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act, a bundle of legislative provisions that together represents the most sweeping changes to the retirement plan system (which includes 401(k) plans) since the Pension Protection Act of 2006. The U.S. House of Representatives had passed substantially the same legislation by a wide margin earlier in the year (see our previous blog for a recap), but the proposal had remained stalled in the Senate until it was wrapped into the year-end omnibus spending bill late in the week.
President Trump signed the new legislation into law on Friday, December 20th. The text of the legislation can be found here, with the SECURE Act provisions grouped under the section entitled “Expanding and Preserving Retirement Savings.”
The product of broad bipartisan effort and support, the SECURE Act incorporates 29 separate retirement-related provisions, many of which have been percolating in one form or another for a number of years. Not all of the 29 provisions apply to 401(k) plans. For example, individual retirement accounts (“IRAs”), defined benefit plans, and Internal Revenue Code Section 529 qualified tuition programs are all affected by various provisions in the new legislation.
Highlights of Key 401(k) Plan Provisions. Altough we will discuss many of the 401(k) provisions in greater detail in a future blog, here is a very general overview of some of the highlights of the new law that directly apply to 401(k) plans:
- Increases In 401(k) Retirement Plan Access for Smaller Employers. The SECURE Act will make it easier for small employers to provide 401(k) retirement plans for their employees by expanding and modifying the present-day multiple employer plan rules. After SECURE, small employers meeting certain requirements may now band together to offer 401(k) plans with a reduced amount of fiduciary liability concern, and less administrative cost, than has previously been the case.
- Increases in Business Tax Credit for Small Employer Retirement Plan Startup Costs. In an effort to help make setting up retirement plans more affordable for small businesses, a separate SECURE Act provision increases the business tax credit for plan startup costs. Under the new law, the tax credit increases from the current cap of $500 to up to $5,000 in certain circumstances.
- Boosts in Annuity Options Available Within 401(k) Retirement Plans. In one of the more significant and controversial changes from previous law, the SECURE Act significantly expands the existing rules that allow 401(k) plan sponsors to select annuity providers for distribution options in the form of annuities. Previously, plan providers had the sole fiduciary responsibility to scrutinize annuities and their providers. The new rules generally shift this fiduciary liability onto insurers and other annuity providers, charging these providers with the duty to provide employers with the appropriate products. Thus freed from the fiduciary burden, plan sponsors theoretically are in an enhanced position to offer these annuity products in their plans without fear of liability.
OBSERVATION: Although the SECURE Act provision seeks to expand the use of annuities in 401(k) plans, with the stated goal of providing increased retirement income security to retirees, critics have charged that the provision could instead encourage insurance companies to sell annuity products to plans that may be overly complex, inadequately communicated, or simply inappropriate for the plan’s general demographic. Now that this provision is the law, we are optimistic that the goal of increased retirement security will be realized and concerns to the contrary will be diminished.
- Increases in the Age at Which Required Minimum Distribution Must Commence. Under the SECURE Act, required minimum distributions from 401(k) plans must now commence starting at age 72, which is up from the previous starting age of 70 ½. Notably, this provision is effective for distributions made after December 31, 2019, for individuals who attain age 70 ½ after this date (see “Effective Dates,” below).
CAUTION: Individuals who are affected by the change in age are advised to promptly confer with their individual tax advisors, for purposes of advice in planning the timing of any required distributions that may need to be taken (or not taken) in 2020.
- Increases in the Auto-Enrollment Safe-Harbor Compensation Cap. The SECURE Act increases the auto-enrollment “safe harbor” maximum cap on an employee’s automatically increasing elective deferral contributions from 10 percent to 15 percent of his or her compensation. This is intended to further expand and encourage the use of automatic enrollment arrangements, consistent with the overall policy goal to increase 401(k) plan participation across the board.
- Provision of Penalty-Free Distributions for Childbirth or Adoption. A new exemption from the 10 percent penalty tax for early withdrawals from 401(k) plans now allows an aggregate amount of $5,000 to be distributed from a 401(k) plan in the event of a “qualified birth or adoption,” provided the distribution occurs within one year of the event. While new parents can opt to repay the withdrawal amount in one or more payments if they wish, thereby replenishing their 401(k) plan accounts, the distribution is not considered to be a plan loan, and so it is not subject to the regular plan loan repayment rules.
- Simplification of Non-Elective Contribution 401(k) Safe-Harbor Arrangement. The SECURE Act simplifies the “safe harbor” plan rules for plans that use the non-elective contribution safe harbor method. Generally stated, the safe harbor notice requirement for nonelective contributions is eliminated, and plan sponsors generally may now switch to a safe harbor 401(k) plan using nonelective contributions at any time prior to the 30th day before the close of the plan year. The notice and amendment requirements for other types of safe-harbor plan arrangements (for example, those using a safe-harbor matching contribution) have not been changed by the new law.
- Tax Credit Available for Certain Auto Enrollment Plans. The SECURE Act creates a new tax credit of up to $500 per year for up to three years to employers for purposes of defraying the initial costs of establishing a 401(k) plan, provided that the plan includes an automatic enrollment feature. Here again, this provision is meant to facilitate auto enrollment and to boost 401(k) plan participation overall.
- Requirement for 401(k) Plans to Allow Long-Term, Part-Time Employees to Participate. Very generally stated, the SECURE Act now requires employers maintaining a 401(k) plan to include a dual eligibility provision, under which an employee must be permitted to participate upon completion of either: (i) a one year of service requirement (with the regular 1,000-hour rule); or (ii) three consecutive years of service, in which the employee completes more than 500 hours of service. There are a number of related conditions and special rules regarding nondiscrimination testing, vesting, and other items.
- No More 401(k) Plan Loans by Means of Credit Cards! The SECURE Act contains a somewhat unexpected provision that prohibits the distribution of plan loans through credit cards or similar arrangements. According to a House Ways and Means Committee report, the change is intended to ensure that plan loans are not used for routine or small purchases, thereby preserving retirement savings. This provision is effective immediately (see “Effective Dates,” below).
- Provision of Lifetime Income Disclosures for 401(k) Plans. The SECURE Act requires all defined contribution plans (including 401(k) plans) to furnish a lifetime income disclosure notice to participants at least once every 12 months. The notice is designed to show how much income a participant’s lump-sum balance could generate his or her projected retirement span.
- Modifies Closed Plan Nondiscrimination Rules to Protect Older, Longer Service Participants. The new law modifies certain IRC’s nondiscrimination rules to permit existing participants in “closed” plans (i.e., plans having closed classes of participants or who are often older employees or participants having relatively longer periods of service) to continue to accrue benefits. This modification is intended to protect retirement benefits for older, longer service employees as they near retirement.
- Increases in Internal Revenue Code Penalties for Failure to File Certain Retirement Plan Returns. The new legislation modifies some of the penalties for failure to file certain retirement plan information returns under the IRC. For example, the penalty for failure to timely file a Form 5500 series report is increased to $250 per day, not to exceed $150,000. This is up from the current IRS penalty of $25 per day, not to exceed $15,000. The penalties for similar information returns are similarly increased.
OBSERVATION: The U.S. Department of Labor (“DOL”) has the authority to impose separate penalties under ERISA for failure to file information returns, which are in addition to the IRC penalties mentioned above. The DOL penalty dollar figures are currently substantially higher than those under the IRC, and they are not affected by the new legislation.
Other Provisions. The above list is meant only to generally highlight the most prominent 401(k) plan-related changes and is not intended as an exhaustive inventory of all of the SECURE Act’s provisions that might have an impact on 401(k) retirement plans or other retirement vehicles.
COMMENT ON IMPACT OF NEW LEGISLATION ON CURRENT PRACTICES: As is always the case with significant new legislation, it will take time for practitioners and commentators to begin to “flesh out” many of the SECURE Act’s provisions, as they attempt to ascertain the full impact of each of the provisions upon current plans and administrative practices. As always, we will be working to keep you up-to-date with the latest expert thinking and current developments along these lines.
Effective Dates. Remarkably, the majority of the 401(k) plan-related changes made by the SECURE Act are effective for plan years beginning after December 31, 2019 – which certainly doesn’t leave much “ramp-up” time to familiarize employers and administrators with the changes, and/or to prepare for required modifications in administrative procedures, participant notices, and so forth. The fact that this landmark legislation was enacted in the midst of the traditional year-end Holiday Season certainly does not help in this regard.
Certain other provisions (e.g., the change allowing unrelated employers to band together to offer multiple employer plans, and the provision requiring 401(k) plans to allow long-term, part-time employees to participate in the plan) become effective for plan years beginning after December 31, 2020, which gives plan sponsors and benefits professionals a welcome additional year to prepare. (The related increase in the business tax credit for retirement plan startup costs (see above), however, remains effective for taxable years beginning after December 31, 2019.)
The SECURE Act provision prohibiting 401(k) plan loans from using credit cards or similar methods is effective immediately upon enactment – in other words, it is effective as of December 20, 2019.
There are also additional effective dates for certain minor provisions not addressed in this blog.
Plan Amendments. The SECURE Act specifically provides for a special remedial plan amendment period. Generally stated, the Act states that plan sponsors have until the last day of the 2022 plan year – or a later date, should the U.S. Department of Treasury so provide – in which to make any plan amendment required under the SECURE Act.
OBSERVATION: If the past is any guide, the 2022 amendment deadline is likely to be eventually extended – probably in order to reflect guidance in the form of regulations and other official governmental pronouncements that is certain to be issued in the coming months and years in response to SECURE.
The information and content contained in this blog post are for general informational purposes only, and does not, and is not intended to, constitute legal advice. As always, for specific questions concerning the potential effects of the SECURE Act upon your 401(k) retirement plan, please consult your own ERISA attorney or advisor.