Passed by Congress and signed into law at the midnight hour as part of the 2019 comprehensive budget appropriation package, the Setting Every Community Up for Retirement Enhancement (“SECURE”) Act is now the law of the land. In a previous blog, we listed and discussed in a very general way many of the SECURE Act’s most important provisions affecting 401(k) plans.
In this series of two blogs, we are zeroing in on a few of the main SECURE Act 401(k) plan provisions and providing a little more detail. Part One of this series generally covered the following topics:
- Increases In 401(k) Retirement Plan Access for Unrelated Employers Through Open MEPs
- Increases in Business Tax Credit for Small Employer Retirement Plan Startup Costs
- Increases in Annuity Options Available Within 401(k) Retirement Plans
- Increase in the Age at Which Required Minimum Distributions (“RMDs”) Must Commence
- Establishment of Penalty-Free 401(k) Withdrawals for Childbirth or Adoption
- Simplification of Non-Elective Contribution 401(k) Safe Harbor Arrangement
In this Part Two of the series, we are covering the following additional topics:
- Increase in Default Contribution Rate and Tax Credit Available for Certain Automatic Enrollment Plans
- Requirement for 401(k) Plans to Allow Long-Term, Part-Time Employees to Participate
- Modification of Closed Plan Nondiscrimination Rules to Protect Older, Longer Service Participants
- Provision of Lifetime Income Disclosures for 401(k) Plans
- No More 401(k) Plan Loans by Means of Credit Cards
- Increases in Internal Revenue Code Penalties for Failure to File Certain Retirement Plan Returns
IMPORTANT NOTE: By concentrating on the provisions discussed in Part One and Part Two of this series, we will not be attempting to exhaust every SECURE Act provision that could conceivably have an effect on 401(k) plans. Furthermore, not all of the Act’s provisions apply to 401(k) plans. For example, individual retirement accounts (“IRAs”), defined benefit retirement plans, and Internal Revenue Code Section 529 qualified tuition programs are all affected by various provisions in the new legislation. UNLESS OTHERWISE NOTED, THESE NON-401(K) PLAN PROVISIONS WILL NOT BE ADDRESSED IN THIS SERIES.
As future developments occur – for example, if official guidance in the form or regulations or other pronouncements are released covering any SECURE Act provisions discussed in these blogs – we will be sure to keep you up-to-date.
Background. As we reported in the previous blogs referenced above, the SECURE Act incorporates 29 separate retirement-related provisions, many of which were proposed in one form or another over the course of several years. The product of broad bipartisan effort and support, the SECURE Act has been rightfully called the most sweeping change to the retirement plan system (which includes 401(k) plans) since the last comprehensive legislative package – the Pension Protection Act (“PPA”) of 2006.
The text of the budget appropriations act can be found here, with the SECURE Act provisions grouped under the section entitled “Expanding and Preserving Retirement Savings.”
Keeping in mind that many of these provisions are already effective (or soon will become effective), here is a breakdown of six of the key provisions that we believe will be sure to have a major effect on 401(k) plans (as previously stated, six others were addressed in Part One of this series):
- Increase in Default Contribution Rate and Tax Credit Available for Certain Automatic Enrollment Plans. An increasing number of employers these days are offering 401(k) plans with automatic enrollment provisions, in which eligible employees automatically become plan participants, even if they do nothing to sign up. Workers can always opt-out of the plan if they choose, but studies indicate that a large percentage do not.
Typically, the plan sponsor sets a default contribution rate for employees, although the employee can choose to contribute at a different rate. Frequently, the employee’s default contribution rate starts at three percent of his or her annual pay and gradually increases to ten percent with each year that the employee stays in the plan – although this is an example and is not the only possible model.
Increased Default Contribution Rate. Up until now, the maximum default contribution rate that could be imposed under an automatic enrollment arrangement was ten percent of a participant’s compensation. The SECURE Act increases the maximum default contribution rate from ten percent to fifteen percent, except for an employee’s first year of plan participation (in which case the cap is still fixed at ten percent).
New Tax Credit. The SECURE Act also creates a new tax credit of up to $500 per year for up to three years, available to certain small employers for purposes of defraying the initial costs of establishing a 401(k) plan, provided that the plan includes an automatic enrollment feature. The credit is also available to small businesses that convert an existing 401(k) retirement plan into an automatic enrollment plan.
NOTE: This new credit is in addition to the “Increased Business Tax Credit for Small Employer Retirement Plan Startup Costs” that is discussed in Part One of this two-part blog series.
OBSERVATION: By increasing the default contribution rate to fifteen percent, and by providing “instant” tax incentives for certain small employers, the legislation seeks to foster retirement savings and open up 401(k) plan participation to additional employees – particularly individuals employed by smaller organizations – by further incentivizing automatic enrollment provisions. Automatic enrollment not only helps to increase retirement savings overall and encourage workers to start saving for retirement as soon as possible, but it can also assist plans in passing nondiscrimination tests by increasing participation among lower paid employees.
Effective Date – Both the increase in the default contribution rate and the tax credit for certain automatic enrollment plans provisions are effective for plan years beginning on and after December 31, 2019.
- Requirement for 401(k) Plans to Allow Long-Term, Part-Time Employees to Participate. Qualified retirement plans, including 401(k) plans, are subject to strict participation requirements. Under prior law, employers could exclude part-time workers who work fewer than 1,000 hours per year. This has had the effect of excluding a great many part-time, seasonal, and other employees who may not be able to consistently meet the 1,000 per year requirement – a category of workers whose ranks, according to recent surveys, are increasing.
The SECURE Act attempts to close the gap by requiring most employers maintaining a 401(k) plan to include a dual eligibility provision, under which an eligible employee must be permitted to participate upon completion of either:
- Completion of one year of service (under the previous 1,000-hour rule); or
- Completion of three consecutive years of service, in which the employee completes more than 500 hours of service in each year.
Unfortunately for plan sponsors, including larger numbers of part-time and lower hour employees, who may be less likely or able to contribute to the plan, can sometimes skew nondiscrimination test results downward. The SECURE Act attempts to counter this effect by easing some of the nondiscrimination and coverage provisions. Specifically, in the case of employees who are eligible solely by reason of the new law provision, employers are permitted to exclude such employees from testing under the Internal Revenue Code’s nondiscrimination and minimum coverage testing rules, and from application of the Code’s top-heavy requirements.
The new dual eligibility rules do not apply to 401(k) plans maintained under a collective bargaining agreement.
Effective Date – The dual eligibility rules are generally effective for taxable years beginning after December 31, 2020.
- Modification of Closed Plan Nondiscrimination Rules to Protect Older, Longer Service Participants. The SECURE Act contains a provision that modifies the Internal Revenue Code’s nondiscrimination rules to permit certain existing participants in “closed” defined benefit pension plans (i.e., pension plans having “frozen” classes of participants, who are often older employees or employees having relatively longer periods of service) to continue to accrue benefits under these traditional pension plans – even if the plans are not open to newer, younger employees. This change in the law is intended to protect the retirement benefits of a growing class of older, longer-service employees who have been switched over from traditional defined benefit pension plans to defined contribution plans – particularly 401(k) plans.
NOTE: Although this SECURE Act provision applies directly to defined benefit pension plans instead of to 401(k) plans, it was specifically included in the Act to acknowledge the potential adverse effect that converting from traditional pension plans to 401(k) plans might have on employees who were not given the opportunity to begin saving through their 401(k) plans early in their careers.
OBSERVATION: This provision – along with the SECURE Act provision opening up annuity options to 401(k) plans (see Part One in this series of blogs) and the new requirement for 401(k) plans to provide lifetime income disclosures (see Item 4, immediately below) – suggests that there may be growing governmental concern that the decline of guaranteed lifetime streams of income might result in decreasing retirement security for increasing numbers of workers reach retirement age. (See “Postscript,” below.)
Effective Date – The new provision is generally effective on the date of enactment; i.e., December 20, 2019, although plan sponsors may elect to apply the rules as early as for plan years beginning after December 31, 2013.
- Provision of Lifetime Income Disclosures for 401(k) Plans. As noted in Part One of this series, 401k plans typically distribute benefits in the form of a single lump-sum payment, or sometimes in a series of installments. Less typical are annuity payment options – although the SECURE Act makes significant strides in opening up opportunities for including annuity options in 401(k) plans (see Item No. 3 in Part One of this series for more details.)
The SECURE Act further 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 over the course of his or her projected retirement span, by converting the account balance into a monthly annuity beginning at his or her normal retirement age.
The statute directs the DOL to issue a “model lifetime income disclosure notice” by no later than one year after the date of enactment – in other words, by no later than December 20, 2020. The DOL must also release actuarial assumptions for converting participant account balances to lifetime income-stream equivalents. Under the legislation, no plan fiduciary, plan sponsor, or other person will be held liable under ERISA for lifetime income-stream equivalents that are derived from the DOL’s model disclosure notice and/or actuarial assumptions.
Effective Date – According to the statute, the new rules apply to pension benefit statements furnished more than 12 months following the date that the DOL issues interim final rules, the model disclosure notice, and related actuarial assumptions.
- No More 401(k) Plan Loans by Means of Credit Cards. The overwhelming majority of contemporary 401(k) plans have a loan feature that permits participants to borrow against the vested balances in their 401(k) accounts. Being that the purpose of a 401(k) plan is to build up funds for retirement purposes, these loans were originally intended to be used chiefly for major, often unforeseen expenses – not to defray everyday costs. As 401(k) plans have become more common and plan loans more easily available, there is concern that, in the aggregate, substantial retirement savings are being squandered through misuse of the loan provisions.
The SECURE Act combats this with a provision that prohibits the distribution of plan loans by means of credit cards or any similar arrangement. According to a House Ways and Means Committee report available, the change is intended to help ensure that plan loans are not used for routine or small purchases, thereby helping to preserve retirement savings. This seems to be in keeping with one of the SECURE Act’s overall goals of helping to expand retirement plan coverage and preserve savings.
Effective Date – The new exemption is effective on the date of enactment; i.e., December 20, 2019.
- Increases in Internal Revenue Code Penalties for Failure to File Certain Retirement Plan Returns. Under ERISA, both the DOL and the IRS have the authority to impose a number of penalties and excise taxes designed to enforce compliance with the law. Over time, the dollar amount of many of these penalties has increased, ostensibly to keep current with inflation, but these increases have frequently also been used as revenue-raising measures. Because both the DOL and the IRS can impose separate penalties sanctioning the same behaviors, it is important to take each of them into account when ascertaining potential liability for any failures.
The SECURE Act modifies some of the IRS penalties that are imposed for failure to file certain retirement plan information as follows:
- Failure to timely file the Form 5500 series annual report can now be assessed up to $250 per day, not to exceed $150,000 per plan year. Before the SECURE Act, the penalty was $25 a day, not to exceed $15,000.
- Failing to file Form 8955-SSA can now be assessed up to a $10 per day per participant, not to exceed $50,000, up from a penalty of $1 per day per participant, not to exceed $5,000.
- Failing to provide income tax withholding notices can be assessed up to $100 for each failure, not to exceed $50,000 for a calendar year, up from $10 for each failure, not to exceed $5,000 for a calendar year.
OBSERVATION: As previously mentioned, the DOL also has the authority to impose penalties under ERISA for failure to file information returns, which are in addition to and separate from the IRC penalties mentioned above. The DOL penalty dollar figures are currently substantially higher than those under the Internal Revenue Code, and they are not affected by the new legislation.
Effective Date – The increased penalty amounts apply to returns, statements, and notifications required to be filed, and notices required to be provided, after Dec. 31, 2019.
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.
Postscript – Where Is Retirement Security Headed? Looking at the SECURE Act as a whole, one gets the impression that a lot of effort has been put into helping enhance and preserve retirement savings, coming at a time when the concept of retirement is for many Americans believed to be in jeopardy. There are the provisions that help more employers offer 401(k) plans to a broader range of employees, provisions encouraging benefits paid in the form of lifetime income streams, provisions encouraging automatic enrollment and safe-harbor nonelective contributions, the easing of certain fiduciary liability rules, and the tightening up of plan loan availability. Clearly one can discern a pattern of well-meaning changes that seem to have been designed to help shore-up the retirement system overall.
But looking beyond the surface, one can see cracks forming at the same time these positive efforts are being made. 401(k) plans are simultaneously being viewed as sources of income for purposes other than retirement – for example, we have seen that the SECURE Act introduces new penalty-free withdrawals for childbirth and adoption expenses. Although special repayment provisions have been included as an offset, once retirement funds have been depleted from the plan, they are unavailable to continue to earn compounded tax-free income – which, over time, can have a significant negative impact on retirement savings. Added to this, there are serious discussions in employee benefits circles about further amending the 401(k) rules to allow participants to pay back student loans using their account balances.
401(k) plans were implemented as retirement savings vehicles and have largely replaced more traditional retirement plans – meaning that they are the sole source of retirement income for many Americans. When participants are increasingly encouraged by law to use their 401(k) savings for non-retirement purposes, this does not bode particularly well for the prospect of increased retirement security.
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.