SECURE Act Finally Secure: New Law Makes Major Changes to Retirement Plan Rules
In May of 2019, the U.S. House of Representatives passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act by a 417-3 vote, but the bill did not advance in the Senate, due at least in part to concerns about how the cost of certain tax breaks would be recouped via other provisions. In a move that was not expected until late in 2019, however, the SECURE Act ended up being tacked on to the Further Consolidated Appropriations Act 2020 (the law required to fund operations and avoid another government shutdown), and the SECURE Act was in fact signed into law by President Trump on December 20, 2019.
The SECURE Act is the most significant retirement plan legislation since the Pension Protection Act of 2006. Generally, the main purpose of the law is to increase the coverage of American workers in employer-sponsored plans. As the effective date of many of the provisions remains January 1, 2020, some adjustments in retirement plan administration will need to be made quickly.
The most significant changes effected by the SECURE Act are summarized below. Each summary includes (a) a description of the rule in effect prior to the new law, (b) a description of the new rule, and (c) applicable effective dates.
1. Multiple Employer Plans:
a. Prior Rule. A multiple employer plan (MEP) is a plan sponsored by two or more employers that are not treated as a single employer under IRS rules, i.e., employers that are not members of a controlled group. (The term should not be confused with a “multiemployer plan,” which is a plan covering employees of several employers who are represented by a single union for collective bargaining purposes.) Historically, there have been two major impediments to so-called “Open MEPs,” plans without any particular connection among the participating employers. First, the Department of Labor’s position has been that a plan sponsored by multiple employers without “commonality” among the employers technically constitutes separate plans subject to separate annual reporting (Form 5500) requirements. Second, under the IRS view, the tax-qualified status of a MEP has been subject to the “one bad apple” rule; one non-compliant participating employer could affect the tax qualification of the entire plan, for all participating employers.
b. New Rule. The SECURE Act solves both the commonality requirement and the one bad apple rule by creating a new type of MEP called a “Pooled Employer Plan” (PEP). A PEP meeting applicable requirements will have just one plan document, one annual Form 5500 filing, and one plan audit. The concept is that unrelated employers (particularly smaller employers) will be able to band together to share administrative costs and lesser expenses related to plan investments (e.g., mutual fund share classes with lower expense ratios based on a larger pool of assets). Each PEP will be sponsored by a qualified “Pooled Plan Provider” (e.g., a mutual fund company, third-party administration firm, etc.) that will serve as the plan administrator and “named fiduciary” required by ERISA.
c. Effective Date. The PEP provisions are effective for plan years beginning after December 31, 2020. (As a lot of details will need to be developed around these new rules, guidance from the IRS and DOL on the operation of PEPs is expected, and Pooled Plan Providers will no doubt need time to update their systems to accommodate PEPs.)
2. Part-Time Employees:
a. Prior Rule. Historically, a 401(k) plan has been permitted to impose an eligibility requirement of one year of service (defined to require completion of 1,000 hours of service in a 12-month period). Under a plan with such a provision, a part-time employee who never exceeded the 1,000 hour threshold (the rough equivalent of 20 hours per week) would never enter the plan, for purposes of both employee contributions and employer contributions.
b. New Rule. The SECURE Act requires that a 401(k) plan provide for the participation of any part-time employee who has completed three consecutive 12-month periods of employment, with at least 500 hours of service in each such period. However, no employer contributions will be required for such employee, unless and until the employee has satisfied the plan’s regular eligibility requirements. Ultimately, therefore, this new rule increases the access of part-time workers to savings opportunities without increasing the employer’s costs (beyond those costs related to having a higher participant count).
c. Effective Date. The new rule is effective for plan years beginning after December 31, 2020. (Periods of service before 2021 need not be counted for purposes of the three year requirement, however, so the practical effect of the change need not be realized until 2024.)
3. Small Employer Tax Credits:
a. Prior Rule. Prior to the SECURE Act, a small employer (an employer with no more than 100 employees with at least $5,000 in compensation in the prior year) that adopted an eligible retirement plan was entitled to a tax credit of up to $500 per year, for three years, for qualified start-up costs.
b. New Rule. The existing credit is increased to up to $5,000 per year for three years. In addition, the SECURE Act adds a new credit (up to $500 per year for three years) for a new plan, or an amendment to an existing plan, that provides for automatic enrollment.
c. Effective Date. The new credits are available for tax years beginning after December 31, 2019.
4. Safe Harbor 401(k) Plans:
a. Prior Rule. A safe harbor 401(k) plan is one under which the nondiscrimination requirements applicable to employee deferrals and employer matching contributions (the ADP and ACP Tests) can be avoided via the employer’s promise to make certain employer contributions to the plan. Typical safe harbor contributions are either a “nonelective” contribution equal to 3% of compensation for all eligible employees, or a matching contribution equal to 100% of employee deferrals up to 3% of compensation plus 50% of employee deferrals from 3% to 5% of compensation. With some exceptions, the safe harbor must be in effect at the beginning of the plan year and must remain in effect for the entire plan year, and a notice of the employer’s use of the safe harbor must be provided at least 30 days before the beginning of each plan year. A plan with a Qualified Automatic Contribution Arrangement or “QACA” (a plan under which employees are automatically enrolled and which meets certain other requirements) is permitted to provide for “automatic escalation,” i.e., automatic increases in employees’ 401(k) deferrals, up to 10% of compensation.
b. New Rule. The SECURE Act makes several changes to the rules governing safe harbor 401(k) plans. First, an employer that sponsors a safe harbor plan providing only for nonelective safe harbor contributions is no longer required to provide an annual notice to employees. (Plans that also provide for matching contributions intended to fall within the ACP safe harbor must still give notice.) Second, provisions for safe harbor nonelective contributions may be adopted at any time up to 30 days prior to the end of the plan year for which they are effective. If the normal nonelective contribution is increased from 3% of compensation to 4% of compensation, the provisions for safe harbor nonelective contributions can actually be adopted as late as the end of the year following the year for which the contributions are made. Finally, the maximum automatic enrollment/escalation 401(k) contribution under a QACA is increased from 10% to 15%.
c. Effective Date. The changes are effective for plan years beginning after December 31, 2019.
5. Adoption Deadline for New Plans:
a. Prior Rule. Historically, in order to establish a new plan for a particular plan year, the plan document had to be signed by the last day of the plan year. (Note: Employee 401(k) deferrals are never permitted prior to the actual adoption of the plan document or amendment authorizing such deferrals.) In this respect, tax-qualified employer plans have always differed from an IRA, which can be established by an individual taxpayer at any time up to the due date of the individual’s tax return for the year for which the IRA is effective.
b. New Rule. The SECURE Act treats a new employer plan like an IRA, allowing the employer to adopt the plan at any time up to the due date of the employer’s tax return, including extensions. The change allows for more tax planning opportunities, as decisions on new plans will no longer need to be made by year end. (401(k) deferral provisions must still be in place before the plan accepts any employee 401(k) contributions.)
c. Effective Date. The new rule is effective for plan years beginning after December 31, 2019. (A new plan established for 2019 still had to be adopted by December 31, 2019.)
6. Required Minimum Distributions:
a. Prior Rule. Each participant in a qualified plan (and each IRA owner) has historically been forced to commence required minimum distributions (RMDs) by April 1 of the year following the year in which the individual attained age 70½. (Participants in employer plans who were not owners of more than 5% of the employer have been permitted to postpone RMDs until actual retirement.) Also, a beneficiary of a deceased participant (or IRA owner) has been permitted to take RMDs based on the life expectancy of the beneficiary, resulting in substantial and ongoing tax deferral. This strategy has commonly been referred to as the “stretch IRA.”
b. New Rule. The SECURE Act changes the required beginning date for RMDs to April 1 of the year following the year in which the individual reaches age 72. However, the lifetime distribution option for a beneficiary who is not an “eligible designated beneficiary” (a spouse, minor child, disabled or chronically ill individual, or beneficiary who is no more than 10 years younger than the decedent) has been eliminated, with distributions to such a beneficiary now being required over a period of 10 years (thus removing the opportunity to effect a stretch IRA).
c. Effective Date. The changes are generally effective with respect to individuals who reach age 70½ or die after December 31, 2019. (The old rules continue to apply for any individual who reached age 70½ or died before January 1, 2020.)
7. Form 5500 Penalties:
a. Prior Rule. While filing annual plan returns (Forms 5500) is not a condition of tax-qualified plan status, both the IRS and the Department of Labor can impose substantial penalties for failure to file such returns in a timely manner. The maximum DOL penalty is $2,200 per day. The maximum IRS penalty has previously been $25 per day, subject to a cumulative maximum of $15,000 per return. In addition, the IRS could impose separate penalties of $1 per day for each failure to report a separated participant on Form 8955-SSA, subject to a maximum of $5,000. However, both IRS and DOL penalties can largely be avoided through use of the DOL’s Delinquent Filer Voluntary Compliance Program (DFVCP), with a single, reduced penalty based on the size of the plan (with a maximum of $4,000).
b. New Rule. The SECURE Act increases the potential IRS penalties for Form 5500 failures tenfold, from $25 per day to $250 per day, and from a maximum of $15,000 to a maximum of $150,000 Similarly, the Form 8955-SSA penalties increase from $1 per day to $10 per day, and from a maximum of $5,000 to a maximum of $50,000. (Maximum DOL penalties are not affected.) These increases emphasize the importance of plan reporting in a timely fashion, and taking advantage of the DFVCP when failures occur.
c. Effective Date. The changes are effective with respect to returns due after December 31, 2019 (e.g., returns due in 2020 for a 2019 plan year).
Although some of the provisions in the SECURE Act are effective right away, in 2020, the law provides for a “remedial amendment period” under which employers will have until the end of the 2022 plan year to adopt conforming amendments. Thus, while plans will have to be operated in accordance with the new rules, employers will have significant time to achieve plan document compliance. Employers whose plan documents are maintained by Houston Harbaugh will be contacted at the appropriate time.