A Q&A and More Delay: IRS Begins to Issue Clarifying Guidance on SECURE 2.0 Provisions

SECTION 101 – AUTOMATIC ENROLLMENT AND ESCALATION

SECURE 2.0 requires new 401(k) and 403(b) retirement plans with a cash or deferred arrangement (CODA) established after the date of enactment of SECURE 2.0 (December 29, 2022) to automatically enroll eligible employees in the plan. Enrollees start at a deferral rate of at least 3%, and the rate automatically increases annually up to a maximum percentage beginning on or after January 1, 2025. The Notice clarifies the date that the plan is established is the date the plan terms providing for the CODA were first adopted, not the effective date of an amendment or restatement.

The IRS also explained how plans in effect prior to SECURE 2.0 are affected by a plan merger. Generally, a merger between a plan in effect prior to SECURE 2.0 and a plan subject to the new automatic enrollment rules will not result in a plan that is exempt from the new automatic enrollment rules. However, a merged plan under these same facts will be exempt from the new automatic enrollment rules if the exempt plan is designated as the ongoing plan, if the merger is in connection with a transaction, and if the merger occurs by the end of the Internal Revenue Code (Code) Section 410(b)(6) transition period (typically the end of the year following the year in which the transaction occurs).

In addition, a plan that is spun off from a plan in effect prior to SECURE 2.0 will not be treated as a “new” plan and is exempt from the automatic enrollment requirement. Please note that special rules apply to plan mergers involving multiple employer plans.

SECTION 113 – SMALL IMMEDIATE FINANCIAL INCENTIVES

SECURE 2.0 permits employers to offer small financial incentives, like gift cards, to employees to encourage participation in 401(k) and 403(b) plans, effective on or after January 1, 2023. The Notice explains that a financial incentive is de minimis if it does not exceed $250. It can also be provided to employees in installments, contingent on the employee continuing to defer. For example, an employer may provide a $100 gift card at the time that the election is made and another $100 gift card on the one-year anniversary if the employee is still deferring into the plan.

However, the financial incentive can only be offered to employees from whom no election to defer is already in effect. The IRS also confirmed that a matching contribution cannot be a small financial incentive. In addition, de minimis financial incentives are not subject to the qualification and deductibility requirements of contributions. Small financial incentives are includible in gross income and subject to withholding taxes unless the incentive satisfies one of the exemptions under the Code for various fringe benefits (which gift cards typically do not).

SECTION 326 – PENALTY-FREE EARLY DISTRIBUTIONS FOR INDIVIDUALS WITH A TERMINAL ILLNESS

SECURE 2.0 provides an exemption from the 10% early distribution penalty tax on distributions taken by terminally ill individuals under 401(k) and 403(b) retirement plans. This exemption also applies to other types of defined contribution plans as well as to defined benefit retirement plans. The Notice clarifies that a participant must be otherwise eligible for an in-service distribution (e.g., hardship or disability) because this relief does not provide for a new distribution right.

The Notice offers significant detail on how to implement the exemption. A “terminally ill individual” means a person certified by a physician as having an illness or physical condition reasonably expected to cause death in 84 months or less. The Notice provides criteria for the certification and indicates that it must be provided to the plan administrator. A plan administrator cannot rely on self-certification, even by a participant who is a physician. The certification must be done prior to the employee receiving the distribution. This penalty-free treatment is optional for plan sponsors.

In addition, an employee covered under a plan that does not implement this provision can claim the relief by filing Form 5329, Additional Taxes on Qualified Plans and Other Tax-Favored Accounts, when filing their taxes.

SECTION 350 – CORRECTION OF AUTOMATIC ENROLLMENT IMPLEMENTATION ERRORS

SECURE 2.0 added Code Section 414(cc) to make permanent certain temporary safe harbor corrections previously available to automatic contribution and automatic enrollment plans under the IRS Employee Plans Compliance Resolution System (EPCRS). Section 350 of SECURE 2.0 provides a permanent safe harbor for the correction of reasonable administrative errors made in implementation of an automatic enrollment or automatic escalation feature, or for failures to afford an eligible employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan.

Section 350(b) of SECURE 2.0 provides that Section 350 applies to errors that occur after December 31, 2023. The Notice clarifies that the correction deadline is the earlier of the first payroll date after the nine-and-a-half-month period following the end of the plan year in which the error first occurred or, if an employee notifies the employer of the error, the first payroll date after the last day of the month following the month in which the employer was notified of the error. Therefore, the effective date will vary based on the date the error occurs, the date compensation is paid, whether the employee notifies the plan sponsor of the error, and whether the plan year is a fiscal year or a calendar year.

A plan sponsor may correct an implementation error with respect to a participant who terminated employment before corrected deferrals began. Terminated employees must still be provided notice of the correction but, understandably, statements regarding appropriate deductions being reinstated and the ability to make future deferrals do not have to be included. The Notice indicates that where a corrective allocation of missed matching contributions, plus earnings, is needed, the allocation must be paid at a reasonable time. This would generally be considered six months from when correct elective deferrals begin.

SECTION 604 – ROTH EMPLOYER CONTRIBUTIONS

SECURE 2.0 allows plan sponsors to provide participants with the option to receive matching contributions or nonelective contributions on a Roth basis, effective after enactment (December 29, 2022). This change is optional for plan sponsors. Employees can only elect Roth treatment of matching contributions and nonelective contributions that are fully vested when contributed to the plan. The Notice clarifies that the vesting requirement will not cause a plan to fail under nondiscrimination rules.

The Notice confirms that a matching contribution or nonelective contribution must be designated as Roth no later than the time that the contribution is allocated to the participant’s account, even if the contribution is deemed to have been made on the last day of the prior taxable year. The Roth designation is irrevocable, provided, however, that participants have the right to change their election once per year. If an employee designates a contribution as Roth, the contribution is includible in the individual’s gross income for the taxable year in which the contribution is allocated, even if deemed to have been made in the prior taxable year. However, designated Roth-matching contributions and designated Roth-nonelective contributions are not included as wages for purposes of federal income tax withholding (i.e., Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA)). Designated Roth contributions are reported using Form 1099-R for the year in which the contributions are allocated to the individual’s account.

PLAN AMENDMENTS

Notably, the Notice also further delays the plan amendment deadlines. A qualified plan (not governmental or collectively bargained) must be amended by December 31, 2026 – one year later than initially required. Plans must still operate in accordance with SECURE 2.0 as of the effective date of each requirement. Therefore, plan sponsors may consider amending their plans sooner than the amendment deadline.