SECURE 2.0 Takes Second Bite at Retirement Security

CHANGES TO REQUIRED MINIMUM DISTRIBUTIONS

• The required minimum distribution (RMD) age is increasing from the current age of 72 to age 73 on January 1, 2023, and age 75 on January 1, 2033. This change is mandatory and impacts both defined contribution and defined benefit plans.
• Effective January 1, 2024, participants will not be required to take RMDs on Roth contributions held in a retirement plan.
• Effective immediately, the penalty for failing to take an RMD will decrease from 50% of the amount of the missed RMD to 25% of such amount.

AUTOMATIC PLAN ENROLLMENT AND ESCALATION

New 401(k) and 403(b) plans must automatically enroll eligible employees in the plan starting at a deferral rate of at least 3% (and no more than 10%). Furthermore, new plans must automatically increase the employee’s deferral percentage annually until it reaches a maximum percentage (which percentage varies depending on plan type). Employees will have the ability to opt out of automatic enrollment. All current 401(k) and 403(b) plans will be grandfathered and will not be required to add automatic enrollment and escalation provisions. This requirement is mandatory for new plans established after the enactment of SECURE 2.0 and is effective for plan years beginning on or after January 1, 2025.

ALLOWANCE OF MATCHING CONTRIBUTIONS FOR ELECTIVE DEFERRED STUDENT LOAN REPAYMENTS

For plan years beginning after December 31, 2023, sponsors of 401(k) and 403(b) plans are permitted to provide employer-matching contributions based on the employees’ qualified student loan repayments outside the plan. Qualified student loan repayments include the repayment of certain qualified education loans incurred by an employee to pay qualified higher education expenses. Plan sponsors may rely on employee certification that payments have been made on such loans. For purposes of nondiscrimination testing, SECURE 2.0 allows the plan sponsor to conduct the actual deferral percentage (ADP) test separately for employees who receive this matching contribution. The US Department of the Treasury (Treasury) is expected to issue regulations with more details on how to administer student loan matching contributions. This change is optional for plan sponsors.

EMERGENCY SAVINGS OPTION

Starting in 2024, 401(k) and 403(b) plan sponsors can allow non-highly compensated employees to establish their own emergency savings accounts within the plan. Non-highly compensated employees can defer a total of $2,500 (indexed) into their emergency savings accounts. Investment earnings can cause the account balance to exceed $2,500, but no additional contributions can be made once the $2,500 limit is reached. These emergency savings contributions are generally treated as Roth contributions. Employers can automatically enroll non-highly compensated employees in these accounts, up to 3% of pay. To the extent an employer matches employee deferrals under its retirement plan, it must also match these emergency savings contributions. These emergency savings accounts must be invested in an investment option designed to preserve principal.

Additionally, these emergency savings accounts are intended to provide accessible funds to employees in the event of an emergency and, therefore, the initial four withdrawals from the account (per year) may not be subject to distribution fees by the plan’s recordkeeper. Highly compensated employees will not have the ability to make emergency savings contributions, but an employee who makes contributions when he or she is a non-highly compensated employee and later becomes a highly compensated employee can continue to access his or her account. We anticipate significant guidance from both the US Department of Labor (DOL) and Treasury regarding the implementation and use of these accounts. Employers are not required to offer these emergency savings accounts under their plans.

EXPANSION OF ROTH ACCOUNT CONTRIBUTIONS

• Effective January 1, 2024, if an employee has wages in excess of $145,000 (indexed) for the prior year, all catch-up contributions made to a 401(k) or 403(b) plan by that employee will be subject to Roth contribution tax treatment. Catch-up contributions made by employees with wages under the $145,000 indexed limit will continue to be treated as pre-tax contributions unless the employee affirmatively elects to make such contributions on a Roth basis. This change is mandatory. Therefore, to the extent a plan offers catch-up contributions, this feature effectively forces plan sponsors to implement a Roth catch-up contribution feature.
• Effective immediately, SECURE 2.0 allows plan sponsors to provide participants with the option to receive matching contributions or nonelective contributions on a Roth basis. This change is optional for plan sponsors and applies only to matching contributions and nonelective contributions that are fully vested when contributed to the plan.

SMALL FINANCIAL INCENTIVES TO ENCOURAGE PLAN PARTICIPATION

SECURE 2.0 permits employers to offer small financial incentives to employees, such as gift cards, to encourage participation in 401(k) and 403(b) plans. This change is effective for plan years beginning on or after January 1, 2023. Plan sponsors are not required to offer financial incentives, but they now have the option to do so.

INCREASED CATCH-UP CONTRIBUTION LIMIT

Effective January 1, 2025, participants who attain ages 60, 61, 62 and 63 during the year will have access to increased catch-up contribution limits. The increased limit is the greater of $10,000 (indexed) or 50% more than the regular catch-up limit. This is a required change.

IMPROVING COVERAGE FOR PART-TIME EMPLOYEES

SECURE 1.0 expanded retirement plan coverage for part-time employees by requiring 401(k) plan sponsors to allow part-time employees the option to make elective deferrals to the plan if they had attained age 21 and worked at least 500 hours of service in the past three consecutive years. SECURE 2.0 reduced the three-consecutive-year requirement to two consecutive years, and it also extended this requirement to apply to the Employee Retirement Income Security Act of 1974 (ERISA)-covered 403(b) plans. Like SECURE 1.0, SECURE 2.0 does not require the employer to provide employer-matching or non-elective contributions on behalf of part-time employees otherwise covered by this provision. This is a required change.

AUTOMATIC CASHOUT CHANGES

Under current law, 401(k) and 403(b) plan sponsors have the option to automatically cash out participants and beneficiaries who have balances of $5,000 or less. For participants whose balances exceed $1,000 but are below the $5,000 cashout limit, the plan sponsor must roll these amounts into a third-party individual retirement account (IRA) established in the participant’s name instead of sending a check to the participant. Effective January 1, 2024, SECURE 2.0 increases the automatic cashout limit from $5,000 to $7,000. Utilization of the higher cashout limit is optional.

SECURE 2.0 also paves the way for “automatic portability providers” to automatically transfer a participant’s balance from a default IRA (established after an automatic cashout) into a defined contribution retirement plan sponsored by the participant’s new employer unless the participant affirmatively opts out of this transaction. The plan sponsor of the receiving plan would engage the automatic portability provider, and the provider would have to meet a number of specific regulatory requirements. The plan sponsor’s retention of an automatic portability provider would be optional. SECURE 2.0 requires the DOL to issue additional guidance on this feature within the next 12 months.

HARDSHIP CHANGES

Plan sponsors of both 401(k) and 403(b) plans may rely on the employee’s certification that he or she meets the deemed hardship criteria specified in the applicable regulations. Currently, plan sponsors can rely on an employee’s certification of the hardship withdrawal amount needed, but the employee must submit documentation to verify that the need for the withdrawal satisfies the deemed hardship criteria. This change applies for plan years beginning on or after December 29, 2022. Furthermore, for plan years beginning on or after January 1, 2024, SECURE 2.0 aligns the hardship withdrawal rules applicable to 403(b) plans with the hardship withdrawal rules currently applicable to 401(k) plans.

DISASTER CHANGES

SECURE 2.0 modified the distribution rules applicable in the event of a federally declared disaster. Under the new rules, if a participant is impacted by a federally declared disaster, they can request a distribution of up to $22,000 from their retirement plan. This distribution is not subject to the 10% early distribution penalty tax and can be taken into income over three years. Participants also have the ability to later repay these distributions to their retirement plans. SECURE 2.0 also allows plan sponsors to increase the maximum loan amounts available to a participant in the event of a federally declared disaster to $100,000 (or 100% of the participant’s account balance, if less). Plan sponsors can also extend the loan repayment period for such participants by one year. These changes are effective immediately and are optional. However, if a participant who is impacted by a federally declared disaster can otherwise request a different distribution from his retirement plan (e.g., the participant previously terminated employment), the participant may still be able to avoid the 10% early distribution penalty by completing his or her tax return accordingly; we are awaiting additional guidance on this point.

PENALTY-FREE DISTRIBUTIONS

SECURE 2.0 removes the 10% early distribution penalty tax on distributions taken by terminally ill individuals (effective immediately) or for certain emergency expenses (effective January 1, 2024) and limited withdrawals taken by victims of domestic abuse (effective January 1, 2024). These penalty tax exemptions apply to both defined contribution and defined benefit pension plans. Participants must have the ability to later repay these distributions to their retirement plans. SECURE 2.0 also provides for penalty-free withdrawals for up to $2,500 per year from a defined contribution plan to pay for certain long-term care insurance contracts. This provision takes effect in late 2025. These changes are optional. However, if a participant otherwise meets one of the criteria described above, the participant may still be able to avoid the 10% early distribution penalty by completing his or her tax return accordingly; we are awaiting additional guidance on this point.

MISCELLANEOUS CHANGES

• SECURE 2.0 requires the creation of a “Lost and Found” database to reunite missing participants with their retirement plan funds. This database will be maintained by the DOL and will cover both defined contribution and defined benefit plan funds.
• The Self Correction Program, the Internal Revenue Service’s (IRS) Employee Plans Compliance Resolution System (EPCRS), is expanded to allow more types of errors to be corrected through the self-correction component of EPCRS. This change is effective immediately, and SECURE 2.0 directs the IRS to update the applicable correction guidance accordingly within the next two years.
• The Saver’s Credit available under current law will be replaced with a retirement plan match. Under this revised program, qualifying low-income individuals who make contributions to their IRA or employer-sponsored retirement plan will receive a federally funded matching contribution to their IRA or retirement plan account of up to $2,000. This change takes effect on January 1, 2027. SECURE 2.0 also directs Treasury to better advertise this program to eligible individuals.
• SECURE 2.0 modified several participant notice provisions. Changes include (i) reducing the number and types of notices that a plan sponsor is required to provide to eligible employees who are not otherwise participating in the defined contribution plan, (ii) new paper statement requirements for both defined contribution and defined benefit plans and (iii) further modifications to the electronic distribution rules. Effective dates for these changes vary.

AMENDMENT DEADLINES

Plan amendments to implement these mandatory and optional provisions must be signed on or before the last day of the first plan year beginning on or after January 1, 2025. This is generally the same plan amendment deadline that was already in effect for the SECURE Act and Coronavirus Aid, Relief, and Economic Security Act (CARES) Act amendments.

ACTION ITEMS

Plan sponsors should be mindful of the various effective dates and watch for communications from their third-party plan administrators requesting plan sponsor direction on the implementation of optional provisions. Plan sponsors should also be on the lookout for further guidance from the DOL, IRS and Treasury regarding the implementation of these new provisions. For more information on these changes, please contact your regular McDermott lawyer or one of the authors listed below.