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Tax Strategy: Inside the SECURE Act

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The SECURE Act, enacted on Dec. 20, 2019, as part of the Further Consolidated Appropriations Act of 2020, includes a variety of new provisions designed primarily to encourage adoption of qualified retirement plans and to make those plans more flexible and portable. At least one provision, scored as a revenue raiser, could have a negative impact on taxpayers by accelerating required distributions after death and eliminating so-called “stretch IRAs.”

1. Expanding plan coverage. Employers are encouraged to set up multiple-employer plans with other like-minded employers. This permits them to spread the plan operation costs and reduce the burden on any one small employer. The employers in an MEP no longer need to be in a shared organizational relationship. These open MEPs, or pooled employer plans, can be administered by a pooled plan provider, such as a bank or insurance company. Also, a violation of ERISA rules by one employer in the MEP will no longer necessarily disqualify the entire MEP. Nondiscrimination testing and correction of plan qualification defects must still be applied by each employer separately.

To further encourage small employers to set up retirement plans, the credit for small-employer pension plan startup costs is increased and extended to apply to added automatic enrollment costs. The revised three-year credit for start-up costs is equal to the greater of $500 or the lesser of $250 times the number of non-highly compensated employees who are eligible to participate or $5,000. The three-year credit for implementation of automatic enrollment is $500. Automatic enrollment is also encouraged by increasing the cap from 10 to 15 percent.

Qualified plans are now required to offer elective deferrals to long-term, part-time employees — employees with at least 500 hours of service in three consecutive 12-month periods. Service before Jan. 1, 2021, need not be considered. These part-time employees may still be excluded from matching, nonelective contributions and discrimination testing.

2. Plan flexibility. In order to help avoid retirees exhausting their retirement plan assets before death, the law provides a safe harbor from liability for plan sponsors in the selection of an annuity provider. While this is designed to encourage annuity options so that employees will not outlive their retirement plan assets, some are also concerned that the change, combined with high annuity fees, may result in reduced overall benefits for retirees. To help alleviate those concerns, new lifetime income disclosures are required in annual benefits statements. However, there will be a need for additional guidance in order to determine the assumptions to be used in calculating these amounts. The law also provides for increased portability of lifetime income options such as annuities.

The safe harbor for making non-elective contributions is streamlined.

The list of permitted penalty-free distributions is expanded to a qualified birth or adoption up to $5,000.

There also is a relaxation of the nondiscrimination rules to protect older, longer-service participants, where testing problems often developed for plans closed to new participants.

IRA holders will now be able to delay the start of required minimum distributions until age 72, for those who reach age 70 ½ after Dec. 31, 2019, and will be able to continue making IRA contributions after age 70 ½, starting for contributions for the 2020 year.

There is a relaxation of the notice and adoption requirements for 401(k) safe harbor plans.

The Consolidate Appropriation Act also includes provisions outside of the SECURE Act reducing the minimum age for making distributions from a pension plan to a participant who has not separated from service from age 62 to age 59 ½, and extending permitted distributions from qualified plans to include victims of presidentially declared disasters.

3. Participant protections. Under the SECURE Act, employer plans are prohibited from making plan loans through credit cards and other similar arrangements.

Taxable non-tuition fellowships and stipends and nontaxable “difficulty of care payments” earned by home health care workers will now count as compensation for purposes of IRA contributions.

4. Rules for special plans. The act includes provisions on the treatment of custodial accounts on termination of Sec. 403(b) plans, clarification of retirement income account rules relating to church-controlled organizations, and special rules for minimum funding standards for community newspaper plans. The Pension Benefit Guaranty Corp. premiums for cooperative and small employer charity pension plans are also modified.

The SECURE Act also increases the benefits provided to volunteer firefighters and emergency medical responders.

Permitted distributions from 529 plans are expanded to include certain expenses associated with registered apprenticeship programs and up to $10,000 of qualified education loan repayments.

5. Administration. Changes to administration requirements include allowing certain retirement plans adopted by the filing due date for the year to be treated as in effect as of the close of that year.

Certain group plans are permitted to file a combined annual report. The plans must share the same trustee, the same named fiduciaries, the same administrator and plan administrator, must have the same plan year, and must make the same investment options available to participants and beneficiaries.


The revenue raisers

The SECURE Act modifies the required distribution rules for designated beneficiaries of retirement plans. Beneficiaries who are not “eligible designated beneficiaries” will no longer be able to take distributions over their life expectancy but instead over a maximum of 10 years, limiting so-called “stretch IRAs.” Eligible designated beneficiaries include a spouse, a minor child of the owner, a disabled or chronically ill person, or a person no more than 10 years younger than the owner. This change is likely to make it advisable for IRA holders and plan participants to review their beneficiary designations as well as their estate plans. Longer payouts may be possible by designating the estate or a trust as a beneficiary, rather than an individual.

In order to help cover the costs of these retirement plan changes, the SECURE Act also increases the failure-to-file penalty and the penalties for failure to file retirement plan returns. The new law also increases required information sharing to help administer excise taxes.


Summary

The SECURE Act offers many changes that plan sponsors and individuals will need to review carefully if they want to take maximum advantage of some of the new flexibility offered. Most plans are likely to require amendments. The change to the beneficiary distribution rules warrants a review of designated beneficiaries in qualified plans and a review of estate plans to make sure there are no unintended consequences from the new distribution rules. New coverage requirements will warrant a review of how an employer handles part-time employees.

In general, these provisions apply to plan amendments made on or before the last day of the first plan year beginning on or after Jan. 1, 2022 (Jan. 1, 2024, for governmental plans). The short time period between the enactment date, Dec. 20, 2019, and the date many provisions are effective, Jan. 1, 2020, will result in some confusion for which timely clarifying guidance from the IRS is likely to be essential.

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