The SECURE Act: What accountants should know when advising their business clients
It may seem like the distant past now in the midst of the coronavirus pandemic, but it was only a few months ago that Congress passed a major piece of legislation on retirement plans. On Dec. 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. The act makes extensive changes to the rules affecting tax-qualified, employer-sponsored retirement plans. This article will highlight certain SECURE Act changes that accountants should know for advising their business clients with respect to their employer plans. (However, it was written before Congress made further changes to retirement accounts with more recent legislation like the Coronavirus Aid, Relief and Economic Security (CARES) Act, which suspended required minimum distributions for 2020.)
Required minimum distributions
To receive favorable tax treatment under the tax code, employer plans must comply with certain required minimum distribution, or RMD, rules. Under these rules, distributions must begin to be made by a certain date called the required beginning date. The required beginning date rules are different for an employee receiving distributions during life, and for a beneficiary receiving distributions after death.
Prior to the passage of the SECURE Act and the CARES Act, an individual’s “required beginning date” was generally April 1 following the later of (i) the year in which the individual turned age 70½, or (ii) the year in which the individual retired. For an individual who is a 5 percent owner of the employer sponsoring an employer plan, the required beginning date has been based solely on turning age 70½.
The SECURE Act replaces the required beginning date age of 70-½ with 72 for any individual who turns age 70-½ after Dec. 31, 2019. Thus, under the new law, RMDs required on or after Jan. 1, 2019 to such individuals do not need to be made until after they turn age 72.
Before the SECURE Act, distributions in cases in which the individual died before their required beginning date generally had to be made either (i) beginning the year after death, over the life or life expectancy of the beneficiary, or (ii) in a complete distribution by the end of the fifth year after the year of death. Certain special rules applied in the case of distributions to a surviving spouse.
This regime is unchanged for defined benefit plans. However, for defined contribution plans, the SECURE Act limits the time period over which most beneficiaries can withdraw inherited retirement assets to a maximum of 10 years. There are special exceptions for spouses, disabled or chronically ill beneficiaries and beneficiaries who are less than 10 years younger than the decedent.
The new rules are effective in the case of participants dying after Dec. 31, 2019.
Adoption of safe harbor plan status for 401(k) plans
Section 401(k) plans are prohibited from providing benefits that discriminate in favor of highly compensated employees, and such plans must satisfy certain nondiscrimination testing requirements. One method of satisfying such requirements is for an employer to adopt a “safe harbor” plan, under which the employer must make either matching or nonelective contributions in specified amounts.
Prior to the passage of the SECURE Act, an employer was required to adopt a safe harbor plan prior to the start of the plan year (unless the plan was newly established).
The SECURE Act modifies the safe harbor rules to allow an employer to adopt a safe harbor employer nonelective contribution structure after the start of the plan year. Under the new rules, an employer may amend its plan:
- Any time before 30 days prior to the end of the plan year, if it is going to provide a nonelective employer contribution equal to 3 percent of participants’ compensation; or
- Any time prior to the end of the following plan year, if it is going to provide a nonelective employer contribution equal to 4 percent of participants’ compensation.
The benefit of such rule changes is that an employer can elect safe harbor status retroactively if its Section 401(k) plan would not otherwise pass required nondiscrimination testing. It should be noted, however, that the retroactive adoption of safe harbor status is only permitted if an employer adopts a nonelective employer contribution structure. Safe harbor matching contributions must continue to be adopted prior to the start of the plan year.
This change applies for plan years beginning after Dec. 31, 2019.
Changes to safe harbor qualified automatic contribution arrangement rules
As discussed above, employers may design their 401(k) plans to be safe harbor plans that automatically satisfy the Section 401(k) nondiscrimination rules by making either employer nonelective contributions or matching contributions to such plans. One safe harbor contribution structure permitted under the tax code is a qualified automatic contribution arrangement (QACA), under which participants are automatically enrolled to make employee deferral contributions to the plan, and the employer makes matching or nonelective contributions to the plan.
Prior to the passage of the SECURE Act, a QACA could not provide for automatic employee deferral contributions greater than 10 percent of compensation (although employees could voluntarily elect to make contributions equal to or greater than 10 percent of compensation).
The SECURE Act changes such rules to increase the maximum automatic contribution amount to 15 percent. This change applies for plan years beginning after Dec. 31, 2019.
Prohibited exclusion of long-term, part-time workers
Under the tax code, an employer plan may not condition eligibility to participate in the plan on the employee’s satisfaction of age or service requirements greater than age 21 or 1,000 hours of service in a plan year. Many employer plans include these minimum age and service requirements, resulting in the exclusion of temporary or part-time workers from the plan who do not work 1,000 hours or more in a plan year.
The SECURE Act changes the “minimum participation” rules stated above for Section 401(k) plans by prohibiting a service-based exclusion for employees who complete 500 hours of service in three consecutive 12-month periods. Under the new rules, part-time employees who do not satisfy 1,000 hours of service in a plan year but work 500 hours of service over three years must be permitted to join the plan and make their own elective deferral contributions to the plan. The employer is not required to make matching or nonelective contributions for such employees, and the employer may continue to limit eligibility to employees who have reached age 21.
This provision applies for plan years beginning after Dec. 31, 2020, but service before Jan. 1, 2021, does not need to be counted for determining whether an employee has satisfied the 500-hour for three consecutive years.
In-service rollovers of annuity options
Recently, Congress and the Department of Labor have sought to encourage sponsors of 401(k) and 403(b) plans to offer annuity investment options under such plans. These options are designed to pay participants retirement distributions over the course of their lifetime, in a manner that replicates payments from traditional pension plans, which could prevent participants from running out of retirement funds in their lifetimes.
The SECURE Act changes the rules related to “lifetime income” annuity options by permitting participants to receive and roll over an in-service distribution of an annuity investment option, if the employer discontinues such an investment option under the plan. The rule allows participants to preserve these investment options by rolling them over to an individual retirement account or other employer plan and avoid any tax treatment associated with the distribution of such an investment option. Such distributions must occur within 90 days of the date that the employer will no longer offer the annuity investment option in the plan.
The SECURE Act made sweeping changes to the rules governing employer plans. Accountants advising business clients with respect to their employer plans should become familiar with the rules discussed above, as well as the various other law changes that now apply to such plans.