The topic on every retirement blog right now—and probably for the next couple of years to come—is the SECURE 2.0 Act that was passed at the end of 2022.
While SECURE 2.0 covers lots of ground, some of the main "themes" of the new law are promoting automatic enrollment, increasing flexibility of distributions, and shifting more contributions to Roth. Many of the most significant of the 90+ sections of the law fall into one of these categories.
Automatic Enrollment
Normally, in a 401(k) plan, employees must make an affirmative election to have contributions withheld from their paycheck. Automatic enrollment, also sometimes called "negative election," is the opposite—contributions will come out of your paycheck automatically unless you actively opt out of having them withheld.
Research has shown that automatic enrollment is very effective when it comes to getting employees to contribute to their employer's retirement plan. Even though they have the option to stop contributing, people tend to continue participating once the deferrals start.
Mandatory Automatic Enrollment for New Plans
The big one under this topic is that starting in 2025, most new 401(k) plans and 403(b) plans will be required to have automatic enrollment. The automatic enrollment percentage must be at least 3% and not higher than 10%. In addition, employees who are automatically enrolled must have their contribution rate increased by one percentage point each year after their first year contributing, unless they choose a different contribution rate. The maximum rate that can be set by this automatic escalation must be at least 10%, but can be as high as 15%.
The default investment for automatically-enrolled employees must meet the requirements of a Qualified Default Investment Alternative (QDIA), which is a Department of Labor safe harbor for default investments in participant-directed plans. It is not clear at this time how this requirement applies to pooled trustee-directed plans.
There is an exception to the mandatory auto-enrollment requirement for plans of employers who have been in business less than 3 years, and for employers who normally employ no more than 10 employees. In the employer's fourth year of business, or in the year after they first normally employ more than 10 employees, their plan must add automatic enrollment.
There is also an exception for plans in existence prior to the enactment of SECURE 2.0, which was December 29, 2022. 401(k) and 403(b) plans adopted on or after December 30, 2022 will have to have automatic enrollment unless they meet one of the exceptions. This section becomes effective for plan years starting in 2025.
Starter 401(k)
SECURE 2.0 introduced a new plan design which automatically satisfies ADP testing and top-heavy requirements without any employer contributions. The plan must have automatic enrollment at a minimum rate of 3% and a maximum rate of 15%. The annual contribution limit is less than in a normal 401(k) plan; the maximum contribution is $6,000 plus $1,000 catch-up if the participant will be at least age 50 by the end of the year. These amounts are indexed to inflation and will be adjusted annually.
This plan design is also available to 403(b) plans; although it is unclear at this time what advantage would be gained by using it. 403(b) plans are normally exempt from the ADP test and top-heavy minimum due to their universal availability requirement.
The Starter 401(k) or 403(b) must be the only plan of the employer. These plan designs are available starting in 2024.
Expanded Corrections for Automatic Enrollment Failures
With the expansion of automatic enrollment, the addition of section 350 of SECURE 2.0 is a welcome relief. Implementing automatic enrollment and automatic escalation can be prone to mistakes, since it requires the Plan Administrator to keep track of a number of different things, including whether an employee is eligible, if they have ever made a contribution election, and whether their current contribution rate is the result of an affirmative election or an automatic election. This section allows sponsors to correct many types of errors associated with automatic enrollment without penalties and without risk of disqualifying their plan.
The correction method applies to any reasonable failure in starting an employee's automatic contributions, or automatically increasing the employee's contribution rate. The way to correct the error is simply to start contributions at the correct rate, and notify the employee.
If the employee would have been entitled to a match had the contributions been implemented correctly, the employer must still contribute the match. Earnings on the match may be owed as well.
The law does not specify the content requirements for the notice, but instead leaves it to the IRS to come up with standards.
The deadline to correct the error is 9½ months after the end of the plan year in which the error first occurred. For example, if an employee was supposed to be automatically enrolled on January 1, 2025 but wasn't, the employer would have until October 15, 2026 to start their contributions under this method. However, if the employee notices that they were supposed to have been auto-enrolled and brings the error to the employer's attention, the correct contributions must start by the first pay date in the month following the month in which the employer was notified.
All in all, this correction method is very generous in that it does not require any corrective employer contributions whatsoever. In most cases relating to missed employee deferrals, improper exclusion from a plan or failure to implement an employee's election, the employer is responsible for penalties and additional punitive contributions. The fact that automatic enrollment errors are being granted such flexible correction options means it will be easier for sponsors to implement automatic enrollment going forward.
Distributions
SECURE 2.0 adds a number of new distribution options and expands existing ones. Some of these will prove to be useful, others maybe not as much.
RMDs
The age for required minimum distributions was increased from 70½ to 72 by the SECURE Act back in 2019. Now SECURE 2.0 has raised it again; effective in 2023 it is increased to 73. Then in 2032 it will increase yet again to 75. Note that due what appears to be a mistake in the wording of the law, it is unclear which age will apply to individuals born in 1959; fortunately we have some time for that to be settled out before it becomes an issue.
To illustrate the change, consider these situations (assuming the person has terminated employment):
An individual born in 1950 turned 72 in 2022. They are covered under the SECURE 1.0 rule, their first RMD year is 2022 and their required beginning date is 4/1/2023.
An individual born in 1951 turns 72 in 2023, so the new rule applies. Their first RMD year is 2024 when they turn 73, so their required beginning date is 4/1/2025.
An individual born in 1960 turns 74 in 2034, so the age 75 rule applies. Their first RMD year is 2035, and their required beginning date is 4/1/2036.
The penalty tax on missed RMDs has also been reduced. This tax was previously one of the most punitive in the Internal Revenue Code, at 50% of the missed RMD. Effective for tax years starting 2023, it is reduced to 25% of the missed RMD. The penalty can be reduced even further, to 10%, if the individual corrects it within an applicable correction window and submits an amended return.
Effective 2024, Roth 401(k) accounts will no longer be subject to RMDs at all while the participant is still alive. This brings them into alignment with the rules for Roth IRAs.
SECURE 2.0 also enhances the ability to use certain annuity contracts to satisfy RMDs in defined contribution plans. Qualified Longevity Annuity Contracts (QLACs) are no longer limited to 25% of the account balance. More types of commercial annuities may now be purchased to satisfy the RMD requirement, and accounts which have been partially annuitized may now have lower RMD requirements.
Starting in 2024, a participant’s surviving spouse may elect to be treated as the deceased employee for RMD purposes. This will have the effect of allowing them to start RMDs later in some cases, as well as simplifying RMD calculations and the beneficiary designation process. IRAs already operate under similar principles.
Force Outs
Effective in 2024, the dollar limit for involuntary distributions ("force outs") will increase from $5,000 to $7,000. Terminated participants whose vested benefit is less than this amount can have their benefits distributed without their consent. The involuntary cash distribution limit remains at $1,000, so distributions of amounts between $1,000 and $7,000 will have to be made to an IRA. This dollar amount is also used to determine whether terminating participants are required to be offered annuity options in a defined benefit plan.
Also related to force outs, SECURE 2.0 creates a new prohibited transaction exemption allowing for "Automatic Portability Transactions." This is an opportunity for providers of rollover IRA accounts which have received forced-out assets to automatically transfer those assets to the new retirement plan of the participant. The automatic portability provider must conduct searches at least monthly to identify a retirement plan to which the forced-out assets can be transferred. They must issue a notice to the participant both before and after the transfer occurs, and the participant must be given the opportunity to affirmatively opt-out.
Hardships
Effective now, plan administrators may rely upon a participant's self-certification that they are experiencing one of the deemed "heavy and immediate" causes provided in the regulations. As a reminder, these deemed hardship reasons are:
Medical expenses,
Purchase of a principal residence,
Payment of tuition and related educational fees,
Payments necessary to prevent eviction from or foreclosure on the principal residence,
Burial or funeral expenses,
Expenses for the repair of principal residence resulting from a casualty loss, and
Expenses and losses incurred on the event of a federally-declared disaster.
Plans can also allow "facts-and-circumstances" hardship distributions for reasons other than these, however the plan administrator must continue to have participants substantiate the request in those cases.
Some plans have been allowing self-certification for several years now, based on guidelines included by the IRS in their internal manual. This new law provides the first specific statutory basis for reliance upon a participant's self-certification, however. The plan administrator may not rely upon the participant's certification if they have actual knowledge to the contrary.
Starting in 2024, 403(b) plans may allow hardship distributions under the same circumstances and from the same money sources as 401(k) plans.
Other Special Event Distributions
SECURE 1.0 added Qualified Birth and Adoption Distributions (QBADs) allowing the distribution of up to $5,000 upon the birth or adoption of a child. It also allowed that such distributions could be repaid, although it did not specify how. SECURE 2.0 clarifies that such repayments must be completed within 3 years after the QBAD is paid. QBADs paid before the enactment of SECURE 2.0 may be repaid up until January 1, 2026.
If you were the administrator of a qualified plan during 2020, you may remember that the CARES Act added a special distribution for individuals affected by COVID-19 (or if you were the administrator of a qualified plan located in Louisiana or surrounding areas in 2005, you may remember KETRA and its Katrina-related distributions as well). SECURE 2.0 generalized the same ideas into a new Qualified Disaster Recovery Distribution (QDRD) which may be made on account of a federally-declared disaster where the participant's principal place of abode was within the disaster area, and who sustained an economic loss by reason of such disaster. The maximum amount of the distribution for a single disaster is $22,000. The QDRD is exempt from the 10% tax on early distributions, and the tax on the distribution may be spread over 3 years. Affected individuals may also be eligible for plan loans with higher-than-normal limits.
Starting in 2024, a participant may take up to $1,000 per year to pay for unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses. The plan administrator may rely upon the participant's certification that the emergency exists. The distribution may be repaid to the plan within 3 years. The participant may not take a second emergency expense distribution within 3 years following an emergency expense distribution unless the first distribution is repaid, or unless their total employee contributions to the plan exceed the amount of the first distribution.
Also starting in 2024, plans may allow distributions to a participant who is a victim of domestic abuse. The plan administrator may rely upon the participant's certification that they have been a victim of domestic abuse. The amount of the distribution is equal to the lesser of $10,000 or 50% of the participant's vested account balance. The distribution may be repaid to the plan, similar to QBADs. Domestic abuse distributions are treated as not eligible for rollover for income tax withholding purposes, and they are exempt from the 10% penalty tax on early withdrawals. Plans which are subject to spousal consent on distributions (including defined benefit plans, money purchase plans, and profit sharing plans which do not meet the requirements to be exempt from the qualified joint & survivor annuity rules) may not offer domestic abuse distributions.
QBADs, QDRDs, emergency expense distributions, and domestic abuse distributions are all optional plan provisions. Plan sponsors are not required to offer them in their plans.
Roth
Many of the Roth provisions added by SECURE 2.0 were included as revenue raisers; because Roth contributions are taxable when made, they make a positive impact on the bill's overall cost, since Congress scores bills on a 10-year horizon.
Roth Catch-Up
Starting in 2024, employees whose earnings in the prior year exceed $145,000 (indexed to inflation) will only be allowed to make catch-up contributions as Roth. If the plan does not allow Roth contributions, employees will not be able to make catch-up contributions at all if there is anyone who is catch-up eligible (age 50 or older) with earnings above the limit.
Because the applicability of this section is based on the prior year's earnings, and it will first be effective in 2024, that means we are looking at employees who will earn more than that amount in 2023 that will be subject to this provision when it first becomes effective. The $145,000 amount is close to, but a little less than the 2023 threshold for Highly Compensated Employees (HCE), which is $150,000. This means that there will be some non-HCEs who are subject to Roth catch-up. Likewise, since an employee who is a 5% owner (or a deemed 5% owner by attribution) is considered to be an HCE regardless of their compensation, it will be possible for some HCEs to not be subject to Roth catch-up.
The application of this provision is straightforward (if maybe complicated to do in practice) when you are talking about the most common source of catch-up contributions, which is when a participant contributes more than the regular deferral dollar limit (known as the 402(g) limit) in a plan year. However, there are three other ways that deferrals can be classified as catch-up: by exceeding the limit on annual additions (the 415 limit), by exceeding a plan-imposed limit, or by recharacterizing excess contributions resulting from a failed ADP test that would otherwise have to be distributed. In particular, ADP catch-up will be awkward to deal with under the new law. In order to have catch-up, the participant would have to have made their deferrals as Roth, but they would be unlikely to know during the year that the ADP test is going to fail and that they will need catch-up. Unless the IRS comes out with some guidance to allow retroactive Roth elections in this situation, it appears that the ability to recharacterize ADP excess contributions as catch-up will be severely limited.
Roth Employer Contributions
At an employee's election, their employer contributions—matching and nonelective (profit sharing)—may be treated as Roth. These contributions will be taxable to the employee in the year they are made, and this treatment is only available if the contributions are 100% vested.
This provision was effective as of the date of enactment of SECURE 2.0, which means it was possible that someone could have received a Roth employer contribution for 2022. That contribution would have to be included in their 2022 income, and that person's 2022 income tax return in due in a few months. At this point, we have no guidance on how Roth employer contributions should be reported. It's likely that either a 1099-R will be issued (similar to how it is done with an in-plan Roth conversion) or it will be included on the employee's W-2, possibly with a special code for Box 1.
Speaking of in-plan Roth conversions, it was already possible to convert employer contributions to Roth within a plan, so there is not much that was added by this section that was not available before. In theory, this section could make it possible to have Roth treatment under a pure profit sharing plan (without 401(k) contributions), or a money purchase plan.
Roth SEP and SIMPLE IRAs
Effective in 2023, SEPs and SIMPLE IRA plans may contain Roth IRAs. The Roth treatment must be made at the election of the employee.
Emergency Savings Accounts
Starting in 2024, plans may offer a separate sub-account to be used as an emergency savings account. Contributions to the account will be made on a Roth basis and participants may (but do not have to be) automatically enrolled to contribute. There is a dollar cap of $2,500 (indexed) on the account; any contribution which would cause the emergency savings account to exceed the dollar limit can be automatically put into the participant's regular Roth account (if they have one), or simply not accepted by the plan. The emergency savings account must be invested in interest-bearing cash, or in a product designed to maintain the dollar value of the investment and preserve principal while providing a reasonable rate of return.
The participant must be allowed to withdraw from the account at least once per month, in any amount at their discretion. In addition, there may not be any fees charged for the first 4 withdrawals made during any plan year.
Emergency savings accounts are not available to highly compensated employees (HCEs). If an employee establishes an emergency savings account and later becomes HCE, they may continue to withdraw from the account, but they may not make any further contributions.
529 Rollovers to Roth IRAs
Assets in a 529 Education Savings Account may be rolled over to a Roth IRA, starting in 2024. The 529 account must have been in existence for at least 15 years before the rollover. The amount that may be rolled over in any given year is limited to the IRA owner's Roth IRA contribution limit for the year, reduced by the amount of any actual IRA contributions made that year. The total amount that may be rolled over in all years is limited to $35,000.
Other Stuff
These are some of the notable changes included in SECURE 2.0 that didn't fit into one of the above categories.
Spousal Attribution Rule
Spouses are generally deemed to own each other's interest when determining if a controlled group exists between two companies. However, there is an exception for spousal non-involvement; it requires that each spouse is not an employee of or involved in the management of the other spouse's business, and that there are no conditions which would substantially limit the spouse's right to dispose of their ownership. This exception can be frustrated in some cases; the new rule under SECURE 2.0 corrects two prominent situations that would otherwise interfere with the spousal non-involvement exception.
Besides spouses, the attribution rules also automatically attribute ownership from a parent to their child if the child is under the age of 21. If a couple has a child together, then that child is considered to own all of their parents' ownership interests in their companies. Because that child is an owner in both companies, now a controlled group can exist even if the parents (married or not) otherwise have nothing to do with each other's businesses. SECURE 2.0 amends the definition of controlled group to specify that a controlled group will not exist solely because of a minor child who is attributed their parents' ownership.
Community property laws (in states which have them) also interfere with the application of the spousal non-involvement exception. SECURE 2.0 adds that community property laws will be disregarded when determining if a controlled group exists.
These changes are effective for plan years starting in 2024. If this will cause a change in the controlled group or affiliated service group status of an employer, they may take advantage of the transition period under Code section 410(b)(6)(C).
Retroactive Plan Amendments
Generally, plan amendments must be adopted no later than the last day of the plan year to which they relate. SECURE 2.0 allows amendments to be adopted as late as the due date for filing the employer's tax return, including extensions.
The amendment must increase benefits, but may not be used to increase matching contributions.
This is effective for plan years beginning in 2024. Since it affects retroactive amendments, we will start seeing these amendments in 2025 for 2024 plan years.
Top Heavy for Otherwise Excludable Employees
Generally, all non-key employees in a defined contribution plan must receive a top heavy minimum contribution if the plan is top heavy and if any key employee receives a contribution. For some employers, this has been a disincentive to offering their plan to employees earlier than the minimum requirements under the law (one year of service and age 21). Starting in 2024, employees who have not met those minimum statutory requirements do not have to receive the top heavy minimum, even if they are allowed to participate in the plan. This means that employers who sponsor top-heavy plans can allow their employees to participate in their 401(k) plan without having to give them a top heavy minimum contribution until they meet a year of service.
Top heavy minimum accruals also apply to defined benefit plans. SECURE 2.0 did not change which employees have to receive the top heavy minimum in a defined benefit plan. If a top heavy DB plan allows employees to participate earlier than 1 year of service, those employees who are not key employees will still have to receive a top heavy minimum accrual.
Age 60-63 Catch-Up
The catch-up limit will be increased starting in 2025, but the "catch" is that it only applies for certain ages. A participant is eligible for regular catch up starting in the year in which they will attain age 50; they do not actually have to be 50 years old at the time they begin making catch-up contributions. The increased catch-up works the same way. A participant is eligible for the increased catch-up limit in the years in which they will attain age 60 through age 63; starting in the year in which they will attain age 64, it goes back to the regular catch-up limit.
The increased catch-up limit for 2025 will be equal to the greater of $10,000 or 150% of the 2024 regular catch-up limit. The 2024 catch-up limit will be announced later in 2023, so at that point we will know what the 2025 increased catch-up limit will be.
That's all?
Hardly! Here are some of the provisions which were included in SECURE 2.0 that weren't mentioned in this article:
Increased Saver's Credit (now known as Saver's Match)
Increased startup credit for small employers
Credits for plans that cover military spouses
IRA catch-up limit now indexed to inflation
Student loan matching contributions may be counted in the ACP test
Employers may provide small immediate financial incentives for participating in a 401(k) plan
Expansion of self-correction for most inadvertent plan errors
Consolidation of plan notices
Reduction of PBGC variable-rate premiums
With all of these new rules, we will be spending a lot of time working on how to best implement them. As I said at the beginning, we are sure to be hearing about these changes for months and years to come.