SECURE Act Finally to Become Law

Congress is subject to one of the same vices as many Americans, namely, putting off important activities until the last moment. Earlier this year, the House of Representatives by a 417-3 vote, approved the Setting Every Community Up for Retirement Enhancement (SECURE) Act (or “Act”), but it never advanced in the Senate, in part because of reservations as to how it would be paid for. However, this week the House and Senate approved the Further Consolidated Appropriations Act 2020, the legislative package of spending bills necessary to keep the government fully operational for the time being, which includes the SECURE Act.  President Trump is expected to sign it before the end of the day today, when current funding expires.  As is also often true of last minute activity, several of the provisions would go into effect for calendar year plans on January 1, 2020.

Several significant provisions are contained in the SECURE Act, the first major pension legislation since the Pension Protection Act of 2006. The provisions creating the most buzz are those dealing with so-called open multiple employer plans (“MEPs”), referred to in the SECURE Act as “pooled employer plans.” These provisions do not include the conditions imposed under the Department of Labor’s recent association retirement plan regulations (see our related law alert, here). The SECURE Act also eliminates the so-called “one bad apple rule,” the rule under which a failure by one employer (or by the plan itself) to satisfy an applicable plan requirement will result in the disqualification of the MEP for all employers maintaining the plan. The designated pooled plan provider must be the named fiduciary and plan administrator, must register with the DOL or IRS, and is subject to an increased ERISA bond of $1 million. Although participating employers in these pooled provider plans will have limited fiduciary responsibilities, they will still have responsibility for the selection and monitoring of the pooled plan provider or any other named fiduciary.

Another important change is the modification of the non-discrimination testing rules for so-called “soft” frozen defined benefit plans, i.e., plans that do not allow for any new participants after a specified date, but permit participants in the plan as of such date to continue to accrue benefits.  In almost all instances, these plans are not discriminatory at the time of the freeze with respect to their covered participants, but over time, solely as a result of attrition in the workforce, these plans tend to cover older, longer service employees who are frequently highly compensated as defined under the Internal Revenue Code and, hence, become discriminatory. The IRS has issued notices that address this issue in part, but provisions in the Act address this matter fully and directly. The provisions will be effective upon the date of enactment, without regard to the date the plans were modified to close entry into the plan.

Several changes are made with respect to 401(k) plans. First, the automatic enrollment safe harbor is modified to raise the automatic escalation cap from 10% to 15% of pay. Second, several changes are made to the election of safe-harbor status through the use of nonelective contributions: (i) the notice requirements is eliminated; (ii) plan sponsors are permitted to switch to a safe harbor 401(k) plan with nonelective contributions at any time before the 30th day before the close of the plan year; and (iii) an amendment after that date is permitted, but the nonelective contribution in that case is increased to 4% of compensation. Third, as with all other tax-qualified plans, there is a prohibition against making loans through credit cards and similar arrangements. Fourth, except in the case of collectively bargained plans, the SECURE Act will require employers maintaining 401(k) plan to have a dual eligibility requirement under which an employee must complete either a year of service requirement (with a 1,000 hours requirement) or three consecutive years of service in which the employee completes more than 500 hours of service. As an incentive for plan sponsors to adopt such a provision, with respect to any employees who become participants in the plan by virtue of this SECURE Act provision, the employer may elect to exclude such employees from testing under the nondiscrimination and coverage rules.

To encourage the adoption of tax-qualified plans, the Act increases the credit limitation for small employer pension plan startup costs. It also creates a new tax credit not to exceed $500 per year to employers to defray startup costs for new 401(k) plans and SIMPLE IRAs that include automatic enrollment features. This credit is also available to employers that convert an existing 401(k) plan to an automatic enrollment design.

There are three provisions relating to lifetime income options. The first provision addresses the issue of portability, by permitting participants in tax-qualified defined contribution plans, 403(b) plans and governmental 457(b) plans to take a distribution of a “lifetime income investment” in the form of a qualified plan distribution annuity so long as:  (i) the lifetime income investment is no longer authorized to be held as an investment option under the plan, and (ii) the distribution is made by direct rollover to a retirement plan or IRA, or distribution of an annuity contract. Second, the Act would require benefit statements provided to defined contribution plan participants to include a lifetime income disclosure at least once every 12-month period. The Secretary of Labor is required to draft a model disclosure statement. Third, with respect to the selection of a lifetime income provider, a fiduciary act under ERISA, fiduciaries are afforded an optional safe harbor to satisfy the prudence requirement with respect to the selection of insurers for a guaranteed retirement income product and are protected from liability for any losses that may result. The practical effect of these provisions remains to be seen. Clearly, many individuals are concerned about outliving their retirement income, and plan sponsors may have an increased focus upon assisting their employees prepare for retirement.  However, to date, we have seen limited interest in lifetime annuity options.

Other changes under the SECURE Act include increasing the age for required minimum distributions from age 70-1/2 to age 72.  Elimination of the half-year convention reflects the manner in which most individuals think of their age. This change should also be viewed in conjunction with the IRS proposal last month to update the mortality tables that are used to determine an individual’s required minimum distribution.  Also, the Act creates a penalty-free withdrawal from defined contribution plans, not to exceed $5,000, for childbirth and adoption expenses. The long-standing rule that tax-qualified plans must be adopted by the last day of the plan year is modified. Under the Act, tax-qualified plans adopted by the due date for the tax return for that taxable year, including extensions, will be treated as having been adopted on the last day of the taxable year. There are also special disaster related rules for the use of retirement funds, and a direction to the IRS and the DOL to effectuate the filing of a consolidated Form 5500 for similar tax-qualified defined contribution plans. Individuals who have attained age 70-1/2 will now be permitted to contribute to traditional IRAs.

Almost all tax qualified plans will require amendment to reflect the SECURE Act, which provides for a remedial amendment period until the 2022 plan year (the 2024 plan year for governmental plans), or a later date if Treasury provides for any plan amendment required under the SECURE Act.

Legislation such as the SECURE Act results in a loss of revenue to the government, which must be paid for. One source of revenue will be increased penalties for failure to file retirement plan returns. The Form 5500 penalty is modified to $250 per day, not to exceed $150,000. Failure to file a registration statement incurs a penalty of $10 per participant per day, not to exceed $50,000. Failure to file a required notification of change results in a penalty of $10 per day, not to exceed $10,000 for any failure. Failure to provide a required withholding notice results in a penalty of $100 for each failure, not to exceed $50,000 for any failures during a calendar year.

These revenue raising provisions are overshadowed by the elimination of the “stretch IRA,” although technically the provision applies to all tax qualified defined contribution plans as well as IRAs. Under the new rules, designated beneficiaries of IRAs and plans are required to draw down IRA and plan assets within 10 years of the death of the IRA owner or plan participant.  However, this provision is not applicable to a beneficiary who is:  (i) the surviving spouse, (ii) disabled, (iii)  chronically ill, (iv) an individual not more than 10 years younger than the participant or IRA owner, or (v) a child who has not attained the age of majority.  This rule is generally effective for deaths after December 31, 2019.

In the short run, guidance from the IRS and DOL on these provisions, especially with respect to the new pooled provider plans, is likely.  Moreover, there has been speculation that if the SECURE Act were enacted, other more detailed pension reform, such as legislation proposed by Senators Portman and Cardin, will likely follow.