SECURE Act Becomes Law: What This Means for Retirement Plans and IRAs
On December 20, 2019, President Trump signed into law the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) as part of the government’s end-of-year spending bill. The new law is designed to strengthen retirement security across the country and includes a number of tax-advantaged changes to retirement plans and IRAs. Here’s a summary of some of the most noteworthy provisions:
- Required Minimum Distributions Pushed Back to Age 72. Under prior law, required minimum distributions (“RMDs”) from 401(k) plans and traditional IRAs must begin by April 1 of the year after the year in which a participant turns age 70½ (unless the participant continues working after reaching age 70½, in which case RMDs need not begin until after retirement). But for participants who turn age 70½ after December 31, 2019, the SECURE Act changes the required minimum age from 70½ to 72, allowing retirement funds to grow for an extra year and a half before participants must begin receiving distributions.
- Elimination of “Stretch IRAs.” While much of the SECURE Act contains tax-favorable provisions, such provisions may be overshadowed by the elimination of “stretch IRAs.” Under the new rules, IRA and retirement plan assets must be distributed to designated beneficiaries within 10 years of the death of the IRA owner or plan participant. Prior to the SECURE Act, IRA or plan assets could be stretched over the beneficiary’s lifetime, potentially allowing the funds to grow tax-free for decades. This change applies to distributions with respect to participants who die on or after January 1, 2020.
This provision is not applicable to a beneficiary who is (i) the surviving spouse of the decedent, (ii) disabled, (iii) chronically ill, (iv) not more than 10 years younger than the decedent, or (v) a child who has not attained the age of majority.
- Automatic Contribution Cap Expanded to 15%. Automatic enrollment in 401(k) plans is becoming more frequent as a means for employers to encourage retirement planning and boost overall participation. In an automatic enrollment arrangement, the employer implements a default salary reduction rate, but employees may opt out of the automatic enrollment entirely or elect to contribute to the plan at a different rate.
Under a qualified automatic contribution arrangement (“QACA”), the employee’s default contribution rate starts at 3% of his or her annual salary and gradually increases each year to, eventually, 6%. Under prior law, an employer could not set a QACA contribution rate exceeding 10% for any year, but the SECURE Act increases this 10% cap to 15%.
- 401(k) Safe Harbor Plan Design. Beginning January 1, 2020, employers making nonelective safe harbor contributions under a safe harbor 401(k) plan design (i) are not required to provide annual notices pursuant to the safe harbor rules, (ii) may amend their plans to implement this feature up to 30 days before the end of the plan year, and (iii) may amend their plans even after 30 days before the end of the plan year if the nonelective contribution is at least 4% of compensation.
- Part-Time Employees Eligible for 401(k) Participation. Under current law, employers can exclude part-time employees working fewer than 1,000 hours during a year. But effective January 1, 2021, the SECURE Act requires employers maintaining a 401(k) plan to permit employees who have worked at least 500 hours per year for three consecutive years to be eligible to participate in the plan. Service before 2021 does not count for purposes of the 500-hour requirement, and eligible part-time employees are only required to participate for purposes of elective deferral contributions – plans are not required to provide matching or other employer contributions for eligible part-time employees. Part-time participants may be excluded from the employer’s nondiscrimination and coverage testing rules and from application of the top-heavy rules.
- Withdrawals for the Birth or Adoption of a Child. Beginning January 1, 2020, the SECURE Act permits penalty-free withdrawals from defined contribution plans, not to exceed $5,000, for childbirth and adoption expenses. Such withdrawal is exempt from the 10% early distribution penalty tax for distributions but is subject to income tax unless the funds are repaid to the plan.
- Small Employer Plan Tax Credits Enhanced. For small employers starting a retirement plan, the SECURE Act increases the tax credit from $500 to $5,000 per year, available to cover startup costs for the first three years that the plan is in effect.
The SECURE Act also implements a new $500 tax credit for newly adopted small employer 401(k) plans and SIMPLE IRA plans that include an automatic enrollment feature. The new credit is also available to small employers that convert an existing retirement plan to an automatic enrollment plan. This credit is available to cover startup costs for the first three years that the new or converted plan is in effect.
- Rollovers of Lifetime Income Investments Permitted. Effective January 1, 2020, participants in tax-qualified defined contribution plans, 403(b) plans, and governmental 457(b) plans may directly roll over “lifetime income investments” to a retirement plan or IRA without causing a distribution event if the plan from which the rollover is made no longer authorizes lifetime income investments as an investment option under the plan.
- Lifetime Income Disclosure Statements Required. The SECURE Act requires defined contribution plan administrators to provide “lifetime income disclosure statements” at least once every 12 months to plan participants. These lifetime income disclosure statements would show how much money the participants could get each month if their total account balance were used to purchase an annuity. The DOL is directed to draft a model disclosure statement for this purpose; the new requirement will not come into effect until 12 months after the DOL drafts such model statement.
- Changes to Multiple Employer Plans (“MEPs”). The SECURE Act makes a number of changes to MEPs. Beginning January 1, 2021, employers can more easily participate in a MEP or in a new “pooled employer plan,” of which multiple participating businesses with no common interest other than plan sponsorship could be a part. Although participating employers in these pooled employer plans will have limited fiduciary responsibilities (as a designated “pooled plan provider” will be the named fiduciary and plan administrator of the pooled employer plan), participating employers will still have the fiduciary responsibility for the selection and monitoring of the pooled plan provider or any other named fiduciary. Furthermore, each participating employer will be treated as a plan sponsor with respect to the portion of the pooled employer plan attributable to the employees of that employer.
The SECURE Act also eliminates the “one bad apple” rule applicable to MEPs, which provided that noncompliance by one participating employer disqualified the entire MEP arrangement.
We anticipate the IRS and DOL will enact interim guidance related to MEPs and pooled employer plans before these new provisions become effective in 2021.
- Consolidated Form 5500. The SECURE Act directs the IRS and DOL to establish a consolidated Form 5500 filing for similar tax-qualified defined contribution plans no later than January 1, 2022. Specifically, if the plans have the same trustee, named fiduciary, administrator, plan year, and investment options, the plans need file only one consolidated Form 5500.
- Credit Card Loans Prohibited. Effective immediately, retirement plan loans enabled through a credit card, debit card, or similar program will be treated as plan distributions and subject to taxation. This provision is designed to prevent easy access to retirement funds for routine or small purchases.
- Graduate Student IRA Contributions. Contributions to retirement accounts generally cannot exceed the amount of an individual’s annual compensation. Under prior law, stipends, non-tuition fellowships, and similar payments to graduate and post-doctoral students were not treated as compensation for contribution purposes. But effective January 1, 2020, such payments are treated as earned income, allowing graduate and post-doctoral students to make contributions to an IRA based on such compensation.
- Age Restriction on IRA Contributions Eliminated. Beginning January 1, 2020, the SECURE Act repeals the age limit for making contributions to a traditional IRA. Taxpayers who have attained age 70½ and older may now continue making contributions to a traditional IRA.
We anticipate that the IRS and DOL will publish guidance and directives on these new laws in the coming weeks.