SECURE 2.0 has made a significant impact on retirement plan policy. It includes both mandatory changes and optional ones. Mandatory changes affect day-to-day plan administration, so getting up to speed is essential.
One crucial change allows participants to treat employer matching and non-elective contributions as after-tax contributions. This change is effective for taxable years beginning after December 29, 2022.
Defined Contribution Plans
The SECURE Act changes some rules governing defined contribution plans, especially 401(k) and 403(b) plans. One change is eliminating a government that prohibits employer-sponsored retirement plans from offering de minimis financial incentives (not paid for with plan assets) to encourage participation. This provision will take effect for plan years starting after the date of enactment.
Another change allows employees to make catch-up contributions on a pre-tax basis. The maximum catch-up contribution limit is currently limited to up to a hundred dollars of wages, indexed for inflation.
A third change is to allow employers to provide “savers match” contributions of up to 4% of a participant’s income to their retirement account. Previously, this was only permitted under certain circumstances.
Finally, SECURE 2.0 expands a temporary relief program, allowing participants to withdraw from their retirement plans for specified emergency expenses. This expansion is effective for distributions made after January 26, 2021. It also provides that plan administrators may rely on the employee’s self-certification that the expense is necessary to meet a genuine emergency to determine whether the distribution is an eligible hardship withdrawal.
In addition, Secure Act 2.0 shortens the requirements for long-term part-time workers to participate in a 401(k) plan from three years to two and extends this change to ERISA-covered 403(b) plans. This is a significant improvement for many lower-income individuals.
Qualified 401(k) Plans
401(k) plans are among the most effective tools for increasing employee retirement savings rates. In addition, research demonstrates that it is much easier for employees to save regularly when it is automatically deducted from their paychecks. Unfortunately, only about half of eligible workers participate in their employer’s plan despite these benefits.
The SECURE Act makes it easier for employers to adopt automatic enrollment and auto-escalation in their 401(k) and other qualified retirement plans. It requires that new plan sponsors establish a default contribution level of 3 percent of pay and increase the amount annually by one percentage point, up to 15 percent of revenue. This is an essential step in closing the retirement savings gap, but will not close it alone.
SECURE 2.0 also increases the permitted forced cash-out amount. This allows participants to withdraw a portion of their vested balance in case of a change in employment or to address emergency expenses. It also changes the rules regarding top-heavy testing, allowing plan sponsors to treat the same classes of employees differently for purposes of the test, and expands eligibility for long-term, part-time employees.
Employers with more complex needs can also use SECURE 2.0 to streamline their retirement offerings by partnering with a service provider to offer a pooled or multiple-employer plan (MEP or PEP). These are pre-established multiemployer pension plans that share services and costs. They provide a more streamlined administrative and fiduciary oversight.
Qualified IRA Plans
Over the past 15 years, Congress has sought to increase employee retirement plan participation by requiring automatic enrollment and auto-escalation features. This explains how these features work and how they can benefit your employees’ financial futures.
Automatic enrollment is a feature that automatically puts newly eligible employees on a path to meaningful savings in a company’s retirement plan. Credible studies show that this helps many workers establish a habit of saving and boosts savings rates for those who remain in the program.
An alternative to employer-sponsored defined contribution plans is the individual retirement account, known as an IRA. The primary types of IRAs are the traditional IRA and the Roth IRA. These accounts allow owners to defer income taxes on earnings, and distributions at retirement are tax-free. Until recently, employers could not provide de minimis financial incentives to encourage plan participation in an IRA-based plan (a “SEP” or “simplified employee pension”) because doing so raised prohibited transaction issues under the Internal Revenue Code and Employee Retirement Income Security Act of 1974 (“ERISA”).
The SECURE Act requires most new 401(k) and 403(b) plans to include automatic enrollment and an automatic escalator feature, effective for plan years beginning after December 29, 2022. Exceptions apply to small plans with ten or fewer employees, new businesses under three years old, churches, and governmental projects.
Employer Matching Contributions
Many plan sponsors now automatically enroll new employees in their retirement plans. Some take it a step further and use auto-escalation. This feature increases employee contribution rates yearly until they reach a certain level, such as 10% salary. It can be a powerful tool to get people on the right track toward their long-term savings goals.
However, there are some risks associated with this approach. One concern is that it can increase company matching costs since a significant percentage of lower-paid workers are added to the plan. This could strain the firm’s finances. In some cases, automatic enrollment has increased savings rates to a point where the employer match is no longer feasible. This can cause people to stop deferring or, worse, to opt out of the plan entirely.
Another issue with automatic escalation is that it can be seen as overly paternalistic and may interfere with employees’ short-term financial plans. This can lead to many complaints from participants, mainly from low-paid workers. One way to avoid this problem is to start with a higher floor, such as 6%, and then increase the rate annually by 1% until the participant hits their target saving rate of 10%.
