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  • Secure 2.0 Brings Big Changes to Retirement Plans

    Congress recently passed the SECURE 2.0 Act of 2022. Building on the Setting Every Community Up for Retirement Enhancement Act of 2019, SECURE 2.0 attempts to expand retirement plan coverage and increase retirement savings opportunities for United States workers. In this episode of Pensions, Benefits & Investments Briefings, Michelle McCarthy and Ashley Dunning discuss the key provisions of SECURE 2.0 most likely to impact 401(k) and 403(b) plans sponsored by large private-sector employers and also touch upon a few of the provisions that will impact 401(a) plans administered by governmental retirement systems.

    Transcript: Secure 2.0 Brings Big Changes to Retirement Plans

    0:00:00.0 Ashley Dunning: Setting Every Community Up for Retirement Enhancement Act of 2019, or the SECURE Act, was enacted on December 20th, 2019, as part of the Further Consolidated Appropriations Act of 2020. It was the first significant piece of federal retirement plan legislation to be enacted in more than a decade. Congress enacted the second on December 29th, 2022, the SECURE Act 2.0. In this episode of Pensions, Benefits & Investments Briefings, we summarize the key provisions of SECURE 2.0, most likely to impact 401(k) and 403(b) plans sponsored by large private sector and nonprofit employers. We'll also touch on a few of the provisions that will impact 401(a) plans administered by governmental retirement systems.

    0:01:03.8 Intro: Welcome to Pensions, Benefits & Investments Briefings, Nossaman's podcast exploring the legal issues impacting governmental, private and nonprofit pension systems and their boards.

    0:01:25.5 AD: Welcome to another episode of Nossaman's Pensions, Benefits & Investments Briefings. I'm Ashley Dunning, co-chair of Nossaman's Pensions, Benefits & Investments group and I'm joined today by Michelle McCarthy, our newest Pensions, Benefits & Investments partner. Welcome to the firm and to this podcast, Michelle.

    0:01:43.7 Michelle McCarthy: Thanks, Ashley. I'm excited to be here at Nossaman and on the podcast. Before I begin, I just note that SECURE 2.0 has more than 90 retirement plan provisions. We won't be able to touch on all of them in today's podcast, but I'm going to touch on the ones that I think are the most relevant.

    0:02:01.9 AD: As we start out, though, sort of big picture, I understand that many of these changes are mandatory while others are optional. Is that right?

    0:02:11.1 MM: That's exactly right. Further complicating matters, a number of these changes take effect over multiple years and have different effective dates for each provision. It's complicated. Also, the DOL and the IRS haven't issued guidance on these. They haven't had an opportunity to issue that guidance, so we're awaiting a lot of that. That should be coming down the pipe, but I'll note that when I go over each of the provisions individually. The first notable change that I'll talk about is the automatic plan enrollment and escalation rule, which applies to new 401(k) and 403(b) plans. Note that it applies to new 401(k) and 403(b) plans. That's 401(k) and 403(b) plans that are established after SECURE 2.0 went into effect. Under this new rule, plans must automatically enroll eligible employees in the plan, starting at a deferral rate of at least 3% and no more than 10%. And new plans must also automatically increase the employee's deferral percentage annually until it reaches a maximum percentage, which percentage is going to vary depending on the type of plan.

    0:03:15.6 MM: Employees will have the ability to opt out of automatic enrollment. This only applies to new plans. It would only apply to plans that are established after SECURE 2.0 was enacted and plans have until January 1, 2025 to gear up for this change.

    0:03:36.8 AD: That seems like a pretty big change to have an automatic enrollment provision and I'm sure those in the audience who administer these plans are trying to work through the nuances of it and the applicable dates, as you noted. Would this rule apply, though, in the event of, say, a spinoff, where, for example, a new plan is created by spinning that plan off from a currently existing plan?

    0:04:01.3 MM: That's a really good question. Where an employer spins off a plan from an existing plan and creates a new plan and transfers plan assets from the old plan to the new plan, I don't know the answer to that question. I think that we're going to just have to wait for guidance on that, but that's a good question, Ashley.

    0:04:17.8 AD: Fair enough. This is all very new. I understand that SECURE 2.0 addresses a part-time employee coverage. Could you tell us about that, please?

    0:04:28.8 MM: Yes. Currently, part-time employees can be excluded from a 401(k) or 403(b) plan. The original SECURE Act required 401(k) plans to permit part-time employees the option to make elective deferrals to the plan if they had attained age 21 and worked at least 500 hours of service in the last three consecutive years, but that change never went into effect. The IRS delayed the effective date, most likely due to the pending SECURE 2.0 legislation, I'm guessing, which reduces the three consecutive year requirement to two consecutive years and extends the requirement to ERISA covered 403(b) plans. Under this new rule, part-time employees that obtained age 21 and have worked at least 500 hours in the last two consecutive years have to be eligible to participate in the plan. One thing I would just note is that employers are not required to provide employer matching on non-elective contributions on behalf of part-time employees that become eligible under this new rule.

    0:05:32.6 AD: Is that 500 hours total in two years or each year 500 hours?

    0:05:35.5 MM: That's 500 hours cumulative, so total.

    0:05:39.1 AD: That still seems like a somewhat cumbersome administrative requirement to have to track a part-time employee's hours. Do you have a sense of whether, in that context, it would make sense for employers that currently exclude part-time employees simply to allow all employees to participate that way, they could avoid the administration required to keep track of the employee's hours during any two-year period.

    0:06:04.9 MM: That's a good point. It certainly is a cumbersome administrative requirement to keep track of, but the one thing I would just note is that if a part-time employee becomes eligible under the new rule, the employer is not required to provide employer matching, whereas if part-time employee becomes eligible to participate by virtue of the normal course, then the employer would need to pay matching contributions on the amount that the part-time employee elects to defer. So I guess employers are just going to have to weigh whether it's worth the administrative burden of keeping track of the hours over a two-year period.

    0:06:41.5 AD: Interesting changes. One other aspect of SECURE 2.0 I've heard about is it permits plan sponsors and administrators to offer small financial incentives to encourage plan participation. Could you tell us a bit about that change?

    0:06:57.8 MM: Before SECURE 2.0, employers could only offer matching contributions to incentivize employees to participate in their retirement plans, but now employers can offer the small de minimis financial incentive to get employees to participate, perhaps like a $10 gift card. The point is to keep it small and employers probably want to be conservative because de minimis is not defined anywhere and in other contexts, the IRS has issued guidance which says that anything over $100 could never be considered de minimis. So I don't know if this means that if an employer could give a gift card for $99, I think employers are going to want to try to be conservative about that, at least until the guidance is issued.

    0:07:42.0 AD: Michelle, I understand that SECURE 2.0 also permits employer matching contributions to cover student loan repayments. Is that right?

    0:07:53.1 MM: So that's correct, Ashley. Beginning for plan years starting January 1, 2024, sponsors of 401(k) and 403(b) plans are permitted to provide employer matching contributions based on the employee's qualified student loan repayments that are made outside of the plan. So this is a great benefit for employers and a lot of employers will be interested in this because employees that are making student loan repayments maybe aren't able to make deferrals under the 401(k) like other employees might be financially able to do.

    0:08:23.7 MM: Qualified student loan repayments include the repayment of qualified education loan amounts that are incurred by an employee to pay qualified higher education expenses. And one thing that plan sponsors might be excited about too, is that now under this new rule, an employee can self-certify that the payments have been made on such loans and that such loans constitute qualified higher education expenses. So it becomes a lot easier for the employers to administer this benefit.

    0:08:51.8 AD: That does seem like a really great benefit, Michelle. I mean, it seems like there'd be real value both to the companies as you note and to their employees to adopt this benefit.

    0:09:02.3 MM: Absolutely. I agree. I think that there will be a lot of interest from C-suite to offer this and show that the company cares about employees and is a forward-thinking place of employment. It's really something that companies should discuss with their advisors and think about speaking with vendors about to ensure that they can have this up and running for 2024 assuming that they want to do that.

    0:09:25.3 AD: So on these matching contributions on student loans, may those be at a different rate than for the matching contributions for elective deferrals?

    0:09:34.5 MM: The one thing that the legislation is clear about is that it has to be at the same rate both on the matching and on the student loan repayments. The two must mirror one another.

    0:09:45.1 AD: Good to know. On a different topic, the catch-up contribution issue is getting a lot of attention. Could you explain those changes that are in 2.0?

    0:09:56.1 MM: So catch-up contribution limit for 2023 is 7,500. That's the current catch-up contribution limit. The increased limit for participants who attain ages 60 through 63 during the year is going to be the greater of $10,000 index for inflation or 50% more than the regular catch-up limit. This is a required change if the plan offers catch-up contributions at all. So it's going to raise the limit to $11,250 for 2025.

    0:10:28.5 AD: That's going to be important for, again, for the employees and the employers to keep track of. Tell us a little bit about the change in Roth contributions.

    0:10:38.5 MM: Another change is the expansion of Roth contributions. So effective 1/2024, if an employee has wages in excess of $145,000 in the prior plan year then all catch-up contributions that are made to a 401(k) or a 403(b) plan by that employee are going to be subject to Roth contribution tax treatment. Catch-up contributions made by an employee with wages under the $145,000 index limit can continue to be treated as pretax contributions unless the employee affirmatively elects to have it treated like a Roth contribution. But for other employees, the change is going to be mandatory. So if they have over $145,000 in wages in the prior plan year, then their catch-up contributions will be treated like a Roth contribution.

    0:11:25.9 AD: Would this force the plan sponsors to offer a catch-up to implement a Roth contribution feature?

    0:11:31.9 MM: Yes, that is a really good point. This is going to force plan sponsors that offer catch-ups to implement Roth because to the extent that they have any employees that make more than $145,000 in the prior plan year, then they're going to have to implement a Roth feature. Another facet of the Roth contribution changes that is effective immediately is that SECURE 2.0 allows plan sponsors to provide participants with the option to receive matching contributions or non-elective contributions on a Roth basis, so on an after-tax basis. And this is an optional change and it applies only to matching contributions and non-elective contributions that are fully vested when contributed to the plan.

    0:12:13.6 AD: Lots of information to digest. On another topic that I understand is in SECURE 2.0, could you tell us about the new emergency savings option?

    0:12:23.9 MM: Sure. So SECURE 2.0 also adds an emergency savings option to be set within a 401(k) or 403(b) plan. Employees can be automatically enrolled, but it's at no more than 3% of their salary. And the portion of an account attributable to the employee's contribution is capped at $2,500 or lower set by the employer and indexed for future years. Contributions are made on a Roth-like basis and are treated as elective deferrals for purposes of employer matching contributions. And they must be invested on an investment option designed to preserve principal and offer a reasonable rate of return. The first four withdrawals from that emergency savings account each plan year may not be subject to any fees or charges solely on the basis of the employee having made the withdrawal.

    0:13:11.2 MM: Basically, it's going to be pretty easy for employees to say, for example, their furnace goes out. They could easily just tell the employer that they need to make a withdrawal from their emergency savings account and it would be done. Another feature that I just note is that on termination, employees may take their emergency savings accounts as cash or they could roll it into a Roth defined contribution plan or an IRA. The last thing I just note about this is that the change is optional and it's effective for plan years beginning on or after January 1, 2023.

    0:13:44.3 AD: That's really interesting. Do you think that adding this provision will likely reduce the number of hardship withdrawals?

    0:13:51.4 MM: Absolutely. I think so. I mean, it's going to be so much easier for employees to make this withdrawal. It would definitely... The employees are going to tap into their emergency savings option before they tap into the hardship withdrawal provision. This is definitely something that employers might want to consider adding to their plans.

    0:14:12.1 AD: I'd like to shift gears and talk now about the required minimum distribution rules as impacted by SECURE 2.0. I understand that that's a new rule that's going to have even broader applicability to both the governmental plans as well as the ERISA plans that you've been talking about.

    0:14:29.9 MM: That's right, Ashley. These changes apply not only to the private and nonprofit plans governed by ERISA that I referenced in my earlier comments, but also governmental plans as you note. Prior to the original SECURE Act, the required minimum distribution age was 70 and a half. The original SECURE Act increased that age to 72 for people that were born on or after July 1, 1949. And then the SECURE 2.0 increases the RMD age to 73 for people who turn age 72 after 2022 and age 73 before 2033. For people who turn age 74 after 2032, the RMD age is now 75.

    0:15:15.3 MM: This is a mandatory change. It's going to impact both defined contribution and defined benefit plans. One caveat is that if you are a defined benefit plan and want to retain a younger forced out age, you can still do so. This avoids the actual increase that applies at 70 and a half. Also affected January 1, 2024, participants will not be required to take RMDs on Roth contributions that are held in their retirement plan. And this impacts both 401(k), 403(b) as well as governmental 457(b) plans. Also effective immediately, the penalty for failing to take an RMD is going to decrease from 50% of the amount of the missed RMD to 25% of that amount.

    0:16:00.7 AD: Well, that's a lot of changes to RMDs and I'm sure plan administrators are going to be considering how to effectively communicate this information to their employees and their members generally in these governmental plans. Another topic I understand SECURE 2.0 addresses is cash out limits. Could you tell us about those?

    0:16:22.1 MM: Sure. Under current law, 401(k) and 403(b) plans can automatically cash out participants and beneficiaries who have balances of $5,000 or less, provided the balance exceeding $1,000 and up to $5,000 must be rolled over to an IRA established in the participant's name. So SECURE 2.0 allows an optional change. This change goes into effect January 1, 2024, if employers elect it and it would increase the automatic cash out limit from $5,000 to $7,000. SECURE 2.0 also allows an automatic portability provider to automatically transfer a participant's balance from a default IRA established after an automatic cash out into a defined contribution retirement plan sponsored by the participant's new employer, unless of course the participant affirmatively elects otherwise. So this again is an optional change and we're expecting some DOL guidance on this provision shortly.

    0:17:16.0 AD: Let's talk about changes to the hardship rules. Those have changed under SECURE 2.0 as well, right?

    0:17:23.5 MM: That's correct. Beginning in 2023, employers may rely on a written representation from a participant confirming that a hardship request meets the plan's need and amount requirements. So before this, it was a lot more difficult for employers to ascertain whether the amount that the participant was requesting met the requirements of a hardship withdrawal. In order to constitute a hardship withdrawal, the employee must have an immediate and heavy financial need and the distribution must be limited to the amount, "necessary to satisfy" the financial need. This self-certification is permitted as long as the employer has no actual knowledge. To the contrary and the employer may also use one of two other methods if desired. They could use the traditional substantiation method. So that would be to obtain the actual source documents that substantiate the need for the distribution or the summary substantiation method, rely on a participant's provided summary of the financial hardship.

    0:18:26.7 AD: Michelle, is there any guidance as to what types of events would allow someone to establish that they have an immediate and heavy financial need under this rule?

    0:18:35.2 MM: So the seven events that establish immediate heavy financial need are for medical care, costs related to purchase of primary residence, tuition payments, payments necessary to avoid eviction, funeral expenses, expenses to repair the principal residence, or expenses resulting from a federally declared disaster.

    0:18:55.3 AD: Well, that's all very good to know and important for people who need those funds. I understand that SECURE 2.0 also modifies distribution rules applicable in the event of a federally declared disaster, is that right?

    0:19:09.6 MM: That's correct. Under the new rules, if a participant is impacted by a federally declared disaster, she can request a distribution of up to 22,000 from her retirement. This distribution is not subject to the 10% early distribution penalty tax and it can be taken into income over three years. And the participant has the ability to repay this distribution to the retirement plan in a later year. SECURE 2.0 also allows plan sponsors to increase the maximum loan amount that is available to a participant in the event of a federally declared disaster to $100,000 or 100% of the participant's account balance if that amount is less.

    0:19:50.1 MM: Plan sponsors can also extend the loan repayment period for such participants by one year. And these changes are effective immediately and they're optional. However, even if the plan sponsor does not implement these changes, a participant could still avoid the penalty tax by completing his or her tax return to indicate that it was used for hardship or a federally declared disaster.

    0:20:12.8 AD: Aren't there other exceptions to the distribution penalty, for example, with terminally ill individuals?

    0:20:19.1 MM: So that's correct. Under SECURE 2.0, there are some additional exceptions to the 10% early distribution penalty tax that would otherwise apply for distributions taken by terminally ill individuals, as you mentioned and then also in certain emergency circumstances and where a limited withdrawal is taken by a victim of domestic abuse. For the latter two, for the emergency expenses and the victims of domestic abuse, that change is not effective until January 1, 2024.

    0:20:50.4 AD: But the change for distributions taken by terminally ill individuals are effective immediately, right?

    0:20:56.2 MM: That's correct. The penalty tax exemptions apply for both defined contribution and defined benefit pension plans and the participants must have the ability to repay these distributions to the retirement plans too.

    0:21:10.9 AD: Michelle, what if a plan sponsor doesn't adopt these changes? Could a participant avoid the 10% penalty tax and take the amount into income over three years just simply by completing his or her tax return and indicating there that the distribution was due, for example, to a federally declared disaster?

    0:21:28.5 MM: So that's correct, Ashley. The participant could still avoid the changes. So even if a plan sponsor decides not to amend the plan to allow the early distribution, an employee could still avoid that 10% distribution penalty by just indicating on their tax return that the amount was used for one of these reasons.

    0:21:47.7 AD: Good. That's important to note. I understand that SECURE 2.0 has made some miscellaneous other changes for ERISA plans in particular relating to participant notice provisions. What are those changes?

    0:22:01.0 MM: So that's correct, Ashley. Under SECURE 2.0, defined contribution plans must provide one paper statement every year and defined benefit plans must provide one paper statement every three years. And this change is less burdensome than what was previously in effect. It's a mandatory change. It's effective December 31, 2025. These plans are no longer required to provide paper communications to people who have elected to receive electronic communications.

    0:22:29.7 AD: But again, this is applying to ERISA plans specifically, not governmental plans, correct?

    0:22:35.1 MM: That's correct. This is only applying to ERISA plans. Another change that is implemented under SECURE 2.0 is that the DOL is going to be creating a lost and found database that's going to reunite missing participants with their retirement funds. This database will cover both defined contribution and defined benefit plans and it will enable individuals who lost track of their 401(k) or 403(b) plan accounts to search their plan administrator's contact information and hopefully reunite the participant with their missing monies. The DOL has two years to create this database.

    0:23:10.8 AD: That's so interesting, Michelle. Is this database something that might help governmental plans as well who are looking for members?

    0:23:19.6 MM: I'm uncertain about that. I don't know whether the DOL would have access to the information enough to include governmental plans in the database, but I don't know exactly how the DOL is going to collect the information necessary to complete this database from other plans. So it will be interesting to see.

    0:23:40.6 AD: Great. All right. Michelle, along the lines of the other miscellaneous changes in SECURE 2.0, I understand that there also is a change in the IRS correction program. Could you tell us about that?

    0:23:58.1 MM: Sure. This is another change that I think plan administrators are going to be excited about. It's a change to the IRS correction program and the change currently, it's only directly applicable to plans governed by ERISA. However, they also may provide some comfort to administrators of governmental plans that the IRS is taking a broader view of permissible means by which the errors made in the administration of the plans may be corrected. Specifically, the Employee Plans Compliance Resolution System, or EPCRS, is expanded to allow more types of errors to be self-corrected and to cover IRA errors.

    0:24:33.9 MM: So plan fiduciaries are not required to recover inadvertent overpayments that are made to participants and beneficiaries, assuming the plan complies with the applicable tax limitations on benefits and the minimum funding rules. So if the plan fiduciary does not seek recovery of the overpayment, the participant may treat the overpayment as eligible for tax-free rollover. In addition, as the plan is governed by ERISA, the IRS is not prohibiting recovery of inadvertent overpayments from participants and beneficiaries for periods in excess of three years.

    0:25:04.8 AD: Well, that's really interesting. So basically inserting a statute of limitations concept into the collection of overpayments, is that right?

    0:25:12.5 MM: That's correct.

    0:25:14.2 AD: These changes under EPCRS, are those effective immediately?

    0:25:17.5 MM: Yes, that's correct. These changes have already taken effect, but the IRS hasn't updated the guidance yet and we anticipate that they'll do so within the next two years.

    0:25:28.9 AD: Michelle, the anticipated change in EPCRS is really interesting and important. Could you please share any thoughts you may have on how this change may or may not impact error corrections by governmental plans?

    0:25:41.5 MM: Sure. So regarding governmental plans, given that EPCRS is being revised to incorporate requirements of SECURE 2.0, we expect the IRS to approach the inadvertent overpayment topic with the same policy perspective as it has with private and nonprofit plans. That is, we expect the IRS to confirm publicly that plan fiduciaries may not be required to recover inadvertent overpayments made to participants and beneficiaries, but rather that any such losses to the retirement fund may be collected through additional contributions by the participating employer, which typically would be made through a direct payment or inclusion of payments towards the unfunded actuarial accrued liability of the fund. This approach has been permitted on a one-off basis from governmental plans previously, but it will be extremely useful to have that approach reflected in EPCRS itself.

    0:26:30.9 AD: That's true. That's a really interesting and helpful development. Finally, in this miscellaneous change category, I understand that there's a savers credit notion within the SECURE 2.0.

    0:26:44.4 MM: Yes. The savers credit under current law is going to be replaced with the retirement plan match. Under the revised program, qualifying low-income individuals who make contributions to their IRA or employer-sponsored retirement plan will receive a federally funded matching contribution to their IRA or retirement plan account of up to $2,000. And that change takes effect January 1, 2027.

    0:27:06.0 AD: Michelle, this is such helpful information you've provided to our audience on a topic that is of great interest to so many administrators of plans that are impacted by SECURE 2.0. I appreciate learning from you and I hope our audience did as well. Thank you for joining me today. And thank you to all of our listeners for joining us for this episode of Pensions, Benefits & Investments Briefings. For additional information on this topic and other pension issues, please do visit our website at Nossaman.com. Don't forget to subscribe to Pensions, Benefits & Investments Briefings wherever you listen to your podcasts so you don't miss an episode. Until next time.

    0:27:50.4 Speaker 2: Pensions, Benefits & Investments Briefings is presented by Nossaman LLP and cannot be copied or rebroadcast without consent. Content reflects the personal views and opinions of the participants. The information provided in this podcast is for informational purposes only. It is not intended as legal advice and does not create the attorney-client relationship. Listeners should not act solely upon this information without seeking professional legal counsel.


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