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SECURE Act Alters 401(k) Compliance Landscape

The new law changes retirement plan design, administration and compliance requirements

January 20, 2020 | Stephen Miller, CEBS

A golden egg sits on top of a stack of money.

Update: IRS Issues SECURE Act Guidance

IRS Notice 2020-68, released Sept. 2, 2020, answers questions about how employers should implement key provisions of the Setting Every Community Up for Retirement Enhancement (SECURE) Act. See the SHRM Online article IRS Guidance Clarifies Employers' SECURE Act Obligations.

President Donald Trump on Dec. 20, 2019, signed into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act, a bill to help employers create and run retirement plans for workers. The Society for Human Resource Management (SHRM) strongly backed the measure, which the House first passed in May and the Senate approved on Dec. 19 as part of a year-end appropriations package.

"This legislation will help hard-working Americans prepare for a financially secure future by incentivizing small businesses to set up employer-sponsored retirement plans," said SHRM Chief of Staff Emily M. Dickens, who oversees SHRM Government Affairs. "There is no better way to prepare Americans for retirement than supporting and strengthening employer-sponsored plans."

SHRM joined the employer community in advocating for the past year in support of the SECURE Act.

"The SECURE Act contains the most significant legislative enhancements to the private-sector retirement system in over a decade and will improve the retirement readiness of millions of Americans," said Phil Waldeck, CEO of workplace solutions group at Prudential Financial, which administers retirement plans."

"To a large extent, the SECURE Act is a hodgepodge of a lot of little retirement policy initiatives that have been on the minds of policymakers for the last several years," said John Lowell, an Atlanta-based actuary and advisor with October Three Consulting. These changes could, in time, greatly alter how employers provide retirement savings plans, benefits advisors said.

In the meantime, plan sponsors need to understand and respond to the SECURE Act's many changes to the compliance landscape, and in particular to those changes that take effect immediately or at the beginning of 2020. Effective dates for major provisions are listed in the box at the end of this article.

(For coverage of other SHRM-backed employment-law changes in the year-end spending package—including full repeal of the "Cadillac tax" and extensions of E-Verify and the Work Opportunity Tax Credit—read "Congress Passes SHRM-Backed Measures That Include Cadillac Tax Repeal.")

Small-Business Incentives

Among the provisions to encourage employers to become plan sponsors, the SECURE Act will:

Increase the business tax credit for plan startup costs to make setting up retirement plans more affordable for small businesses. The tax credit will increase from the current cap of $500 to up to $5,000 in certain circumstances.

Encourage small-business owners to adopt automatic enrollment by providing a further $500 tax credit for three years for plans that add auto-enrollment of new hires.

Simplify rules and notice requirements related to qualified nonelective contributions in safe harbor 401(k) plans.

Extend the period of time for companies to adopt new plans beyond the end of the year to the due date for filing the company tax return, giving employers additional time to cover their employees with a profit-sharing contribution.

Offer a consolidated Form 5500 for certain defined-contribution plans with a common plan administrator to reduce administrative costs, but also increase penalties for failure to file retirement plan returns such as Forms 5500, required notifications of changes and required withholding notices.

Multiple-Employer Plans

The SECURE Act allows unrelated small employers to band together in "open" 401(k) multiple-employer plans (MEPs)—also referred to as pooled employer plans (PEPs)—reducing the costs and administrative duties that each employer would otherwise bear alone. Currently, only "closed" MEPs are allowed; participating employers must share common organizational relationships, such as being in the same industry or members of an established trade association.

In July, the Department of Labor (DOL) issued a final rule that would allow open MEPs, in the form of association retirement plans, to be offered by existing organizations such as local chambers of commerce or associations formed to administer the MEP. The SECURE Act goes further and will allow open MEPs to be administered by what the legislation calls a pooled plan provider, such as a financial services company.

"A PEP has a single plan document, a single Form 5500 filing and a single independent plan audit," noted Craig P. Hoffman, an attorney with law firm Trucker Huss who focuses on Employee Retirement Income Security Act (ERISA) matters. A pooled plan provider, whether a financial services firm, insurance company, third-party administrator or similar entity, "must serve as the ERISA section 3(16) plan administrator, as well as the named fiduciary for the plan."

The act insulates companies in MEPs from penalties if other members violate fiduciary rules—for example, by failing to funnel employee contributions to the plan on schedule. The so-called "one bad apple" liability risk that a negligent member can pose to an entire plan has been a major stumbling block for MEPs and was also addressed in a DOL proposed rule issued in July.

"We're not trying to create a different type of savings vehicle. We're trying to develop a way to efficiently and cost-effectively give small employers access to the same type of plans that large and midsize employers have," said Bob Holcomb, vice president for legislative and regulatory affairs at retirement plan services firm Empower Retirement.

Some, however, don't favor the use of MEPs. "In truth, index funds and technology have made high-quality 401(k) investments and administration services accessible to employers of any size for very low fees," wrote Eric Droblyen, president and CEO of Employee Fiduciary, a provider of 401(k) services for small businesses. "These highly efficient 401(k) plans can cost much less than a MEP."

While MEPs could be "a game-changer for small businesses," said Allison Brecher, general counsel at Vestwell, a retirement-plan digital-platform firm, "business owners should be aware of certain restrictions including standardized investment options, and requirements such as fiduciary oversight of service providers, they might not be prepared to handle." However, "there are opportunities for MEP-like experiences, and this is a great way to open up the door for those conversations," she said.

Robert Toth, principal at retirement plan legal services firm Toth Law and Toth Consulting, noted a SECURE Act provision that offers an alternative to joining a MEP for small plans seeking the advantages of scale, by permitting a combined Form 5500 annual report for a group of plans filed by a common plan administrator, with a single audit report by an accountant selected by the plan administrator.

[SHRM members-only toolkit: Designing and Administering Defined-Contribution Retirement Plans]

Raised Default Savings Cap

To promote additional savings, the SECURE Act allows automatic-enrollment safe harbor plans to increase the cap on raising payroll contributions from 10 percent to 15 percent of an employee's paycheck, while giving employees an opportunity to opt out of the increase. The step up is usually made annually either at the beginning of the year or when annual raises are given out.

A 10 percent cap may "sound like it's going to be sufficient when you're bringing employees in at a very young age," said Jack VanDerhei, director of research at the nonprofit Employee Benefit Research Institute. However, "when you've got midcareer hires who unfortunately may not have had any coverage previously, or who may have cashed out those amounts, then having the ability to get those people escalated up to 15 percent is going to be extremely important" to their retirement security.

Lowell called this change one of the most significant reforms in the bill, although, he said, "I wonder how many eligible employees would opt out" of an automatic deferral increase above 10 percent of their pay.

Delayed Required Distributions

The SECURE Act allows retirees to delay taking required minimum distributions (RMDs) until age 72, up from the current age of 70 1/2, for participants in 401(k) and other defined-contribution plans, defined-benefit pension plans, and for individual retirement account (IRA) holders. RMDs are the minimum amount participants must withdraw from their retirement accounts each year, set by actuarial tables.

This change "is geared toward the perception that Americans are working longer and living longer," Lowell said, and will need to make their savings last throughout their retirement years.

"A theoretical $500,000 portfolio, earning 5 percent annually, would have $33,500 more at age 89 if the RMDs started at age 72," CNBC reported.

The change applies only to distributions made after Dec. 31, 2019, for people who reach age 70 1/2 from Jan. 1, 2020, onward.

"One of the most common failures for qualified plans is the failure to timely make minimum required distributions," according to law firm Hunton Andrews Kurth. "The delay in having to start minimum required distributions may help compliance with this rule."

In a related development, the IRS proposed changes to the RMD rules in November 2019, updating the life expectancy tables used in calculating required distributions. The new tables were developed based on projected mortality rates for 2021 and, if finalized, they would reflect longer life expectancy assumptions and, consequently, reduce required distribution amounts.

Part-Time Employee Participation

The SECURE Act requires employers to include long-term part-time workers as participants in 401(k) plans except in the case of collectively bargained plans. Eligible employees will have completed at least 500 hours of service each year for three consecutive years and are age 21 or older. However, these participants can be excluded from safe harbor contributions, nondiscrimination and top-heavy requirements. Previously, part-time workers could be excluded if they haven't worked 1,000 hours in a 12-month eligibility period.

"I can't help but wonder if employers will decide that it will be easier to just allow any employee who works 500 hours in a 12-month period to make elective contributions to their plan on the next entry date," wrote Annemarie Keehn, a consultant at Retirement Management Services in Louisville, Ky. "Yes, this would allow more workers into the plan than what is required under the new rule (which would require the worker to be there for three years before being eligible) but from a tracking standpoint, this would be simpler."

The new 500 hour, long-service provision apparently does not apply to 403(b) plans.

In-Plan Annuities

In-plan annuities can give participants lifetime income during retirement, but employers "are concerned about being sued for breach of fiduciary duties if the annuity provider they select faces problems years from now, and about what their responsibilities would be for ongoing monitoring and oversight of that provider," said Dominic DeMatties, a partner with law firm Alston & Bird's employee benefits and executive compensation team in Washington, D.C.

To address the 401(k) plan "annuity conundrum," the SECURE Act creates a safe harbor that employers can use when choosing a group annuity to include as an investment within a defined-contribution plan, with new provider-selection rules. For instance, the legislation will protect employers from liability if they select an annuity provider that, among other requirements, for the preceding seven years has:

Been licensed by the state insurance commissioner to offer guaranteed retirement income contracts.

Filed audited financial statements in accordance with state laws.

Maintained reserves that satisfy all the statutory requirements of all states where the annuity provider does business.

The SECURE Act also increases the portability of annuity investments by letting employees who take another job or retire move their annuity to another 401(k) plan or to an IRA without surrender charges and fees.

Easing the way for in-plan annuities "will enhance retirement readiness and retirement security for all Americans," said Bob Melia, executive director of the Institutional Retirement Income Council, an annuities industry think tank.

"401(k) plans have proven to be effective vehicles for the accumulation of retirement benefits," said Fred Reish, an employee benefits partner at law firm Drinker Biddle. "However, as the Baby Boomers retire, they face the daunting task of making that money last for 20 or 30 years, or more, in retirement. The SECURE Act authorizes a solution for companies to include in their plans insured guaranteed lifetime income."

Some are critical of using annuities in defined-contribution plans, pointing to their complexity and high fees. "There will come a time where we will point back to this as the start of a trend toward high-cost annuities being offered in 401(k) plans to the detriment of retirement savers," Barbara Roper, director of investor protection at the Consumer Federation of America, told the New York Times earlier this year.

SHRM's 2019 Employee Benefits survey of 2,763 HR specialists found that only 7 percent of respondents said their organizations offered lifetime income solutions, such as in-plan annuities or help for retirees to purchase an out-of-plan annuity with in-plan assets.

Annual Disclosure of Projected Income

The SECURE Act will require plan sponsors to annually disclose on 401(k) statements an estimate of the monthly payments participants would receive if their total account balance were used to purchase an annuity for the participant and the participant's surviving spouse. The DOL will devise assumptions 401(k) plans can use to estimate the monthly income workers’ 401(k) balances are likely to generate over their lifetime, and the disclosure must be made on workers’ 401(k) statements a year after regulators finalize those assumptions. The Secretary of Labor is also directed to develop a model disclosure.

"While the devil will be in the details of what DOL requires in such disclosures, they will likely be telling participants the amount of lifetime income that they could achieve in a somewhat fictitious, perfect world," Lowell said.

Limit on 'Stretch' Plans

The SECURE Act imposes a 10-year distribution limit for most nonspouse beneficiaries to spend down inherited IRAs and defined-contribution plans. Before passage of the act, withdrawals from inherited accounts could be stretched over the life of beneficiaries to mitigate taxes.

This provision, which is intended to generate tax revenue and offset the cost of the act's tax credits, "will have a significant impact on the tax and estate planning of plan participants and beneficiaries," according to Fred Farkash and Laurie DuChateau, consultants with HR Advisory firm Buck. Noted Keith Durkin, a partner at law firm BakerHostetler in Orlando, Fla., the new law substantially changes the income tax deferral most clients expected in their estate plans."

However, 401(k)s and IRAs "were not designed to be large intergenerational tax-avoidance vehicles," Aron Szapiro, the director of policy research at investor website Morningstar, told The Washington Post.

Disaster Relief

Plans may offer qualified disaster distributions to participants who lived in a presidentially declared disaster area. The distribution would be subject to a lifetime cap of $100,000 per disaster across all plans in the plan sponsor's controlled group. Qualified disaster distributions are exempt from the 10 percent penalty for distributions taken before age 59 1/2, and participants receiving qualified disaster distributions are permitted to spread taxes on the distribution over three years. Participants can also repay all or a portion of their disaster distribution to the plan that issued it within three years, or can roll it over to another eligible retirement plan, such as an IRA.

These provisions are in addition to the new safe harbor for disaster-related plan withdrawals created by an IRS final rule issued in September 2019.

Penalty Increases

Both the IRS and DOL impose penalties on qualified plans that file late or materially incomplete returns, explained Alexander Mattingly, an attorney with law firm Graydon in Washington, D.C. "The SECURE Act has given the IRS more teeth by increasing the maximum permitted penalties tenfold," he noted.

IRS penalties have increased for forms and notices due after 2019 as follows:

Failing to timely file Form 5500 can be assessed up to $250 per day, not to exceed $150,000 per plan year. Before the SECURE Act, the penalty was $25 a day, not to exceed $15,000.

Failing to file Form 8955-SSA can be assessed up to a daily penalty of $10 per participant, not to exceed $50,000, up from a daily penalty of $1 per participant, not to exceed $5,000.

Failing to provide income tax withholding notices can be assessed up to $100 for each failure, not to exceed $50,000 for the calendar year, up from $10 for each failure, not to exceed $5,000.

A separate, annually adjusted DOL penalty of up to $2,194 per day for late filing of Form 5500 (for plan year 2019) was not changed by the SECURE Act.

Other Defined-Contribution Plan Changes

The SECURE Act will also:

Expands 529 education savings plans to include student loan repayments and the costs of apprenticeship programs under the definition of qualified higher education expenses. Student loan interest paid for with tax-free 529 plan earnings is not eligible for the student loan interest deduction.

Prohibit the distribution of plan loans through savings plan credit cards so that funds are not easily available for routine or small purchases.

Permit employers to add a safe harbor feature to their existing 401(k) plans once the year has started if they contribute at least 4 percent of employees' pay instead of the regular 3 percent. This flexibility will help employers to correct failed ADP/ACP or top-heavy tests by shifting to a safe harbor plan and making a 4 percent nonelective contribution to participants.

Convert custodial accounts from terminated 403(b) plans into IRAs.

Eliminate the age limit for traditional IRA contributions. Those who are still working can continue to contribute to a traditional IRA, regardless of their age, instead of eligibility to contribute ending at age 70 1/2.

Allow exception to the 10 percent penalty for birth or adoption. New parents can now withdraw up to $5,000 from a retirement account within a year of a child’s birth or adoption without the 10 percent penalty those younger than 59 1/2 would normally owe. The distribution, which is still subject to tax, can be repaid to a retirement account.

Relief for Frozen Pension Plans

The SECURE Act addresses long-standing issues affecting pension plans that are frozen to exclude new hires.

As part of the transition from defined-benefit pensions to 401(k)-type defined-contribution plans, "many employers have closed their traditional defined-benefit plans to new employees but continue to allow existing employees to accrue benefits under the plan," DeMatties said. "Over time, the group of employees that continues to accrue benefits under the traditional defined-benefit plan generally becomes older and higher paid, which frequently can result in difficulty satisfying the tax code's nondiscrimination requirements" that prohibit retirement plans from favoring high-income employees.

If certain conditions are met, the SECURE Act modifies these nondiscrimination rules to permit older, longer-service and generally higher-paid employees to continue to accrue benefits under a defined-benefit plan, even though younger, shorter-service and generally lower-paid employees do not accrue these benefits.

Plan Amendments

The law provides for an extended remedial amendment period, which means that although plans must comply with SECURE Act provisions by the effective dates specified in the law (see the box below), "plan documents can be updated to incorporate the required plan provisions by a later date—the last day of the first plan year beginning on or after Jan. 1, 2022, unless the Secretary of Treasury provides an extension," wrote Farkash and DuChateau.

For governmental plans and collectively bargained plans, the deadline will be no later than Jan. 1, 2024.

A separate amendment deadline applies to the disaster relief provisions, which must be adopted no later than the last day of the plan year beginning on or after Jan. 1, 2020, or two years later in the case of a governmental plan.

"We expect that as the regulatory agencies digest the law, they will be issuing guidance to help plans comply with the numerous changes," Farkash and DuChateau noted.

Effective Dates Vary by Provision

The effective dates for SECURE Act changes vary by tax, calendar and plan years, according to Toth Law and Toth Consulting, with some modifications taking effect in 2020, such as the increase in age for mandatory plan distributions, or in 2021, such as the MEP provisions. Effective dates for major SECURE Act provisions are listed below.

Enactment of the SECURE Act:

Plans prohibited from making loans through credit cards and similar arrangements.
Fiduciary safe harbor for selection of lifetime income provider.
Modification of defined-benefit plan nondiscrimination rules to protect longer-service participants.
Expansion of qualified education expenses that can be paid through 529 plans, effective for distributions made after Dec. 31, 2018.

Plan years beginning after Dec. 31, 2019:

Safe harbor plans using automatic escalation can raise their cap after the first year of participation from 10 percent to 15 percent of compensation.
Safe harbor notices are eliminated for plans using the nonelective contribution option, and employers can wait until 30 days before the end of the plan year to adopt the 3 percent nonelective safe harbor.
Employers can choose to add the nonelective safe harbor with an amendment by the end of the following year, but the amendment would need to provide 4 percent rather than 3 percent of compensation.
In-service distributions from defined-benefit plans and government 457(b) plans can be taken as early as age 59 1/2 rather than starting at age 62.

Tax years beginning after Dec. 31, 2019:

Increase in credit limit for small employer plan startup costs.
Small employer automatic enrollment credit.
Repeal of maximum age for traditional IRA contributions.
Portability of lifetime income options.
Penalty-free withdrawals from retirement plans for individuals following birth of a child or adoption.
The age for requiring participants to begin taking mandatory distributions rises to 72 from 70 1/2.

Calendar years beginning after Dec. 31, 2019:

Increased penalties for failure to file Form 5500 retirement plan returns (applies to returns and notice due dates after this date).
Limits on stretch payments to beneficiaries, effective for deaths after 2019.

Plan years beginning after Dec. 31, 2020:

MEP provisions.
Non-bargained 401(k) plans can no longer exclude long-term part-time employees from participating if they work at least 500 hours in each of three consecutive years. Service before 2021 will not be counted.

Plan years beginning after Dec. 31, 2021: