The Setting Every Community Up for Retirement Enhancement (Secure) Act was signed into law on December 20, 2019, with little fanfare. However, the Secure Act is a significant piece of retirement legislation that includes provisions designed to help businesses offer retirement plans for their employees and for individuals to save for their own retirement. It also severely restricted, for many potential beneficiaries, the valuable tax benefit of stretching distributions from inherited retirement accounts over many years.

Secure Act Provisions Affecting Employers

The numerous provisions of the act fall into two main categories: those affecting employers, and those affecting individuals. The authors outline the former below; the latter are discussed in the following section.

Lower Barriers for Offering Multiple Employer Plans

Many small- and medium-sized businesses are unable to offer their employees a retirement plan due to the high administrative costs and substantial compliance burdens associated with such plans. Under previous rules, employers that desired to join together to offer a single retirement plan—thereby lowering administrative costs and sharing a single plan administrator—had to share a “communality” or relationship that bound the employers together (i.e., operating in the same industry). These are known as multiple employer plans (MEP).

Section 101 of the Secure Act amends IRC section 413 by easing many of the restrictions related to MEPs. This facilitates the ability of unrelated employers to participate in pooled employer plans and share the costs of operating retirement plans for their employees. Significantly, the act also eliminates the “one bad apple” rule, which previously stipulated that all employers participating in an MEP could face adverse tax consequences if even one employer in the group failed to satisfy the tax qualification rules for the MEP. This rule will no longer apply once Secure Act section 101 takes effect in plan years beginning after December 31, 2020.

Another notable advantage to small employers is that, because section 101 requires only one IRS Form 5500 for the retirement plan as well as only one plan audit, the administrative costs and burdens associated with offering retirement plans are reduced. Under the pooled plan provider guidelines, only the plan provider is required to file a Form 5500 tax return. The act defines a pooled plan provider as the person who is designated by the terms of the pooled employer plan as a named fiduciary, as the plan administrator, and as the person responsible for the performance of all administrative duties under the plan (frequently an insurance company or other pension provider). Small businesses are defined in section 101 as plan sponsors.

Given that section 101 of the Secure Act does not take effect until plan years beginning after December 31, 2020, small businesses that do not currently offer retirement plans should explore the possibility of joining a pooled employer plan. Note that section 101 does not apply to defined-benefit, multi-employer plans that are frequently included as a benefit under union labor agreements.

401(k) Safe Harbor Changes

A safe harbor plan is one which includes an employer match that allows the employer to avoid most of the annual compliance tests associated with defined contribution plans. These safe harbor provisions are contained in Internal Revenue Code (IRC) sections 401(k)(11–12) and 401(m)(11). The three safe harbor provisions are generally referred to as 1) a non-elective safe harbor, 2) a basic safe harbor match, and 3) an enhanced safe harbor match. Under a non-elective safe harbor, eligible employees receive an annual employer contribution based on a percentage of their salary. The employee becomes fully vested in the contribution immediately and the employer contributes the amount regardless of whether the employee contributes to the plan. Under the basic safe harbor match, the employer matches 100% of the first 3% of an employee’s contribution and 50% of the next 2% of employee contributions; under the enhanced safe harbor match, the employer matches 100% of the first 4% of an employee’s contribution to the plan. (Note that employee participation in the plan is required under both the basic and enhanced safe harbor matches.)

Many employers include a provision in their 401(k) plans that automatically enroll new employees into the plan. For employees, automatic enrollment tends to raise participation rates and enhance retirement savings balances; for employers, it tends to help defined contribution plans avoid plan discrimination issues. Secure Act section 102 increases the second-year cap of an employee’s participation in the plan from 10% to 15%. This provision is effective for plan years beginning after December 31, 2019. (For a participant’s first year, the maximum deferral remains 10%.)

Generally, business retirement plans are subject to annual nondiscrimination testing, which is intended to ensure that highly compensated executives are not receiving excessive retirement benefits compared to other employees. If a business’s 401(k) plan fails nondiscrimination testing, it may face penalties, administrative paperwork, and a return of contributions to highly compensated executives. In addition, the Treasury Regulations require that an employer provide employees with a notice of their rights under the 401(k) plan at the beginning of a plan year and that the employer may not adopt a safe harbor provision during a plan year. These safe harbor requirements have been changed by section 103 of the Secure Act. The act eliminates the advance notice requirement for 401(k) plans that include non-elective contributions (contributions made by an employer that may be, but are not required to be, matched by the employee). Section 103 also allows an employer to amend a 401(k) plan in order to create a non-elective safe harbor plan, provided the amendment is made before the 30th day before the end of the plan year and becomes effective before the end of the next plan year. Section 103 also raises the non-elective safe harbor contribution from 3% to 4%.

Under the Secure Act, 401(k) plans are required to adopt rules to allow long-term, part-time workers to participate in qualified retirement plans.

Employer Tax Credits

Secure Act section 104 increases the tax credit limitation for small employer pension plan startup costs. Prior to the act, small employers could claim a tax credit equal to only 50% of eligible startup costs up to a maximum of $500. A small employer is defined as having 100 or fewer employees. The Secure Act increases the credit for plan startup costs for small employers to the greater of: (1) $500; or (2) the lesser of (a) $250 multiplied by the number of non–highly compensated employees of the eligible employer who are eligible to participate in the plan or (b) $5,000. The credit applies for up to three years.

Section 105 of the Act created the small employer automatic enrollment tax credit. This new tax credit offers up to $500 per year to employers to help cover startup costs for new section 401(k) plans and Simple IRA plans that include an automatic enrollment feature. This credit is in addition to the plan start-up credit under section 104 and is available for the first three plan years. The credit is also available to employers that convert an existing plan to one that includes an automatic-enrollment amendment. For purposes of this credit, a small employer is defined as an employer with 100 or fewer employees. These tax credits apply to plan years beginning after December 31, 2019.

For example, a small business employer that begins offering employees a qualifying pension plan can, potentially, receive a tax credit of $15,500 per year for the first three years of the plan. A small employer that adds an automatic enrollment amendment to an existing pension plan could receive a tax credit of $500 per year for the first three plan years after the automatic-enrollment amendment is added to the plan document.

Expanded Plan Eligibility for Part-time Employees

Under the Employee Retirement Income Security Act of 1974 (ERISA), employees generally must work at least 1,000 hours per year to be eligible to participate in their employers’ retirement plan. This provision applies to both full-time and part-time employees. Critics have charged that because women are more likely than men to work on a long-term, part-time basis, they were unfairly penalized by this requirement.

Under section 112 of the Secure Act, 401(k) plans are required to adopt rules to allow long-term, part-time workers to participate in qualified retirement plans. Specifically, if employees work at least 500 hours per year for three consecutive years, they must be allowed to participate in the employer’s 401(k) retirement plan. Employees must still meet normal age requirements (i.e., be at least 21 years of age) to participate. In addition, the Secure Act does not require employers to match an employee’s voluntary contributions to a 401(k) plan if the employee qualifies to participate in the plan solely under the new 500-hour rule. Employees must still meet the 1,000-hour rule to qualify for employer matching contributions. This change applies to plan years beginning after December 31, 2020; 12-month periods beginning before January 1, 2021, are not considered.

In light of the move toward more employees working remotely due to COVID-19, more individuals may be interested in part-time work—making the expanded participation availability an especially timely development. Offering participation in a 401(k) plan to part-time employees may encourage more people to consider part-time work arrangements and may inspire current long-term, part-time employees to continue working. Matching contributions are not required, and the ERISA nondiscrimination rules do not apply. Should an employee move to full-time employment, however, he or she would be subject to normal Employee Retirement Income Security Act (ERISA) rules and no longer covered by the Secure Act. Finally, employees covered by a collective bargaining agreement are not covered by Secure Act section 112.

Certain Loans Treated as Distributions

The Secure Act prohibits employers from making loans from qualified employer retirement plans through the use of credit cards (see section 108). Prior to enactment, employees were able to borrow funds from their qualified employer retirement plan through various methods, one of which was the use of a credit card, without the loan being treated as a plan distribution. Today, funds in any qualified employer retirement plan accessed through a credit card will no longer be treated as loans; instead, they will be considered plan distributions. Loans made through direct withdrawal from a qualified employer retirement plan will continue to be treated as loans.

Employers with qualified retirement plans that allow employees to borrow against the employee’s balance should ensure that such borrowing is not done via credit card; otherwise, such borrowings will be treated as distributions. Any loans made through a credit card prior to enactment and outstanding after enactment are not subject to reclassification as distributions. Loans treated as distributions from a qualified employer retirement plan are subject to income tax and potential penalties, and are not eligible for repayment, thereby causing the employee to lose the future benefit of tax-deferred growth. The requirements of section 108 apply to loans made after the date of enactment (December 20, 2019).

Plan sponsors that were previously reluctant to include annuity options among their defined contribution investment options may now wish to revisit that decision in light of the new safe harbor provision of the Secure Act.

Fiduciary Safe Harbor for Lifetime Income Options

The Secure Act relaxes previous Department of Labor guidance regarding annuity options in defined contribution plans by allowing the adoption of annuity income options in these plans. It does so by creating a new fiduciary safe harbor for plan sponsors that offer an annuity option in defined contribution plans. Specifically, section 204 of the act provides a safe harbor for employers as long as the employer meets minimum fiduciary requirements in choosing an annuity provider, thereby relieving the employer of liability for any losses that may result from an annuity provider’s inability to satisfy its financial obligations under the terms of such contract. Section 204 significantly limits the employer’s liability, and risk of being sued, should the chosen annuity provider go out of business or is otherwise unable to pay in accordance with the terms of the annuity contract. The provisions of section 204 became effective on the date of enactment.

Annuity options as part of a retirement portfolio offer employees the ability to choose a lifetime income option that provides guaranteed lifetime benefits for at least the remainder of the life of the participant, or the joint lives of the participant and the participant’s designated beneficiary, as part of an individual account plan. Lifetime income options as part of a 401(k) plan function similarly to a traditional defined benefit pension plan, which has fallen out of favor with many employers. Providing a lifetime income option through 401(k) plans should enable employees to develop a more realistic expectation of the level of income they might expect in retirement. Furthermore, given the stock market volatility of recent months, many employees may welcome the addition of an annuity option to their 401(k) plan offerings. Accordingly, plan sponsors that were previously reluctant to include annuity options among their defined contribution investment options may now wish to revisit that decision in light of the new safe harbor provision of the Secure Act.

Secure Act Provisions Affecting Individuals

Although the Secure Act included several provisions that are applicable to employers, it also included elements designed to directly enhance the retirement security of individuals. Several of the provisions relate primarily to individual retirement accounts (IRA).

Impact on Individual Retirement Accounts

Secure Act section 106 amended the definition of compensation in the tax code to include any amount paid to an individual, which is also included in the individual’s gross income, while in pursuit of a graduate degree or postdoctoral study. Prior to the enactment of section 106, fellowship and stipend payments were excluded from the IRC definition of compensation, which includes earned income as defined in IRC section 401(c) (2). Contributions to an IRA are limited to the lesser of an individual’s “earned” income, or an inflation adjusted amount (generally $6,000 for 2020 and 2019). Graduate assistance and postdoctoral fellows receiving payment in the form of stipends may have been unable to contribute to an IRA due to the earned income limitation; however, following the enactment of section 106, individuals and postdoctoral fellows receiving stipend payments will be able to include these payments when calculating the amount of earned income toward an IRA contribution.

It is important to note that section 106 applies only to receipt of taxable non-tuition stipend payments. To the extent that an individual receives payments for tuition and related expenses, these payments are not included in the individual’s gross taxable income and are therefore not included in calculating earned income toward any IRA contribution. Section 106 applies to plan years beginning after December 31, 2019.

Two provisions affect the age requirements of certain retirement plans. Secure Act section 107 repeals the maximum age limit for contributions to a traditional IRA. Previously, upon reaching age 70½, individuals were no longer allowed to contribute to a traditional IRA; section 107 removes the age limit and allows qualified individuals of any age to continue making contributions to traditional IRAs. For individuals who continue working past age 70, this change will provide additional benefits when planning for long-term financial security. The removal of the 70½ age limit for making contributions to a traditional IRA takes effect for taxable years beginning after December 31, 2019. Given the level of economic uncertainty associated with the global pandemic, financial planners may want to consider whether it is now appropriate for individuals to resume or continue contributing to retirement plans that previously had been unavailable for expansion.

Individuals remaining in the workforce beyond the traditional retirement age may now take advantage of the increase in age for contributions to a traditional IRA as well as an increase in the age at which RMDs must begin.

Section 114 of the Secure Act raises the age for which required minimum distributions (RMD) from tax-deferred retirement accounts must begin. Prior to the change, an individual was required to begin taking distributions from all tax-deferred accounts [e.g., 401(k)s, IRAs] in the year he or she reached age 70½. Section 114 raises the age for which RMDs must begin to age 72; this applies to individuals who reach age 70½ after December 31, 2019. Individuals turning 70½ prior to this date are still required to take minimum distributions or be subject to penalties up to 50% of the required amount.

As a result, individuals remaining in the workforce beyond the traditional retirement age may now take advantage of the increase in age for contributions to a traditional IRA as well as an increase in the age at which RMDs must begin. Specifically, individuals working past retirement age may continue to defer taxable income by making contributions to a traditional IRA while deferring minimum distributions, thus maximizing growth potential for tax-deferred accounts. Taken together, these two provisions could substantially strengthen the retirement security of older Americans.

Penalty-Free Withdrawal for Childbirth or Adoption

Section 113 of the Secure Act allows for the penalty-free withdrawal of up to $5,000 of funds from all retirement plans, apart from defined benefit plans, for individuals in case of the birth, or the adoption, of a child. The $5,000 amount is per parent, thus allowing access to $10,000 per couple, but must be distributed from the account within one year of the qualifying birth or adoption. While amounts distributed from retirement accounts for qualified childbirth or adoption are not loans, section 113 allows for subsequent repayments of a qualified birth or adoption distribution up to the amount withdrawn or $5,000, whichever is less. These provisions apply to distributions made after December 31, 2019.

Young families may delay saving for retirement due to the financial impact of childbirth or adoption. Section 113 allows young families to invest money into tax-deferred retirement accounts without fear of being penalized should they need to tap into these accounts at the time of a birth or adoption. It is important to remember that defined benefit plans are not eligible for qualified birth or adoption distributions, and any distributed amounts may be—but are not required to be—repaid.

Elimination of Stretch in Estate Planning

Although the Secure Act features several highly positive elements designed to enhance retirement security, it also includes a provision that largely eliminates the “stretch” technique from estate planning strategies. As part of the revenue provisions of the Act, section 401 made modifications to the required distributions of designated beneficiaries of IRAs. Previously, designated beneficiaries of an IRA or defined contribution plan account could generally “stretch” the RMDs over their own life expectancy. This option allowed younger beneficiaries to spread the RMDs and related income tax liability over an extended period of time. Section 401 of the Secure Act substantially eliminates the ability of most beneficiaries to stretch distributions over their lifetime; instead, it requires that the entire tax-deferred account be distributed within 10 years of the death of the account owner. As a result, the elimination of stretch IRAs is forecast to raise $15.75 billion in federal revenues from 2020 through 2029 (Joint Committee on Taxation, “Estimated Budget Effects of the Further Consolidated Appropriations Act, 2020”).

Section 401 of the act creates exceptions for designated beneficiaries. Eligible designated beneficiaries are a surviving spouse, a minor child of the account owner—but only until the minor child reaches the age of majority, after which any remaining balance must be distributed within a 10-year period—a designated beneficiary who is disabled or chronically ill, and any other beneficiary who is not more than 10 years younger than the account owner. These changes to the stretch distribution rules are generally effective with respect to deaths after December 31, 2019 (with certain exceptions). As a result, it may be prudent for many individuals to reconsider and perhaps revise beneficiary designations.

Although the Secure Act features several highly positive elements designed to enhance retirement security, it also includes a provision that largely eliminates the “stretch” technique from estate planning strategies.

Under the Radar

The Secure Act was part of broader legislation funding the federal government for FY 2020. It includes numerous provisions aimed at encouraging small businesses to offer retirement plans for their employees as well as elements designed to directly enhance the retirement security of individuals. As a result, CPAs and other financial advisors would be wise to familiarize themselves with the major provisions of the Secure Act. For example, now that the rules for joining a multiple-employer pension plan (i.e., pooled employer plans) have been relaxed, many small businesses may reconsider joining such a plan so that they can share the costs and administrative burden. Moreover, the expanded tax credits available to businesses that establish new retirement plans may make the decision to offer such plans more feasible. From an individual’s perspective, the age at which RMDs must begin has increased from 70½ to 72, and the upper age limit at which contributions can be made to traditional IRAs has been eliminated.

The Secure Act also creates new estate planning pitfalls, such as the elimination of the “stretch” strategy for most beneficiaries of an inherited IRA. Consequently, estate planning techniques will also need to evolve and adapt to the Secure Act.