With the last major piece of retirement legislation occurring in 2006 (the Pension Protection Act that enabled participant auto-enrollment into 401(k) plans), our retirement system was in desperate need of some updates. Last year, the House overwhelmingly passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The Senate passed the act just before the holiday break in December of 2019 and the President has now signed it into law.
The SECURE Act has several major provisions that can impact small businesses sponsoring 401(k) plans and individuals saving for retirement. We’ve summed up some of the key components below and will follow up with more details in 2020 as the implications become clearer.
Pooled Employer Plans
A major provision of the SECURE Act is the introduction of Pooled Employer Plans (PEPs). These plans are a type of Multiple Employer Plan (MEP) that allow small employers that are not connected to join together in the same overall 401(k) plan. In addition, Congress removed the “one bad apple rule,” which previously could disqualify an entire pooled plan if one plan sponsor was not operating in accordance with the MEP’s plan documents.
The PEP provisions of the law will become effective for plan years beginning after Dec 31, 2020. This will give the IRS and Department of Labor time to provide more detailed guidance to plan providers and allow them to adjust their offerings.
The thought behind PEPs is that economies of scale will enable lower costs to small plans. However, it remains to be seen whether there will be savings for participants and plan sponsors. Because of the operational complexities of having multiple employers and coordinating multiple payrolls, and the costs of servicing plans across multiple locations, these savings may never be realized. Some costs are also not affected by the plan’s status such as mutual fund expense fees. Further, if you are looking for any flexibility in plan provisions a PEP might not be a good choice because usually plan design is one size fits all. Still, with the new law and guidance, we expect PEPs to become more popular starting in 2021. Though with Guideline you can start a low-cost, full-service, individualized 401(k) plan today.
Tax Credits for Small Plans
Currently, small businesses starting new 401(k) plans can get up to $500 per year for the first three years to help with 401(k) administrative costs. The SECURE Act increases this credit to up to $5,000 depending on how many non-highly compensated employees are eligible for the plan.
Additionally, the SECURE Act creates a new tax credit of up to $500 per year to employers who start 401(k) plans that include automatic enrollment. The credit is in addition to the expanded new plan credit and would be available for three years and up to $1,500. The credit would also be available to employers that convert an existing plan to an automatic enrollment design. This means that the new maximum eligible tax credit for offering a new 401(k) is now $5,500 for up to 3 years or $16,500 in total.
At Guideline, we are big proponents of auto-enrollment given the dramatic impact it has on plan participation and lifetime savings. Since all Guideline 401(k) plans feature automatic enrollment, new Guideline plans will be eligible for this tax credit.
Safe Harbor for Annuities
This provision has been pushed by the insurance companies with their “lifetime income” initiative over the last few years. It allows plan sponsors to offer a wider array of annuities in their 401(k) plans so participants can protect their investment balance and draw down over time.
In theory this is a good thing. But annuities tend to be driven by sales commissions and are often egregiously expensive. They can also lock retirement investors into an overly rigid drawdown schedule that doesn’t match to fluctuating income needs in retirement. It remains to be seen whether this safe harbor will strengthen or weaken a participant’s retirement savings.
Access for Part Time Employees
Current law allows 401(k) plans to exclude part time employees from participating indefinitely if they work less than 1,000 hours per year. The SECURE Act changes this by requiring that access to the plan is given to anyone who has worked 500 hours a year for three consecutive years.
Here again Congress is opening up employer retirement plans to more employees. Guideline has traditionally done this by using a length of time service requirement (i.e. three, six, or twelve months) instead of hours - we have a strong belief in enabling retirement access for all individuals in the workforce.
In addition to changes that apply to 401(k) plans, there are a few important changes for individual workers as well. Individuals of any age can now contribute to a traditional IRA account, as long as they have earned income. This means workers over age 70 ½ who haven’t retired yet can still contribute to their retirement via IRA.
Congress also increased the required minimum distribution (RMD) age from 70 ½ to 72. This is great because Americans are living longer on average, retiring later, and need more time to save.
Lastly, Congress is now allowing penalty free distributions for childbirth or adoption expenses. This can incentivize employees to contribute more to their retirement accounts, since they know they can access funds more easily if needed.
To offset some of the additional tax benefits and credits in the legislation, Congress made some changes that will increase tax revenue. The bill eliminated the so-called Stretch IRA which, under current law, allows a non-spouse beneficiary to stretch the required minimum distributions over the beneficiary's life after the death of a plan participant or IRA owner. Under the SECURE Act all the assets must be distributed within 10 years of the transfer. This means taxes will be paid within a decade rather than over the lifetime of the beneficiary.
The Act also increases penalties for failing to file retirement plan returns (such as Forms 5500), and increases penalties for individuals who fail to file tax returns. (Guideline files the 5500 form for its clients.)
On the whole, we are excited that Congress moved forward with a major piece of retirement legislation and are hopeful that it will have a positive impact on the retirement security for working Americans. In the meantime, we will as always, offer an all inclusive, low cost 401(k) plan that includes auto-enrollment features and enables retirement savings for the next generation of small business owners and their participants. We will continue to monitor legislative and regulatory changes and adjust our retirement offerings to serve our clients and their employee participants.