The SECURE 2.0 Act of 2022 (SECURE 2.0) became law on December 29, 2022. The new law makes sweeping changes to 401(k) plans – particularly plans sponsored by small businesses. It includes provisions intended to expand coverage, increase retirement savings, and simplify and clarify retirement plan rules. Employers of all sizes should understand the law’s provisions to ensure their 401(k) plan is ready to meet their effective date.
The new law builds upon the SECURE Act of 2019 efforts to increase plan coverage and retirement savings. It also makes major changes to distribution rules, participant disclosures, and plan testing procedures – just to name a few. Here is a summary of the major 401(k) provisions. I will follow up next time with my thoughts on the effectiveness of these changes.
Tax Credits for Small Businesses
- Startup tax credits – Section 102 increases the tax credit for starting a new plan from 50 percent to 100 percent for employers with up to 50 employees. Small businesses can earn an additional credit for making employer contributions, up to a per-employee cap of $1,000. This full additional credit is limited to employers with 50 or fewer employees and phased out for employers with between 51 and 100 employees. The applicable percentage is 100 percent in the first and second years, 75 percent in the third year, 50 percent in the fourth year, 25 percent in the fifth year – and no credit for tax years thereafter.
Section 102 is effective for taxable years beginning after December 31, 2022.
- Military spouse tax credit - Section 112 creates a tax credit for eligible small businesses that employ military spouses and allow them to participate in their plan subject to special eligibility and vesting requirements. The tax credit equals the sum of (1) $200 per military spouse, and (2) 100 percent of all employer contributions (up to $300) made on behalf of the military spouse, for a maximum tax credit of $500. This credit applies for 3 years with respect to each military spouse – and does not apply to highly compensated employees.
Section 112 is effective for taxable years beginning after December 29, 2022.
- Automatic enrollment for new plans - Section 101 requires new 401(k) plans to automatically enroll participants upon attaining eligibility. The initial automatic enrollment amount is at least 3 percent but not more than 10 percent. Each year thereafter that amount is increased by 1 percent until it reaches at least 10 percent, but not more than 15 percent. Plans established before December 29, 2022 are grandfathered. There is an exception for small businesses with 10 or fewer employees, new businesses (i.e., those that have been in business for less than 3 years), church plans, and governmental plans.
Section 101 is effective for plan years beginning after December 31, 2024
- Faster eligibility for long-term, part-time workers - Under current law, employer must allow employees with at least 1,000 hours of service in a 12-month period or 500 hours of service in a three-consecutive-year period to join their plan – regardless of whether the employee has met the plan’s normal eligibility requirements. Section 125 reduces the three-year rule to two years.
Section 125 is effective for plan years beginning after December 31, 2024.
- Mandatory Roth catch-up for high earners - Section 603 provides all catch-up contributions to qualified retirement plans must be made on a Roth basis, except for participants whose prior year wages didn’t exceed $145,000 (indexed for inflation).
Section 603 is effective for taxable years beginning after December 31, 2023.
- Higher catch-up contribution Limit – Section 109 increases the limit on catch-up contributions to the greater of $10,000 or 50 percent more than the regular catch-up limit ($7,500 for 2023) for individuals who have attained ages 60, 61, 62 and 63. The increased amounts are indexed for inflation after 2025.
Section 109 is effective for taxable years beginning after December 31, 2024.
- New Emergency Savings Accounts - Section 127 permits employers to offer short-term emergency savings accounts (“ESAs”) to non-Highly Compensated Employees. ESAs must be funded with Roth contributions. Contributions are treated as elective deferrals for matching purposes and capped at $2,500 - unless the employer specifies a lower amount. Participants must be allowed to take at least one withdrawal per month, and the first four withdrawals per year cannot be subject to fees.
Section 127 is effective for plan years beginning after December 31, 2023.
- New deferral deadline for sole proprietors - Under the SECURE Act, an employer may establish a new 401(k) plan after the end of the taxable year, but before the employer’s tax filing date and treat the plan as having been established on the last day of the taxable year. Such plans may be funded by employer contributions up to the employer’s tax filing date. Section 317 allows these plans, when they are sponsored by sole proprietors or single-member LLCs, to receive employee contributions up to the date of the employee’s tax return filing date for the initial year if the owner is the only employee.
Section 317 is effective for plan years beginning after December 29, 2022.
- Roth matching and nonelective contributions - Under current law, employers must contribute matching and nonelective contributions on a pre-tax basis. Section 604 allows participants to designate matching or nonelective contributions as Roth contributions when their plan allows.
Section 604 is effective for contributions made after December 29, 2022.
- Saver’s match - Section 103 replaces the saver’s credit with a direct government matching contribution to the taxpayer’s IRA or eligible retirement plan. The match is 50 percent of IRA or retirement plan contributions up to $2,000 per individual. The match phases out between $41,000 and $71,000 in the case of taxpayers filing a joint return ($20,500 to $35,500 for single taxpayers and married filing separate; $30,750 to $53,250 for head of household filers).
Section 103 is effective for taxable years beginning after December 31, 2026.
- Matching of student loan payments - Section 110 permits an employer to make matching contributions under a 401(k) plan, 403(b) plan, or SIMPLE IRA with respect to “qualified student loan payments.” A qualified student loan payment is broadly defined as any indebtedness incurred by the employee solely to pay qualified higher education expenses of the employee. For purposes of the nondiscrimination test applicable to elective contributions, Section 110 permits a plan to test separately the employees who receive matching contributions on student loan repayments.
Section 110 is effective for contributions made for plan years beginning after December 31, 2023.
- Top heavy rules for plans with excludable employees – Section 310 allows a top-heavy 401(k) plan that covers otherwise excludable employees (employees who have not attained age 21 or worked a year of service) to perform a separate top-heavy test for excludable and non-excludable employees.
Section 310 is effective for plan years beginning after December 31, 2023.
- Reform of family attribution rules – Related businesses must be aggregated when testing a 401(k) plan for nondiscrimination if enough common ownership exists. Individuals are deemed to own the stock of certain family members due to IRS-mandated family attribution rules. Section 315 removes 1) attribution for spouses with separate and unrelated businesses who reside in community property states, and 2) attribution between parents with separate and unrelated business who have minor children.
Section 315 is effective for plan years beginning after December 31, 2023.
- Required Minimum Distributions - SECURE 2.0 makes numerous changes to the Required Minimum Distribution (RMD) rules. The changes include:
- Section 107 increases the RMD starting age from 72 to 73 (effective January 1, 2023) and then again to 75 (effective January 1, 2033).
- Section 302 reduces the penalty for failing to take a RMD from 50 to 25 percent. If the failure is corrected timely, the 25 percent penalty is reduced further to 10 percent. This change is effective for taxable years beginning after December 29, 2022.
- Section 325 eliminates the pre-death RMD requirement for Roth accounts. Effective for taxable years beginning after December 31, 2023.
- Section 327 allows a surviving spouse to elect to be treated as the deceased employee for RMD purposes. Effective for calendar years beginning after December 31, 2023.
- Small balance cash-outs – Under current law, employers may transfer the 401(k) account of former employees to an IRA if their balance is no more than $5,000. Section 304 increases the limit from $5,000 to $7,000.
Section 304 is effective for distributions made after December 31, 2023.
- Hardship distribution certification - Section 312 provides that, under certain circumstances, employees are permitted to self-certify that they have had an event that constitutes a hardship for purposes of taking a hardship withdrawal.
Section 312 is effective for plan years beginning after December 29, 2022.
- Disaster distributions - Section 331 provides permanent rules relating to the use of retirement funds in the case of a federally declared disaster. The permanent rules allow up to $22,000 to be distributed from 401(k) plans for affected individuals.
Section 331 is effective for disasters occurring on or after January 26, 2021.
- Emergency distributions - Generally, an additional 10 percent tax applies to early distributions from a 401(k) plan unless an exception applies. Section 115 provides an exception for certain distributions used for emergency expenses, which are unforeseeable or immediate financial needs relating to personal or family emergency expenses.
Section 115 is effective for distributions made after December 31, 2023.
- Penalty-free early distributions - SECURE 2.0 adds several other exceptions to the 10% additional tax that generally applies to early distributions:
- Section 314 allows penalty-free distributions to domestic abuse victims. Effective for distributions made after December 31, 2023.
- Section 326 allows penalty-free distributions to individuals with a terminal illness. Effective for distributions made after December 29, 2022.
- Section 334 permits penalty-free distributions up to $2,500 per year for the payment of premiums for certain specified long term care insurance contracts. Change is effective beginning with distributions three years after December 29, 2022.
- Qualified Birth or Adoption Distributions (QBADs) – Section 311 amends the QBAD provision to restrict the recontribution period to 3 years.
Section 311 is effective to distributions made after December 29, 2022 and retroactively to the 3 year period beginning on the day after the date on which such distribution was received.
- Unenrolled participant notices - Section 320 no longer requires employers provide certain intermittent ERISA or Code notices to unenrolled participants who have not elected to participate in a workplace retirement plan if certain conditions are met.
Section 320 is effective for plan years beginning after December 31, 2022.
- Paper statements - Section 338 amends ERISA to generally provide that, with respect to defined contribution plans, unless a participant elects otherwise, the plan is required to provide a paper benefit statement at least once annually. The other three quarterly statements required under ERISA are not subject to this rule (i.e., they can be provided electronically).
The Labor Secretary must update the relevant sections of their regulations and corresponding guidance by December 31, 2024, and the annual paper statement is effective for plan years beginning after December 31, 2025.
- Recovery of overpayments - Section 301 allows 401(k) plan fiduciaries the latitude to decide not to recover an “inadvertent benefit overpayment.” If the fiduciary does not seek recovery of the overpayment, the recipient is permitted to continue to treat the overpayment as rollover-eligible amount.
Section 301 is effective on December 29, 2022.
- Employee Plans Compliance Resolution System (EPCRS) changes - Section 305 expands EPCRS to (1) allow more types of errors to be corrected internally through self-correction, (2) apply to inadvertent IRA errors, and (3) exempt certain failures to make required minimum distributions from the otherwise applicable excise tax.
Section 305 is effective on December 29, 2022.
- Elective deferral failures - Section 350 creates a grace period to correct, without penalty, reasonable errors in administering automatic enrollment and automatic escalation features. Errors must be corrected prior to 9 ½ months after the end of the plan year in which the mistakes were made.
Section 350 is effective to errors after December 31, 2023.
- Starter 401(k) plans - Section 121 permits an employer that does not sponsor a retirement plan to offer a starter 401(k) plan (or safe harbor 403(b) plan). A starter 401(k) plan (or safe harbor 403(b) plan) would generally require that all employees be automatically enrolled in the plan at a 3 to 15 percent of compensation deferral rate. The limit on annual deferrals would be the same as the IRA contribution limit, which for 2022 is $6,000 with an additional $1,000 in catch-up contributions beginning at age 50.
Section 121 is effective for plan years beginning after December 31, 2023.
- Retirement savings lost and found - Section 303 creates a national online searchable lost and found database for Americans’ retirement plans at the Department of Labor (“DOL”). The database will enable retirement savers, who might have lost track of their pension or 401(k) plan, to search for the contact information of their plan administrator.
Section 303 directs the creation of the database no later than 2 years after December 29, 2022.
- Later deadline for plan amendments – Under current law, amendments to an existing plan must generally be adopted by the last day of the plan year in which the amendment is effective. Section 316 allows discretionary amendments that increase participants’ benefits to be adopted by the due date of the employer’s tax return.
Section 316 is effective for plan years beginning after December 31, 2023.
- SIMPLE IRA replacement - Under current law, employers cannot replace a SIMPLE IRA with a 401(k) plan mid-year. Section 332 permits an employer to replace a SIMPLE IRA plan with a safe harbor 401(k) plan at any time during the year, provided certain criteria are met.
Section 332 is effective for plan years beginning after December 31, 2023.
SECURE Act 2.0 Delivers a Lot of Change!
When the original SECURE Act was enacted, it was considered the most expansive retirement-related legislation in more than a decade. SECURE Act 2.0 is even more expansive.
For the most part, I’m a fan of SECURE Act 2.0. However, the law does include some provisions I think will prove more trouble than they are worth in practice. I’ll break down the good, the bad and ugly provisions of the new law in my next article.